Economics for Heretics:
exposing the myths of orthodox economics

-by Dante A. Urbina-

translated by D. Ohmans
© copyright 2018

Text imprint Lima Peru, ©2015

Economics for Heretics TOC
PREFACE - Economy in crisis and economic theory in crisis: The necessity of an alternative Chap.1 - THE MYTH OF THE RATIONALITY OF THE CONSUMER o The orthodox theory of the rationality of the consumer o A useless function: the utility function o Inconsistent consistency: "rational fools" o Economic individualism: a universal phenomenon? o Are we egotists by nature: a critique of the anthropological assumptions of economic orthodoxy o Egoistic altruism? Ockam's razor and mother Teresa against economic orthodoxy o Reasons of the heart: the ethical factor in economic decisions o An avalanche of anomalies: homo economicus visits the psychologist o Now homo economicus goes to the laboratory: experimental economics o Do not forget the right hemisphere! Performing an encephalogram on the consumer o We are not omniscient! The problem of limited rationality o We are not cold calculators! The problem of uncertainty o Conclusion Chap.2 - THE MYTH OF THE PRODUCTION FUNCTION o The orthodox theory of the production function o The "Holy War" of capital: the controversy of the two Cambridges o Things become viscous: "molasses" and the aggregation of capital o Murdered with its own sword: mathematics against the economic orthodoxy o The production function castrated: the sterility of the orthodox theory to explain the technological process o With what shall we produce? Critique from the ecological perspective of the production function o A supposition it is necessary to substitute: the assumption of substitutability o The final blow: the sophistry of empirical validation of the production function o Conclusion Chap.3 - THE MYTH OF THE THEORY OF DISTRIBUTION o The orthodox theory of distribution o An unproductive concept: the sophistry of "marginal productivity" o A theoretical anomaly quite normal in practice: the Leontief function and marginal productivity o A theory that through sloth does not change: leisure and the work offer o Is the notion of free and competitive labor markets pertinent? The institutionalist critique o To each according to her contribution? The multi-product case o Is the labor factor merely a cost? A critique from Keynesian and neo-Keynesian economics o The final blow: Sraffa's devastating critique of the orthodox theory of distribution o Conclusion Chap.4 - THE MYTH OF PROFIT MAXIMIZATION o The orthodox theory of profit maximization o No to the "mechanical optimizer"! The Schumpeterian conception of the entrepreneur o "Animal spirits": the problem of uncertainty o Maximize profits or minimize losses? The problem of risk o The behavioral economy returns to the fore: the problem of perspective o The broken plates of a divorce: the problem of agency o Consequences of technological change: the power of the technostructure o A true inconvenience: the possibility of seeking other goals o IMg = CMg: and where is the evidence? o Conclusion Chap.5 - THE MYTH OF COMPETITIVE MARKETS o The orthodox theory of competitive markets o The fallacy of free and competitive markets: the planning system o Everyone against everyone? The law of duality o Market and power: the social structures of the economy o Disappearance of the invisible hand: the birth of strategic thinking o Some scissors that should be cut: the supply and demand curves o Extreme unrealism and contradictions: analysis of the assumptions of the perfect competition model o A terribly imperfect theory: logical inconsistencies of the perfect competition model o Failed recursion: the "false Messiah" of successive approximations o Conclusion Chap.6 - THE MYTH OF MARKET EFFICIENCY o The orthodox theory of market efficiency o The markets are not omnipotent! The problem of market failure o Efficiency for what? The uncomfortable question of content and goals o A not at all optimal criterion: Pareto optimality o Efficiency for whom? Market and exclusion o Fair injustice? The fallacy of "prior votes" and the "meritocratic scale" o Destroying a dogma: the fallacy of consumer sovereignty o Competition leads to efficiency? John Nash vs. Adam Smith o An uninformed argument: the market as socializer of information o Endogenous explanation of the crisis: Minsky's hypothesis of financial instability o Conclusion Chap.7 - THE MYTH OF GENERAL EQUILIBRIUM o The orthodox theory of the general equilibrium o A castle in the clouds: the exaggerated abstractionism of the theory of general equilibrium o Impertinent commentaries: analyzing the pertinence of the assumptions of general equilibrium theory o The mirage of relative prices: the non-existence of general equilibrium o An unprofitable theoretical transaction: the surplus costs of uniqueness o Destabilizing stability: the Sonnenschein-Mantel-Debreu theorem o Stability and sterility: the absolute uselessness of general equilibrium o Is the DSGE model salvation? Confessions of an orthodox economist o Conclusion Chap.8 - THE MYTH OF NON-INTERVENTION OF THE STATE o The orthodox theory of non-intervention of the State o Good for nothing? The fallacy of the intrinsic inefficiency of the State o Saved by the State: the industrialization of Germany, Russia, Japan, and China o What is corrupt in the corruption argument: critique of Friedman and the public choice school o More assistance to those who cooperate? The role of the State in the promotion of economic efficiency o Seeking "the optimum" is not always optimal: the Lipsey-Lancaster theorem o In defense of political economy: critique of monetarism and the theory of rational expectations o Against the sword and the wall: totalitarianism of the State or totalitarianism of the market o Liberal hypocrisy: liberalism, dictatorship and other demons o Conclusion Chap.9 - THE MYTH OF FREE TRADE o The orthodox theory of free trade o Welfare for all? The critique by Singer and Prebisch of the comparative advantage theory o Porter's critique: competitive advantages and comparative advantages o Why do factor prices not equalize? Critique of the Heckscher-Ohlin model o Liberal hypocrisy once again: the kick down the stairs o The development of underdevelopment: the problem of circular causality with cumulative effects o The law of the jungle and globalization: international Darwinism o The great fraud: United States and the Free Trade Treaties o Refuting Henry Martyn: fallacies of the analogy of free trade and technological progress o Conclusion Chap.10 - THE MYTH OF DEVELOPMENT o The orthodox theory of development o What can be measured and what cannot be measured: the fetishism of the GNP o The obsession with development: the error of the absence of choice o I'm rich! Yet why am I not more happy? The "paradox of happiness" o Persons or merchandise? The personalist critique of the orthodox theory of development o Is the road to heaven paved with bad intentions? Concerning the good, the beautiful, the dirty, and the useful o Development for all? The fallacy of universal prosperity o Only a question of time? "Schumpeterian underdevelopment" and dependency theory o Predestined enemies: orthodox theory and underdeveloped nations o Conclusion EPILOGUE - "What is to be done? Toward a new economic theory"

                        Economy in crisis and economic theory in crisis:
                    The necessity of an alternative

     Crisis in the economy, crisis in economic theory: that is the context in which we 
live. Nobody knows for certain if we can emerge gracefully from the present world 
economic crisis or exactly how or when we shall do so. It is even possible that the 
crisis originated by the private financial bubble is being "solved" generating a new 
bubble of indebtedness of the States by the massive introduction of fictitious money in 
the bank rescues. Be that as it may, one of the things which the crisis has made clear is 
that we cannot continue as we are with the same scheme of economic theory.
     But what is this scheme? It so happens that in economics there is a focus that is 
clearly dominant: the Neo-classical theory. This focus, which supposedly "renews" the 
classical economists, practically monopolizes the teaching of what strictly has been 
called "economic theory" in almost all the economics faculties of the world. One can speak
of other focuses, it is clear, in courses "without importance" such as those of the 
"History of Economic Thought, Economic History" or "Economic Sociology"; yet the "pure and
hard" courses in economic theory (Macroeconomics and Microeconomics) have to be centered 
and based almost exclusively upon the conventional scheme.
     It is not that the other focuses have not developed analyses and consistent theories 
upon the same field as macroeconomics and microeconomics, yet what happens is they all 
tend to be minimized or ignored as "peripheral" (curiously, the same attitude that the 
"developed" nations have with respect to the underdeveloped) or, in any case, if it is 
incorporated into the teaching, it has to be fitting the corset of the dominant 
epistemological scheme. What better example of this than the case of the considerably 
broad and complex Keynesian theory that is taught almost exclusively in terms of 
formulation of the Neo-classical Keynesian synthesis, that is to say, only after 
having passed through the filter of that which is consistent with the dominant theory. 
Thus, most of the time, the student will be acquiring her comprehension of the economy on 
the basis of such ideas as the competitive market, the rational consumer, the supply and 
demand model, the production function, general equilibrium, market efficiency, free trade,
rational expectations, economic growth as the primordial objective, etc.
     Perhaps with this one could think that the material treated here has only a 
"theoretical" interest without greater relevance in the "practical" world. Nothing more 
false. The economy is a field where the "good" and "bad" theories can have very great 
effects in reality, which range from the most marvelous to the most devastating. If a 
doctor has a bad theory and applies it, she can end up killing one person; if an 
economist has a bad theory and applies it, they can end by killing thousands of 
persons. Curiously, whereas the doctor goes to jail for negligence, the economist who best
know how to apply savage policies can obtain a good post at the IMF, the World Bank, the 
committee of economic consultants of a "developed" nation or some powerful multinational.
What is important is that the savagery be applied in a very calculated and intelligent 
fashion and in consonance with the interests of those who hold the economic power; or 
that is, thus something like an "economic hitman." Examples in this regard can be clearly 
seen in the application of the neo-liberal policies of the so-called Washington Consensus 
in the poor countries of Africa and Latin America.
     Yet something bad is not necessarily required to cause these negative effects. 
Precisely there resides the great venom of a bad theory: that it can cause good men to do 
ill or lose the opportunity of doing good. Thus then, those students who receive 
unilateral formation in economic theory go into the real world and become businessmen , 
ministers, consultants, and even presidents. And they can be applying even with good 
intentions, erroneous economic policies that generate negative effects on society, upon 
culture, institutionality and/ or the environment. Yet to the conventional economist it 
will be difficult to perceive all that in its true dimensions for she has been repeatedly 
taught in the university that all these are important variable but, in the final analysis,
are "exogenous" variables for the economist, which is to say they fall outside of her 
realm of study. To be occupied with those problems, therefore, is principally the labor of
politicians, psychologists, sociologists, and ecologists. Even this same economist can 
complain of all these problems upon reading the newspaper in her house on Sundays, yet in 
the daily calendar of Monday to Friday will not have them as a central preoccupation since
"they are concerned with exogenous aspects.
     And not only that. A deficient economic theory can leave the economist very badly 
situated when the phenomena of reality occur. This is something now almost classical in 
the history of contemporary capitalism; after epochs of optimism concerning the prosperity
of the economy and the "solidity" of the economic theory, the great crises arrive and 
leave the economists perplexed. That was seen en the Great Depression of 1929, the 
petroleum crisis of 1973 and our current "Great Recession" beginning with the financial 
crisis of 2008. In this regard, an economist as recognized as Paul Krugman (Nobel prize 
2008) wrote, in September of 2009, in his column in the New York Times titled "How 
did economists get it so wrong?" proposing that a large part of the epistemological 
failure of the economists before the crisis is that they preferred "beauty to truth," 
that is, they were too complacent with the "mathematical consistency" of their theories 
and they forgot the hard and complex reality. And in large part this is how the 
theoretical scheme of Neo-classical economics functions: constructing mathematically 
adorned myths that function as bridges between the undeniable contrary evidence and the 
faith which they wish to preserve. The problem is that those theoretical myths create 
real monsters.
     What is it that is required, then? Heresy. We need to strongly question that 
"orthodoxy" of economic thought, that which John Kenneth Galbraith would call "the 
conventional wisdom." A heretic is one who does not believe in the orthodoxy. So 
then, this is an heretical book, heretical with respect to that economic theory 
which includes many lies and fallacies wrapped in apparently scientific language. This 
orthodox theory, the Neo-classical, has been proclaimed "the king" of the paradigms of the
economy and circulates very happily through the university halls. But someone has to tell 
the "king" that he is naked, somebody has to unravel the myths of orthodox
economic theory.
     Now, when someone wants to say that "the king is naked," they will not say it to the 
consultants or courtesans of the king, going there first being foolish. Much better one 
is going to say it to the public. The prestige and even the life of the courtesans depend 
upon their obedience to and reverence for the king: if this is denuded, they will follow 
him saying he is wearing a handsome outfit. Thus, they are the persons least disposed to 
objectively analyze embarrassing questions about the king. The people, on the other hand, 
are more open to listen and, what is more important, it is what they need to hear. 
In consequence, this book is not primarily directed to orthodox ultra-specialized 
academics but instead to all those educated and socially committed who might be interested
in the relevant question. Likewise, the book also can be of much interest and utility to 
all those professionals or students of Economics and the like who have "doubts of faith" 
or who are willing to rationally question the "faith" they profess and/ or that has been 
inculcated in them.
     The foregoing, evidently, has implications for the form of printing this book. One 
seeks to realize a serious critique yet, at the same time, that it not be academicist nor 
ultra-specialized. And indeed this book seeks to be fruitful while with academicism and
ultra-specialization there is, in reality, much sterility given that, with an esoteric 
language that the man in the street will never understand, one begins to submerge 
themself in a type of study where one begins to know ever more and more about ever less 
and less, until one ends knowing almost everything about almost nothing. This book 
instead tries to have a general character concerning the critique of economic orthodoxy 
and about the topics of heterodoxy. Obviously the orthodox economists will take advantage 
of that the criticize diverse parts of the work saying that it has insufficient academic 
depth (read "extension") and that such and such a theory has not been analyzed with such 
and such sophistication that was published in such and such a "paper." It is a price 
worth paying so that the book can reach more persons to whom the questions it treats are 
very relevant. To create an academic treatise, apart from that it should have more than 
two thousand pages to represent a minimally "satisfactory" approach in accord with the 
standards of "scientific papers," would result in the book being read, optimistically 
with luck, by little more than a dozen persons.
     Nevertheless, not being "ultra-specialized" does not imply that the book has 
insufficient academic rigor. Even though the language can be considerably sarcastic and 
even amusing, we have sought to realize an approach of pertinent epistemological level and
an abundance of academic literature in books and specialized articles are cited. 
Accordingly, whoever wants to further deepen some topic can refer to the indicated 
reference in that regard and read those sources.
     On another side, is is also possible that the book be criticized for being "too 
radical." With regard to that, three replies might be given. In the first place, to 
welcome the compliment: radical means, in rigorous terms, "that it goes to the 
root" and precisely here we wish to arrive at the bottom of the equivocations of economic
orthodoxy. In the second place, if one wants to use the word in the sense of "extremist" 
one must say that in a certain way it also becomes necessary that there be such a type of 
ideas for in the current context a change is required and the "lukewarm" ideas do not tend
consistently to that but instead, in general, are simply "absorbed" and easily neutralized
by the dominant scheme. Finally, one must say that if it is radical it is not only one's 
fault but instead the orthodox economic theory has its "little share of blame." And 
indeed, this being the established theory, everything that questions it will seem a bit 
presumptuous and even aggressive. Equally, a man who shelters in an old doorway under bad 
conditions and it falls on him could obtain fame as a victim for that. Notwithstanding, 
the poor condition of the door also contributes its part of the blame.
     Yet beyond the foregoing, there will still be those indignant that such a 
"dignified" and "ancient" portal has fallen. They will say, who are you to refute two 
hundred years of economic theory? Well, to tell the truth, two hundred years is not long. 
Economics deals with a "science" still "in diapers" and in an evolutionary process. In 
fact, there have been in physics ideas of greater antiquity and prestige that also have 
been put seriously into question. The emotional attitude of wanting to conserve the 
"intellectual capital" in which we were raised, questioning, when faced with consistent 
criticism, the person who make it (falacia ad hominem) and not the critique itself,
leaves few possibilities for a genuine (and necessary) advance in knowledge.
     In any case, we are dealing with a struggle. And there a "heretic" needs a great 
heart sustained by the confidence that reason is on her side and that she will obtain 
recompense in the "other life." And the recompense in the "other life" of this book will 
be that there can be an economic theory authentically more open to other paradigms, which 
interacts more with other social disciplines and which has a more solid philosophical 
basis. That day, economic theory will be able to do greater and better things for the 
world. And, if there is a struggle that in the final analysis matters, it is the struggle 
for a better world. Let us begin, then, our intellectual contribution to this fight.

                        Chapter 1

                                        "Human action is always rational."
                                            Ludwig von Mises, Austrian economist
The orthodox theory of the rationality of the consumer

     The postulate of rationality is the fundamental postulate of orthodox 
economics. In essence it tells us that economic agents act rationally, which is, 
that they always administer their resources (time, effort or money) in such a way as to 
maximize their level of welfare or utility incurring the least costs possible.
     "The economic model for the conduct of the consumer is very simple: it affirms that 
people try to choose the best patterns of consumption that they can afford ," professor 
Varian tells us concisely in his famous manual of microeconomics. Thus, then, modeling of
the consumer behavior becomes rather simple for the orthodox economist. First she 
constructs a utility function of the general form U = f(x, y) which
captures the level of well-being (measured by U) that an individual experiences as 
a consequence of the consumption of determinate quantities of the goods x and 
y. Following this she finds the function of budget restriction of the 
consumer in question, or to say, the combinations (baskets) of the goods x and 
y that can be bought with the given level of income which is available. This budget
restriction has the form I = Pxx + Pyy, where I 
represents the level of the individual's disposable income and Pxx and 
Pyy are the respective prices of the goods x and y. 
Finally, she applies optimization determining the respective quantities that the 
individual should consume of the goods x and y to maximize her utility. That
is achieved by means of the intensive application of the differential calculus to consumer
conduct modeled by means of the two functions mentioned (utility and budgetary 
     Yet do not think that the majority of orthodox economists consider this model of 
rational choice only as a mere speculative representation of the conduct of 
individuals when they consume. Completely to the contrary. With reason some have spoken of
an "imperialism of the economists" in the sense that they seek to explain whatever 
dimension of human behavior by means of the Neo-classical theoretical apparatus of 
rational choice. Thereby, it becomes valid to consider that the soldiers, the kamikaze 
pilots, the heroin addicts, and even the suicides are mere maximizers of utility. A good 
example of that is the economist Gary Becker, Nobel prize in 1992, who has become famous 
by extending the Neo-classical method of analysis to fields that previously were immune to
economic thought such as marriage, robbery, drugs, and prostitution. He himself writes: 
"The economic focus is not restricted to goods and material needs nor to markets 
with monetary transactions, and conceptually does not distinguish between greater 
or lesser decisions nor between 'emotional' decisions and those of another type. 
Strictly...the economic focus provides an applicable measure to all human behavior: to 
all classes of decisions and to persons in all conditions.
     Thus, then, we see that in the writings of the current orthodox economists they make 
manifest a very particular vision of human nature: that of homo economicus. It 
imagines the individual essentially as a "rational calculator" who seeks to maximize her 
utility in a constant balancing process of costs and benefits.
     However, this vision regarding human nature is not new. Already in the 19th century 
the classical economist John Stuart Mill maintained that economics studied man "only as a 
being who desires to possess wealth, and who is capable of comparing the efficacy of the 
means towards obtaining that end...and as a being who, inevitably, does that with which 
she can obtain the greatest quantity of necessary things, commodities and luxuries, with 
the least amount of work and physical abnegation." Elsewhere, in his famous work of 1776, 
The Wealth of Nations, Adam Smith, the so-called "father of Economics," describes 
man as an essentially egotistical being from whom "it is not from the benevolence of the 
butcher, the brewer, or the baker that we expect our dinner, but from their regard to 
their own interest.
     It is understood that it is important to also indicate, for its operationalization, 
that the Neo-classical model of rational choice requires that certain assumptions be 
fulfilled, which are basically three:
1) Completeness: Before any gamut of options whatsoever, the individual always is 
capable of determining which she prefers.
2) Transitivity: If one prefers A to B and B to C, then she necessarily prefers A 
to C.
3) Monotonicity: The consumer is essentially acquisitive, always preferring having 
more to having less.
     Finally, it is necessary to specify that the concept of rationality which orthodox 
economics postulates is not teleological nor intrinsic, but instead more 
instrumental. In other words, it has to do more with the efficient administration 
of the means than with the rationality and/ or pertinence of the ends or the
constitution of the preferences themselves (for the orthodox economist these are 
"exogenous" and so remain outside the model of analysis). The Austrian economist
Ludwig von Mises agrees with the orthodox focus in this respect: "Praxiology (the science 
of human action) and economics...are concerned neither with the motives that lead 
one to act, nor with the ultimate ends of the action, but instead with the 
means which man must employ to reach the proposed objectives. However fathomless
may be the abyss from which the instincts and the impulses emerge, the means one invokes 
in order to satisfy them are the fruit of rational considerations which consider the 
cost, on one hand, and the result reached, on the other."

A useless function: the utility function

     As we have just seen, the totality of Neo-classical analysis rests upon the notion 
of a utility function, that is to say, that which captures the level of well-being 
that an individual obtains through the consumption of determinate goods. The objective 
will be to maximize that function given the restriction of income. This being so, the 
orthodox economists see it as very useful since by virtue of that, it is possible for them 
to construct sophisticated mathematical models about the conduct of the consumer. However,
we maintain that it deals with a useless and even pernicious notion inasmuch
as it does not permit approaching in a coherent way the dynamic of consumer choice.
     We begin by analyzing the problem of measurement. Utility, in being 
constituted as a mathematical function, must necessarily relate quantities. Yet in 
terms of what quantities can we measure happiness? We have units of measurement for 
weight, altitude, velocity...yet we do not have units in terms of which to measure 
happiness! To tell the truth, considered on its face, such a notion itself seems absurd 
for giving a coherent explanation of the consumer. One does not go around thinking: "I 
shall buy a blue pen instead of a red one because the first gives me 8 units of happiness 
and the second only 3." No, we do not make that type of cardinal evaluation in 
terms of exact quantities but instead we more perform an ordinal comparison in 
terms of which good is qualitatively more suitable to satisfy a concrete need ("I 
buy the blue pen because it is the color I normally use to sign documents").
     Surely the orthodox theorists will reply here, together with Samuelson, that 
"Generally the economists of today reject the concept of cardinal (or measurable) 
utility... Or what counts for the modern theory of demand is ordinal utility. With this 
focus, the consumers need only to determine their order of preferences among the baskets 
of goods." A very lovely reply. The problem is that it is not consistent with an 
essential principle for the orthodox theory of the consumer: the equi-
marginal principle! In accordance with this principle--which Samuelson curiously
expounds on the same page (!) as his previous sentence--the consumer should "adjust her
consumption such that the last dollar spent on each good provides the same marginal 
utility." The mathematical expression corresponding to this, considering the case of 
consumption of n goods is the following:

     UMg1/P1 = UMgn/Pn

Very well, to reach this expression it is necessary, in the first place, to apply 
derivatives to the utility function in order to obtain the marginal utility 
(UMg) with respect to each good and, in the second place, to
divide such results between the corresponding prices. Yet both processes 
necessarily imply a utility function in quantitative terms! Thereby the same Neo-
classical economists have placed the noose around their neck. If they want they can 
perform conceptual juggling arguing that "the utility function only uses numbers to 
summarize ordinal ranges." However one would have to respond, paraphrasing the Austrian
economist Murray Rothbard, that "the scales of valuation for each individual are purely 
ordinal and qualitative, and there is no coherent way to measure the distance between such
a type of ranges; in consequence, any concept involving such a distance is nothing more 
than a fallacy."
     We shall now analyze one of the constitutive notions of the utility curve: the
basket of goods. As we have seen at the beginning of the chapter, the analysis of 
the orthodox economists do not start with a function of the type U = f(x) but 
instead one of the form U = f(x, y) in which quantities of the goods x and
y are considered. Now, we all have the experience of entering a store to buy 
certain goods: we basically think about what we want to buy and decide how many units to 
take of each good. At times we go for a single good (a pastry that we craved, let us say) 
and other times we go for various (10 of bread and two cans of milk, for example). The 
decision process is clearly given in terms of how many units of each good 
we consider buying, and that is natural. Nonetheless Neo-classical economics rejects this
evident fact and depicts us as choosing not between different goods but instead between 
different baskets of goods. That is to say, for the Neo-classical economists we do 
not ask how much bread and how many cans of milk we want to take but instead that we 
perform a joint analysis comparing "baskets" of combinations or bread and cans of 
milk (eight of bread and two cans of milk vs. five of bread and three cans of milk, for 
example). But, why adopt a complication so counter-intuitive and absurd?
For a very simple reason: because the baskets can be topologically equivalent and thus 
assure artificially by force that the representative utility function will be 
mathematically well-defined. As is seen, the orthodox economists have no embarrassment 
whatever in sacrificing clarity and realism to the functioning of their mathematical 
     Finally, we have the question of continuity. The orthodox economists assume 
that utility functions are continuous, namely, that they can consider utility values even 
for decimal or fractional quantities of the goods in question. That condition is 
absolutely necessary to the Neo-classical analysis because if it is not fulfilled 
it is not possible to apply the differential calculus and, in consequence, the 
optimization of the consumer cannot be operationalized. Yet, is this a coherent 
assumption? In no way. A good is defined as an object with the capacity of satisfying some
human need. Now, what concrete need is satisfied with 0.186 computers or 5.17 pens? That 
simply and plainly is not conceivable by the human mind and thus is not relevant to any 
choice in the real world. We human beings do not make decisions on the basis of infinitely
small steps. Ergo, the evidently extensive discretion within good and prices is made 
simply irrelevant to the Neo-classical theory (or how many of us daily confront decisions 
such as how to buy 0.4875 packets of crackers for, let us say, 1.28479 dollars).
     It is evident, then, that the notion of a utility function, in the context in 
which orthodoxy use it, not only generates no utility for economic theory but, on the 
contrary, constitutes an authentic hindrance to the objective comprehension of consumer 
behavior and therefore should be discarded and replaced because, as the saying well says, 
"that which does not help, hinders."

Inconsistent consistency: "rational fools"

     Independently of the above the Neo-classical economists were in any event conscious 
that to sustain their entire theory of the consumer in an unobservable mathematical 
entelechy was exceedingly problematic with respect to the empirical hallmarks. We see 
persons making consumer choices but we do not see the (supposedly) underlying utility
curves. It was necessary, then, to leave the notion of utility without sacrificing all 
the assumptions, axioms and constructs around the postulate of rationality. And it is 
there where Paul Samuelson comes to the rescue with the concept of revealed 
     Following professor Varian, "we would formulate the principle of revealed preference 
saying: 'If one selects the basket (combination of quantities of goods) X instead of Y 
(when it is possible to select that as well) one must prefer X to Y.' In this formulation,
it is evident that the model of conduct permits us to utilize the observed choices to make
some deductions concerning the underlying preferences." In other words, if under the 
theory of rational choice one deduces what a consumer would select starting from 
her preferences (modeled in a utility function), with the focus of revealed 
preferences he deduces the preferences of the consumer starting from her observed 
     Now, this focus on revealed preferences is evidently tied to the assumption of 
consistency. The individual interests are revealed in each act of selection. If it 
observed that some individual chooses a set of goods in place of another, then we say that
that individual has a revealed preference for the first set. Beneath this conception 
individual interests, choice and utility are essentially the same. In consequence, "with 
this body of definitions, the individual cannot help but maximize her own utility, 
except through the effect of inconsistency." Thus, the behavior of an individual is 
considered rational if it can be explained in terms of some preference relation consistent
with the theory of revealed preference.
     The problem with this definition of rationality as consistency is that it can 
lead to many inconsistencies. For instance, if an individual were to act contrary 
to what she really wants yet does so in a consistent fashion an orthodox economist would 
say that is a rational individual. Furthermore, he would say that, given she chose an 
option she did not want in place of one that (supposedly) she did want, she is 
revealing that in reality she preferred the first to the second, which would lead 
us to the logical (?) conclusion that in reality, she wanted what she did not want!
     And do not think that this is an absurd or exaggerated case. As we shall see below, 
behavioral economics and neuro-economics have repeatedly demonstrated that on many 
occasions we choose things which we would not choose if in reality we were to slowly 
consider our decisions. It is thus that Amartya Sen speaks to us of "rational fools," that
is, subjects who are capable of selecting--very "rationally" and "consistently"--things
they really do not want. And so internal consistency is not a sufficient condition for 
guaranteeing a person's rationality. It is still necessary to evaluate whether they 
act in consonance with their own interests or motivations and on the basis of externally
conditioned impulses. However, the impossibility of distinguishing between inconsistencies
and changes in taste puts such a possibility in doubt. Orthodox economics remains trapped 
in a dead end alley.

Economic individualism: a universal phenomenon?

     Anyone who possesses a basic knowledge of anthropology or sociology will have 
already noticed that one of the principal problems of the model of rationality which 
economic orthodoxy proposes is that it postulates as humanly intrinsic and historically
universal something that in reality is very conditioned and particular: 
individualism, a product of the capitalist spirit of modernity and English 
utilitarian philosophy of the 18th century.
     Perhaps many think that this represents an exaggeration and say: "Yes, indeed we 
truly are individualists!" Nevertheless, that is due in large part to our societies (above
all in the West) having been modeled on the capitalist-liberal project of modernity and 
that type of behavior and  towards life becoming common. In this manner, one's
tendency to improve one's own chances, which Adam Smith discusses so much, though in our 
day might seem indisputable, in reality depends upon the type of society. If it is of the
communitarian type (like the Andean society), or rests upon an organicist 
conception (like millennial Chinese society) or is hierarchically structured in 
terms of castes or estates (like the Indian society) vertical mobility will be very 
limited and the individual in general will live in conformity with the security that his 
material lot, except for catastrophes or exceptional events, will be the same for all the 
days of his life. If, additionally, the society in question does not believe in 
progress (an idea belonging to the rationalist philosophy of the Enlightenment) 
there will be no collective endeavor to improve economic welfare and, in consequence, the
individual's greatest preoccupation will  be in following and preserving the tradition of 
his forebears (think for example of feudal Europe).
     In fact, it is squarely in this line of reasoning that, pursuing economic 
anthropology, various critiques of the postulate of rationality have been realized. 
Thus, scholars such as Marshall Sahlins, Karl Polanyi and Maurice Godelier have 
independently demonstrated that in traditional societies the selections that people make 
in matters of production and exchange continue to follow the reciprocity which differs so 
much from what the orthodox model postulates that they have rather tended to call those 
systems "gift economies" instead of "market economies." An example of that is the famous
potlatch ceremony of the North american indians in which they gave away (and even
destroyed) all sorts of goods establishing a kind of duel of gifts where the emerging 
winner would be the one who might give the most valuable gifts to the others. As against 
this, the Neo-classical idea of the egotistical individual, perpetually dissatisfied and 
adverse to working became useless, since the happiest one was he who worked the hardest 
during the year in order to be the one who could give the best and greatest gifts to the 
village. And, in fact, they keep giving today, for example in "stewardship" of religious 
festivals that take place commonly among the Andean peoples whose migrants and/
or descendents, being those who have "invaded" and massively populated cities like Lima 
(more than 10 million inhabitants) in Perú, comprise the true economic motor of the 
country above all as emerging and even informal entrepreneurs.
     In line with the foregoing, another demonstration of economics based upon reciprocity
we find in the interesting phenomenon of "Andean rationality." It concerns a model of 
socio-economic interaction that has been developing since before the Christian era among 
the Andean population of South America and which is principally based on the logic or 
cooperation and reciprocity, as well as on communal property and joint work. So 
structured, the model of Andean rationality differs radically from that of the modern 
West: while in this latter one individually seeks to maximize benefits minimizing the 
risk, in the former the peasant seeks to collectively minimize his risk in order to 
rationalize his endowment of resources. Here one is dealing not so much with 
exploiting the soil to extract as much product as one can, but instead more with 
administering it in harmony with nature and the community.
     It would seem, then, that the orthodox economists, seduced by the entelechy (or the 
fetish?) of the market, must have forgotten that the economy is always and necessarily 
given in a specific socio-cultural environment and it cannot be understood outside of 
it. Thus, when they explain their models they begin by enumerating the assumptions 
upon which they are based yet they always forget to make the most important assumption 
explicit: that they operate in a capitalist market economy. It may seem a tremendous 
truism, yet in reality is not. There are many zones of the world where the socio-cultural 
environment does not entirely correspond with capitalism yet which even so function 
perfectly. Then, when an orthodox economist arrives at one of those she does not 
understand yet even so, on the basis of her predetermined mental schemes, proposes 
politics of "development" that end by being socially destructive (although, it is 
clear, they will never take account of that because the "social" variables are 
"exogenous"). Furthermore, the incoherence of orthodox "developmentalism" goes to extremes
which, on one hand "reward" ecological and organic production via prices while on the 
other introduces massively anti-ecological trans-genetic cultivation creating "green 
     It is absolutely necessary, therefore, that we economists reflect profoundly upon the
following words of Polanyi, Arensberg and Pearson: "The majority of us have been 
accustomed to thinking that the touchstone of the economy is the market... What to do, 
then, when we come across economies that operate upon a totally different basis, without 
any market feature or gain obtained through buying or selling? It is then that we should 
revise our conception of economics."

Are we egotists by nature: a critique of the anthropological assumptions of
economic orthodoxy

     Orthodox economics sees man as an essentially egotistical being who seeks to 
satisfy his own necessities motivated only by personal interests. So important is the 
notion of egotist man for the orthodox theory that it is already taught in the first 
classes to students of economists throughout the world. Perhaps many of them consider 
egoistical motivation as something undesirable yet end by accepting it as the correct 
basis for construction of the economic theory (and reality) for, at the end of the day, 
they see it as an inevitable feature of human nature. Nevertheless, this uncritically
assumed belief should be critically analyzed.
     Perhaps it is due to the myth of egoistical man (above all in Western culture) only 
it was not until the decade of the Seventies that the scientists began to seriously 
examine their assumptions. One of the things that most surprised them was to find that 
qualities previously considered marginal in human behavior like empathy (to be able to 
feel what another feels), altruism (to help someone without expecting recompense) and 
other pro-social behaviors (sharing, helping, consoling, cooperating, et cetera) were much
more frequent than what had previously been believed. How can we explain the reputed 
Argentine philosopher Mario Bunge that "for man to be competitive over cooperative is 
simply false. We are all at once cooperative and competitive, and the majority of us more 
the first than the second. As the contrary we would not be capable of functioning as 
components of social systems, from the family to the transnational firm. To exaggerate 
competition at the expense of cooperation in the manner of the dialectical philosophers, 
the social Darwinists and liberal economists makes comprehending the very existence of 
social systems impossible."
     In particular, the most interesting findings have occurred in the study of babies 
(who have not yet reached school age and, hence, are still not continually compelled by 
their parents and professors to compete with their companions and outmatch them). The 
recently born does not distinguish clearly between herself and others, but cries more 
intensely when they hear the bawl of another baby, evidencing by that an innate tendency 
to respond to the needs of others as if one's own. At one year, they display worry when 
somebody is hurt or shows sadness. At a year and a half, the infant can already 
distinguish between "I" and the "other," but continues assuming that the feelings of the 
other are similar to her own. Already at two years of age, she distinguishes between her 
own feelings and those of others, yet even so seeks to console whoever displays signs of 
pain or sadness, and their empathic emotions are more developed. Thus also at three or 
four years of age it is common to observe all sorts of pro-social behaviors.
     The conclusion of these studies is that the tendency to be concerned for others is as
peculiar to human nature as is preoccupation with oneself. This does not mean that the 
human being is not capable of egotistical and even anti-social attitudes. Yet it does 
demonstrate that persons give evidence of an entire gamut of behaviors from the meanest 
to the most altruistic. Consequently, it becomes clear that the anthropological conception 
of orthodox economics sins from being excessively biased and simplistic.

Egoistic altruism? Ockam's razor and mother Teresa against economic orthodoxy

     As we just saw, a very evident fact exists that puts the myth of egotistical man 
directly in check: the fact that often we are willing to make sacrifices of our own well-
being for the well-being of others. Upon observing that one person is willing to sacrifice
themself for others the most reasonable is to think that he does it for love. However, 
orthodox economics has invented a more "intelligent" explanation: if a person is willing 
to sacrifice themself for another they do it through egoism. For example, 
economics Ph.D. Sean Masaki Flynn of Vassar College tells us: "The economists take as 
given that people make choices in life to maximize their personal happiness. This 
viewpoint invariably provokes objections, because people frequently are willing to 
endure great personal suffering to help others. Nevertheless, the the point of view of an
economist, you may consider this desire to help others as a personal preference. The 
mother who does not eat so as to give the little food she has to her baby may be pursuing 
a goal (helping her child) which maximizes her own happiness. The same can be said of the 
people who make donations to charity institutions. The majority of people consider such 
generosity 'disinterested,' yet it is also possible to suppose that the persons perform 
certain actions in order to make themselves happy. If people make donations because that 
makes them feel good, their disinterested action is motivated by an egotistical 
     This type of explanations of altruistic acts has two problems: one epistemological, 
the other empirical. The epistemological problem is that they violate a basic 
principle of science knows as Ockham's razor by which a simpler theory in 
explanation of a determined phenomenon should be preferred over another that is more 
convoluted. And indeed with the goal of maintaining intact the traditional version of the 
egoistical economic agent the orthodox economists have elaborated an entire series of 
complicated theories (like the already mentioned "egotistical altruism") to explain those 
facts which put it in peril. In consequence, a simple and direct explanation
has been relegated in favor of another complicated and indirect one.
     Obviously intervening there are the prejudices of the various members (in the 
majority English and North Americans) of the "scientific" community who construct (and
have constructed) the economic theory. The popularity of the egoistical interpretation of 
altruistic acts is not due, therefore, to scientific motives, but instead to the fact that
admitting the existence of love does not accord with the standard mental models of the 
human being manipulated and promoted in the West.
     Regarding the empirical problems of the egotistical altruism theory we have, 
in the first place, that a large part of the "evidence" in its favor already begin from 
the assumption that we are egoists (fallacy of petitio principii) or do not refer 
to authentically altruistic acts. Thus, the "evidence" that we have about various persons 
(including ourselves) who give alms solely to "feel good with their conscience" (which is 
evidently egoist) is not so because in reality there is no form of altruism or sacrifice 
for in reality the concept of "alms," at least in the subjectivity of this type of donors,
logically implies that it involves no sort of real sacrifice: our extra money is donated.
     On the other side, there exists strong and important evidence against the hypothesis 
of egotistical altruism. We take as reference one of the most representative cases: that 
of mother Teresa of Calcutta. According to economic orthodoxy mother Teresa performed all
her acts of sacrifice for the poor solely out of egoism. But note, they will tell us, not 
a mean egotism but instead more of an "inclusive egotism" by which mother Teresa would 
maximize her welfare maximizing the welfare of others. In this mode, its utility function 
will be of the form:

               UMT = f(dUP) such that:
               dUMT / dUP > 0
Where UMT measures mother Teresa's level of well-being, 
UP measures the level of well-being of the others (especially the poor 
of Calcutta) and the condition dUMT / dUP > 0 expresses that 
the higher the level of welfare of the others, the higher will be mother Teresa's welfare 
level (in other words, her utility function is a direct function of the utility of the 
     Now then, according to the Indian economist Amartya Sen, Nobel prize in 1998 and also 
known as "the mother Teresa of economics," our preoccupation for others can be based upon 
two types of attitudes: solidarity (I concern myself with others because it affects
my well-being) or commitment (I concern myself with others independently of how it 
affects my well-being). Following this classification most correct would be to say that 
mother Teresa's attitude toward the poor basically was commitment.
     For those who really know their history this becomes evident. And indeed during 
mother Teresa's beatification process various unknown aspects of her inner life kept 
coming to light which demonstrate her authentic commitment to God and to the poor beyond 
her individual "utility function." The most surprising of them is the experience of the 
"dark night of the soul" that characterized 50 years of her existence. She, who had given 
everything for love of God and the poor and being a great symbol of happiness and hope, 
had the constant experience of being abandoned, of not being loved. Her personal 
experience cannot be explained by the paradigm of home economicus nor by the thesis
of "egotistical altruism." Mother Teresa, evidently, does not pertain to economic 

Reasons of the heart: the ethical factor in economic decisions

     An essential postulate of the epistemology that drives orthodox economics is to 
separate aspects of the human reality into spheres or domains which even if 
"somehow" related do not deserve to be studied conjointly. Thus, constitutive aspects of 
social reality such as politics, history, culture, law, and ethics are designated as 
simply "exogenous" and, consequently, are not taken into account at the time of 
constructing the economic theory. As Shackle put it well: "It has been assumed that the 
field of economic events is enclosed within itself and is self-sufficient, separated from 
the rest of the matters of humanity by a wall of rationality."
     Going specifically to the theme of the rationality of the consumer and taking into 
account the aspect of ethics (the same is valid for the other realms: politics, law, et 
cetera) we find that if orthodox economics does not actually approach the consumer as 
immoral it posits them as essentially amoral: "For a homo economicus,
all that counts are the consequences of his behavior for his interests and desires in a 
concrete case. He is flexible and adaptable, and accommodates to each new situation with 
its specific restrictions... He does not voluntarily subordinate his personal 
interests to the interests of others or to the norms of morality and the law."
     However, as Sen has astutely observed, it is evident that just a motivation as simple
as egotism makes it impossible to untangle the economy from ethics. For rationality is not
something merely empty or instrumental as the orthodox theory purports, but instead it 
always has a content. The conceptions of rationality can be seen to be influenced 
by the motivations and values which are held. The economy does not originate in a self-
sufficient laboratory different from that of ethics. Values guide the behavior of 
individuals and they are institutionally conditioned, through example and education, by 
     In this manner, the individuals' selections can have ethical motivations and not 
thereby be irrational. Ethics has a very clear practical connotation in the inter-
relations between individuals and the prosecution of social welfare. It follows that the 
North American economist Kenneth Joseph Arrow, Nobel prize in 1972, in proposing his 
famous impossibility theorem warns that one should keep values in mind and not only
preferences as variable in the social welfare function and also that in order to achieve 
agreement between individual choice and social choice it is necessary for empathy and 
sacrifice to exist in the subjectivity of the individuals.
     If these considerations have not been incorporated into the orthodox economic 
analysis it is principally because the multi-dimensional complexity of the motivations of 
the individuals disrupts the ruling stability of the traditional economic models. Put 
otherwise, keeping in mind ethical considerations within the economic theory would imply
violating the characteristics of egoistical behavior and introduce new concepts relating 
to motivation (sympathy, compromise, norm of conduct, et cetera) which evidently would 
become very uncomfortable for the economic orthodoxy. Nonetheless, as Pascal said it well,
"the heart has its reasons, of which reason knows nothing."

An avalanche of anomalies: homo economicus visits the psychologist

     In the year 2002 a very curious event happened: the Nobel prize in economics was 
awarded to a non-economist, the Israeli psychologist Daniel Kahneman who, according to his
own declarations, never had taken an economics course. The approach of this psychologist 
was to put to test various of the assumptions of Neo-classical economics with respect to 
the rationality of the consumer by means of "heuristic methods" starting from which he 
determined that on various occasions a large portion of us do not behave in a "rational" 
manner. All this made space for a new focus in economics: behavioral economics. The
themes which behavioral economics has studied are various. One of the most interesting is 
that referred to as cognitive bias. In accord with this we are not self-centered 
subjects who objectively contemplate the available options but instead we allow ourselves 
to be influenced by the mere form in which they are presented (it has been found, for 
example, that people tend to choose a certain medical treatment is they are told it give 
them a 20 percent chance of survival yet tend to reject the same treatment when 
they are told they have an 80 percent chance of dying) and on occasion we are not even 
capable of identifying them correctly.
     Likewise it was found that we are much more likely to be controlled by habits 
than by calculated deliberations. In this mode, if we have a good experience with 
an initial product we tend to continually select it even when there are better 
options. So strong is the evidence in favor of this that starting from it Al Ries and 
Jack Trout have formulated their first immutable law of marketing: "it is better to
be the first than to be the best." They write: "Many believe that the fundamental question
in marketing is to convince the consumers that you have the best product or service. It 
is not so... The fundamental question in marketing is to create a category in which one 
can be first. It is the law of leadership: it is preferable to be the first than to be 
the best. It is much easier to enter the mind first than to convince someone that you have
a better product than the one which arrived first." Obviously they could not say this were
we rational consumers who always select, much in accord with the already mentioned theory 
of rational choice, the best option independently of how the options are presented.
     Following this Ries and Trout provide a very suggestive series of examples to prove 
their thesis: "One reason that the first brand tends to maintain its leadership is that 
the name often becomes generic. Xerox the first photocopier, became the name for 
photocopies. The people stand before a Ricoh, Sharp or Kodak photocopier, and say: 'Where 
is a Xerox?' They will request Kleenex when the box clearly says Scott; they will offer 
you a coke when all that they have is Pepsi-Cola. How many ask for self-sticking tape 
instead of Scotch tape? Not many. The majority use names of brands when they become 
generic. Gillette, Fiberglass, Formica, Gore-Tex, Jello, Krazy Glue, Q-Tips, Saran Wrap, 
Valcro; to name a few.
     In turn, the behavioral economists have studied the problem of the consistency
of preferences associated with the assumption of transitivity, and have found various 
incompatibilities. In effect, individuals often prefer A to B, B to C but not necessarily 
A to C. That can seem a  bit counter-intuitive at the logical level for we view it like a 
uniform comparison of numbers with a greater or lesser value, yet if we carefully analyze 
the empirical world we shall observe that such shifts actually exist. Or perhaps if we 
prefer an apple to a banana and a banana to an orange we will always and 
necessarily prefer an apple to an orange? No, it is not that simple. In any event, if 
one is not convinced, they can reflect more carefully about the strange decisions we make 
on the amorous plane. That suffices to give justification to behavioral economics.

Now homo economicus goes to the laboratory: experimental economics

     In the year 2002 the Nobel prize in economics was obtained not only by the 
psychologist Daniel Kahneman but also by an economist: Vernon Smith. Why? Basically, "for 
having established laboratory experiments as a tool in empirical economic analysis." 
With that there emerges, then, the paradigm of experimental economics.
     One of the most interesting topics in experimental economics is that referring to 
testing for possible rational conduct of agents in specific contexts of incentives, 
institutions, strategic interactions, and/ or artificially modeled market mechanisms. 
Thus, for example, they have found that in games of complementary strategy a small group 
of individuals with "pro-social" tendencies can significantly change the behavior of 
egoistical individuals. In this fashion, it turns out that egotism is not an 
unequivocally "given" condition in the interaction of agents but instead that their
survival, decline or development depend upon the praxiological context in which they are 
     Similarly, experiments relative to the "ultimatum game" have demonstrated repeatedly
that people are in general more disposed to sacrifice monetary recompense if it is small, 
which openly contradicts not only the notion of the individual as a marginal 
calculator but also the monotonic assumption according to which we are 
acquisitive beings who always prefer having more to having less.
     On another front, experimental economics has developed a very relevant innovation in 
pedagogy: the experiments with students. Basically it concerns economics professors who 
organize controlled dynamics with their university alumni in order to test certain 
postulates of economic theory. This type of experiment has become so important that 
prestigious scientific journals such as the Journal of Economic Literature include 
sections dedicated exclusively to experiments of this sort.
     A particularly interesting experiment in this respect was that organized by the 
German economist Reinhard Sippel at the end of the Nineties to test the hypothesis of 
consumer rationality. He presented a series of prices to his students which they could use
to "buy" diverse goods, with options established to test how rational the students were 
with regard to the benchmark of Neo-classical economics. The great majority of his 
students turned out to be "irrational" according to this standard because they violated 
some or all of the axioms covering preferences. They preferred A to B and later B to A, or
given a choice between A and B, chose A, later between B and C chose C, and between A and 
C, chose C.
     Yet do not think that experimental economics is charged with demonstrating that 
people are irrational without further discussion. As Camerer has said "the objective is 
not simply to create a list of anomalies, but the anomalies are used to inspire and 
structure formal alternatives to the theory of rational choice." What happens, then, is 
that the standards of "rationality" of the orthodox economists are so unrealistic and 
restrictive that the experiments have no option but to evidence their 
irrationality. For instance, in Sippel's experiment one sees clearly that the 
problem with the Neo-classical standard is that it does not take into account in a 
coherent manner the problem of temporality so that, as Veblen keenly observes, "the
marginal utility theory is of a totally static character. It offers no explanation 
whatsoever of any types of change because it is only concerned with adjusting values in a 
given situation." However, when one deals with real individuals (the pupils in 
the experiment in this case) one learns that the making of decisions is not an atemporal 
act but instead it is more that the human beings constantly confront the passage of
time and the conditionings intrinsic to it. In this way, life more resembles a continuous 
movie with many changing elements than a mere set of photos and, in consequence, the 
method of comparative statics of orthodox economics results in sterility.
     Thus, then, perhaps the orthodox economists should imitate the intellectual honesty 
of professor Sippel who, even when he had organized the experiment precisely with the goal
of demonstrating to his students that the orthodox theory indeed worked, felt obliged to 
admit that "the evidence in favor of maximization of utility is, in the best of cases, 
confused... Therefore, we should pay more attention to the limits of this theory as a 
description of how persons actually behave, that is to say, as a positive theory of 
consumer behavior.

Do not forget the right hemisphere! Performing an encephalogram on the consumer

     The advance of neuroscience or sciences of the brain has not been foreign to the 
economy. In fact it is thanks to them that they have been able to inquire into the 
physical bases of various of the discoveries of behavioral economics, in this way giving 
birth to another new branch in economic studies: neuro-economics.
     As with behavioral and experimental economics, various studies have been performed 
with this new focus and very interesting results and conclusions. The goal is basically to
open the "black box of cerebral activity." We have there, for example, the famous study by
Sanfrey and others, who applied the "ultimatum game" to 30 persons connected to equipment 
to register neurological activity, with the objective of verifying the existence of 
significant differences in individuals before the different stimuli generated by distinct
offers. It suffices to say that the selected subjects participated in various rounds of 
the game, having human beings as opponents in 50 percent of the cases and a computer in 
the other 50 percent.
     The results were extremely interesting. They showed that certain regions of the brain
activated in a disproportionate manner when the subjects received "unfair" offers from 
human beings in comparison with what happened with "fair" offers from humans and with all
offers--fair and unfair--stemming from the computer. That evidently demonstrates that a 
physical basis exists in economic decisions and that these are not exempt from elements of
an emotional nature.
     A very important sub-branch of neuro-economics which is highly related to the theme 
of consumer rationality is that of neuro-marketing. This can be defined as an 
advanced discipline that researches and studies the cerebral processes which influence the
conduct and the decision-making of persons in the fields of action of traditional 
marketing: design of products and services, prices, positioning, publicity, channels, and 
     The contributions of neuro-marketing were crucial. As Néstor Braidot explains in his 
interesting book Neuromarketing: why your clients go elsewhere though they say they 
like you? this new discipline "allowed combining a set of affirmations from 
traditional marketing, like the efficacy of emotional publicity in brand loyalty or the
fallacy of attributing rational behavior to the consumer." Similarly it was discovered
that "the so-called buy button seems to be located in the middle pre-frontal 
cortex. If this area is activated, the client is not deliberating, she has decided to 
acquire or possess the product." Evidently this is very different from the consumer 
orthodox economics assumes, who very rationally deliberates over which will be the best 
option given her restrictions and preferences.
     And not only that. As Braidot well reports, neuro-economics, "on analyzing the 
topic of price, discovered that the maximization of utility based upon rational thought 
is not the principal motivation which weighs in decision-making given that, in most
instances, the triggering factors for the purchases were emotions, values and everything 
that activates the brain's system of rewards."
     Yet perhaps the most interesting part of neuro-economics might be the study of the 
particularities of each of the brain's hemispheres and how they influence our economic 
decisions, principally those of purchasing.
     As is known the human brain consists of two hemispheres: the left and the right. The 
left hemisphere is above all logical and analytic, being what we use when we 
verbalize a speech that we have prepared or resolve mathematical exercises or process the 
information in a sequential fashion, and is related to linear thinking. The right 
hemisphere, on the other hand, is above all creative and synthetic, being what we utilize 
when we accomplish a work of art or fall in love, or process information in a holistic 
form, and is related to creative thinking.
     Very well, it is evident that the left side of our brain corresponds much more to the
calculating and analytic activity belonging to homo economicus. Nevertheless the 
role that said hemisphere plays in our economic decisions is ever less for publicity and 
other forms of influence designed, developed and perfected for marketing are directed 
above all towards the right part of our brain causing our buying and consumption decisions
to be ever more emotional and impulsive. In this manner, directly "attacking" the right 
hemisphere manages to avoid that the rational and critical attitude of the left exceeds 
the first level, and thus a set of habits and preferences for irrational consumption are 
generated in the individual.

We are not omniscient! The problem of limited rationality

     One of the essential assumptions so that the orthodox postulate of consumer 
rationality can function is the assumption of complete information: consumers--and 
in general all economic agents--always consider all relevant information in order to make 
the best decisions.
     However, this assumption has been strongly questioned through the concept of 
limited rationality proposed by the United States economist Herbert Simon. In 
essence what Simon tells us is that we are not omniscient at the moment of making economic
decisions. In the real world we all have limited resources and information and, in 
the end, find ourselves necessarily obliged to make decisions based upon 
incomplete information and/ or analyses. The search for maximum utility 
involves too much time and effort; therefore, we settle for "reasonably good" decisions 
over "optimal" decisions.
     Evidently with this the sacrosanct mechanism of optimization so much used by 
orthodox economics in their mathematical models falls to the ground. Now it is not 
necessary nor even reasonable to think that individuals optimize. It is sufficient to know
that, in given contexts, they follow as best they can the norms established by the 
different sub-groups of society. Expectations do not have to be of the rational Neo-
classical type. People not always (or better put, almost never) have in mind all the 
variable, nor even the relevant ones. Often they try out decisions. Conventions dominate. 
It is necessary to rely on the behavior of the group, because of strength in numbers 
(think, for example, of the decisions referring to clothing, food or movies).
     We have, then, that limited rationality is compatible with sociological 
organicism because, as a consequence of these real-life deficiencies in the logistics 
of choice, individuals should follow procedures and rules based on experience and social 
practice. The Neo-classical theory, however, continues to cling to the deficient focus of 
sociological individualism.
     And this brings us clearly to the point of difference in the operationalization of 
these two visions concerning the economic agent. While for the Neo-classical paradigm the 
decision of the consumer is basically a mechanical and individual process, 
for focus on limited rationality we deal with an interactive and sequential 
process. And in effect: in real life the majority of times we do not make our buying 
decisions in an isolated fashion and only upon the basis of already given parameters such 
as the price but instead we already have in mind the actions and reactions of the other 
agents and we orient ourselves in relation to them. Thus, for example, we very much take 
into account the reactions and experiences of other consumers around us when we attempt to 
obtain technological innovations (software, cellular programs), recreational goods (trips, 
vacations) or fashion products (clothing, footwear).
     Meanwhile, limited rationality leads us to delimit our range of deliberation. 
We are simply not capable of thinking about all the possible options nor do we have a 
structure of preferences configured for all of them. Or how many of us have, for instance,
established preferences for a Boeing 747 or specific computer microparts? Yet it concerns
not only this type of examples. A decision as simple as choosing among different 
merchandise can already imply an immeasurable complexity in combinatorial terms. How many 
shopping carts could be filled with different combinations from among ten products? 
Several thousand! Thus, if the Neo-classical model of rationality were true, upon entering
a supermarket one would have to confront a decision comparable to having to select a 
shopping cart from among thousands hypothetically available in the parking lot each one 
full of different combinations of goods. But evidently it does not happen in this way. 
More likely what people reasonably do is to ignore all those possible combinations 
utilizing groupings of goods ("buy fruit" instead of "buy apples or oranges or pears or 
bananas, et cetera), habits ("I should always get canned soup"), charges ("my mother told 
me I should buy a box of cereal"), or other forms of practical simplification. It is in 
this way that in reality we act in our purchases. Ergo, the model of limited 
rationality is much more plausible than than of Neo-classical rational choice.

We are not cold calculators! The problem of uncertainty

     In his well-known (and critical) characterization of homo economicus the 
economist Thorstein Veblen, father of the North American institutionalist school, tells us
that "the hedonistic conception of mankind is that of an instantaneous calculator of 
pleasures and pains, which oscillates like a homogeneous globule of desire for happiness 
under the influence of stimuli that move him around the area, yet leave him intact." In 
other words, what Veblen is telling us is that for the orthodox  conception the consumer 
is above all a "cold calculator" guided only by that which causes her pleasure.
     Yet is this truly so? We definitely believe it is not. Human beings are exceedingly 
complex entities. We do not reduce to mere "instantaneous calculators" of pleasures and 
pains. We are, preferably, curious, active and erratic. We seek new ways of doing things, 
we probe, we equivocate, learn, do things out of habit, etc. We are, in summary, a 
substantial and diverse framework of social, cultural, historical, political, and 
psychological complexities; not mere optimizers.
     And all this complexity brings us to the problem of uncertainty. This derives 
from the previous paragraph: given that the agents never deal with complete 
information, they always confront the possibility that their actions do not furnish 
the desired result. The agent can make mistakes. Therefore, because of her
uncertainty, she always makes decisions under risk.
     Yet do not think that this is a condition merely external to the deciding agent. 
It is incorporated in her very subjectivity. Yet the Neo-classical theory has not 
wanted to comprehend this and at most arrives at formulating one model or another of 
"decision under risk" in which the uncertainty is treated by means of 
deterministic probability functions! This is an evidently inadequate treatment for 
it implies completely leaving aside the psychological process constitutive of all 
decision-making. And indeed, the orthodox Neo-classicals like it or not, here psychology 
is eminently endogenous, not exogenous.
     So then, the orthodox economists should be more humble and recognize the 
structural limits of their theory attending to the contributions of economic 
anthropology, behavioral economics, experimental economics, neuro-economics, the focus of 
limited rationality, and institutionalism and also learn from the scientific attitude of 
Carl Menger, founder of the Austrian school, who "with his attention fixed on reality, 
could not abstract, and did not abstract from, the difficulties which the subjects 
confronted" being always conscious that man "far from being an 'instantaneous calculator,'
is a creature who runs in circles, who makes mistakes, is poorly informed, tormented by 
uncertainty, perennially floating between attractive hopes and obsessive fears, and 
congenitally incapable of making decisions fixedly calibrated on the search for 
satisfactions." This seems a more exact description of the actual post-modern consumer,
whether the orthodox economists like it or not.


     The goal of this chapter has been to critically examine the orthodox theory of the 
rationality of the consumer. Basically we have seen that:
     1) The so-called utility function is not only useless but even pernicious to 
economic analysis insofar as it necessarily depends upon implausible and incoherent 
conditions like those of cardinality and continuity and unnecessarily complicates the 
analysis with the concept of "basket."
     2) To attempt to correct the foregoing adding on the theory of revealed 
preferences does not truly resolve the problem since the formal condition of 
consistency implied under this focus can lead to inconsistencies of content and generating
"rational fools."
     3) Strong evidence exists beginning with studies of agricultural economists that 
individualism is not a universal phenomenon but instead is socially and culturally 
     4) On the basis of psychological studies it has been determined that the pro-
social tendencies (empathy, altruism, solidarity, cooperation, et cetera) are much 
more present in human behavior than had been thought and, therefore, the egotistical 
motivation model errs as unilateral and simplistic.
     5) The thesis of egoistical altruism is a mere ad hoc hypothesis of the Neo-
classicals that not only violates the epistemological principle of Ockham's razor but also
supplies important empirical evidence en contra (principle of the primacy of reality).
     6) Ethical motivations can influence (and in fact do influence) economic decisions 
above all in a sense which contravenes that postulated by orthodox economics yet without 
becoming "irrational" behavior inasmuch as ethics has a very practical connotation for 
social life.
     7) Behavioral economics has demonstrated that the greater number of us do not 
behave in the "rational" manner predicted by the Neo-classical theory given that our 
behavior and decisional process are found to be systematically affected by an entire 
series of psychological factors related principally to cognitive bias and inconsistencies.
     8) Experimental economics has validated the above finding furthermore that 
"pro-social" agents can have an effect on the behavior of the egotists in certain 
environments, that we do not necessarily take the marginal benefits into account and that 
on repeated occasions the assumptions upon which orthodox economics is built are not 
     9) Neuro-economics, by having demonstrated the great importance of the right 
hemisphere of the brain in decision-making for buying casts to the ground the idea of the 
centered and rational consumer who chooses automatically.
     10) The focus on limited rationality establishes that, given our limitations 
in acquiring, understanding and processing information, what is most reasonable is to make
decisions with bounded schemes and with simple rules and not acting "rationally" by means 
of calculation and detailed analysis of all the possibilities.
     11) The problem of uncertainty is not a mere external restriction that we can 
evade by means of probability calculations but instead endogenously affects our decision 
process, such that we are not "cold calculators."
     All this constitutes a powerful cumulative case en contra to the Neo-classical
postulate of consumer rationality. Therefore, the orthodox theory of consumer rationality 
is nothing more than a myth. May it rest in peace.

                        Chapter 2

                               "The laws and the conditions of production have
                                    the character of material truths. They contain
                                    nothing arbitrary."
                                            John Stuart Mill, classical economist
The orthodox theory of the rationality of the production function

     The production function may be the most important relation for technical 
analysis--as much microeconomic as macroeconomic--of orthodox economics. It may be the 
importance of this notion and the faith placed in it which caused professor Paul 
Samuelson himself, 1970 Nobel prize, to come to say: "As long as they do not revoke the 
laws of thermodynamics I shall continue relating inputs and outputs: that is, 
believing in production functions. While factors obtain their remunerations through
the offers made in quasi-competitive markets, we shall adhere to the Neo-classical
approximations in which the offers relative to the factors are important in the 
explanation of their market remunerations."
     Yet what is a production function? According to professor Nicholson's explanation in
his popular microeconomics text, "the production function depicts what the enterprise 
knows with regard to how to mix different factors in order to produce a product" in terms 
of a "mathematical function that records the relationship between a firm's inputs and its 
outputs. If output is a function of capital and labor only, this would be denoted by:

               "Q = f(K, L)"

...where Q represents the quantity of production of a concrete good over a period, 
K represents the machinery (that is to say, the capital) used during a said period 
and L represents the hours of work inverted.
     Then we learn that the great importance of the production function in orthodox 
economic analysis lies in that it might permit the businessman to know the quantities of 
capital and workforce he will need to use to reach a certain level of production. In this 
approach, the problem of the firm will be above all a technical problem. On 
this point it is very important to indicate as essential assumption for the 
construction of the production function: the assumption that one operates with a 
given technology. In other words, technology remains constant. This 
assumption is absolutely necessary for orthodox theoretization because were it not 
followed one would always be changing the functional relation between capital and the 
workforce and, ultimately, that would be simply impossible to express in determinate 
mathematical terms.
     Later, given the previous assumption, the orthodox economists advance to modeling 
production functions by means of the famous isoquants. But what is an isoquant? 
Well, nothing more and nothing less than a curve that shows the different combinations of 
capital and labor which would generate the same quantity of production. Graphically an 
isoquant would be as follows:
     A very important characteristic of isoquant curves is the degree of 
substitutability they present, or to say, "the facility with which we can substitute 
capital for labor or, in more general terms, how we can substitute one factor by another."
Why is this property so important? Because it permits the businessperson to fire workers 
replacing them with more capital or save on capital by contracting more workers 
maintaining the same production level as in the initial situation.
     And that takes us directly to the subject of the so-called typical production 
functions. In particular, the economists' favorite typical function is the famous 
Cobb-Douglas production function. The enchantment of this function resides in that,
given that the mathematical conditions of continuity and convexity are 
fulfilled, it permits "continuous substitution of factors" and, in the end, the intensive 
application of differential calculus to derive economic theorems. Its general form is:
Q = AKaLb.
     Another typical type of function is the Leontief production function, 
developed by the Russian economist and Nobel prize of 1973 Wassily Leontief and according 
to which the factors of production must be utilized in already determined fixed 
proportions to manufacture the product, such that there is no possibility whatsoever of 
substitution. The general form of this function is: Q = min (aK, bL).

The "Holy War" of capital: the controversy of the two Cambridges

     In the middle of the past century there occurred one of the most titanic intellectual
wars ever witnessed in the history of economics: the famous controversy of the two 
Cambridges around the definition of "capital" in the current orthodoxy. This "war" 
involved an effective army whose barracks commander was found in Cambridge, Massachusetts,
more specifically at the prestigious M.I.T. (Massachusetts Institute of Technology) and a 
fearsome army whose home general was to be found at Cambridge University in England. The 
ranks of the first army were comprised of the most prestigious economists of the era such 
as Paul Samuelson, Robert Solow and Franco Modigliani, among others. With regard to the 
ranks of the second army, these were composed of heretical economists (principally post-
Keynesians and neo-Ricardians) as fearsome as Joan Robinson, Luigi Pasinetti, Pierangelo 
Garegnani, and Nicholas Kaldor, among others.
     The first shot of this war came from Robinson in 1953 when she published a very 
heretical article entitled "The Production Function and the Theory of Capital." Her 
questioning was prophetic. She attacked the heart of orthodox economics placing under 
judgment the notion itself of a production function. She writes: "The production
function has been a powerful instrument of bad education. The student of economic 
theory is taught to write O = f(L, C) where L is an amount of work, C a quantity of 
capital and O a production level of goods. It asks you to assume that all workers are 
equal, and that L is measured in man-hours of labor; mentions to you something about the 
problem of index numbers involved in the selection of a unit of the product, and then 
quickly passes to the next question, in the hope that it does not occur to one to ask 
in what units is C measured. Before she stops to ask, she will already have become 
a professor, and thus the clumsy thought habits are transmitted from one generation to the
     Robinson goes on to ask: "Should capital be valued according to its irrevocable 
past costs or its unknown future profits?" That put the orthodox economists into grave 
straits. If they answered the second they fell inevitably into a fallacy of circular 
reasoning since in order to know the future earning potential of capital it is 
necessary to actualize its yields, that requires knowing the interest rate level, which in
turn is determined as a price in the capital market where, as much for supply as with 
demand for capital, it is necessary to already know measured and valued 
capital itself! Thus, what one sought to explain entered into the explanation and turned 
out to be a dead end (somewhat as if we were to ask someone "What is your telephone 
number?" and they were to respond "Call me and I'll give it to you").
     Yet the second option is also problematic. If the orthodox Neo-classical economists 
responded that capital should be valued as a function of its past costs they fell into the
serious, undesirable and dangerous extreme of endorsing the Marxist theory of 
capitalist exploitation. In effect, to price capital in terms of its past costs they 
would have had to do so in terms of the social labor quantity necessary to produce it and,
consequently, the production function Q = f (K, L) would have become the function
Q = f(L) where the only actually productive factor would be the labor and that 
would make it highly difficult to justify capitalist profit understood as reward to mere 
capital (think of the profits of the stockholders who possess yet do not work) for the 
entirety of the value would be produced by the labor, yet this would not receive 
all of the reward. In this manner, if they advocated for the second solution, the Neo-
classical economists culminated giving a great gift to the Marxists since they thus 
corroborate what Marx said, that  "capital is not solely the possibility of utilizing 
labor, as Adam Smith says. It is, in essence, the possibility of utilizing unpaid 
     Thus, more than 20 years of controversies elapsed. Hundreds of academic articles 
published about this debate. Many brilliant minds working on the problem. Much rivalry 
between the two sides... Yet nobody could consistently resolve Robinson's critique.
The orthodox side in Cambridge Massachusetts was defeated. Eloquent in this respect is the
testimony of Ferguson, the great martyr of orthodox economics: "The problem we confront is
not that of knowing whether the Cambridge critique has theoretical validity. It 
has. It is more of dealing with an empirical or econometric problem: does the system 
possess sufficient substitutability to establish Neo-classical results... Until the 
econometricians give us a solution, to confide in the validity of Neo-classical 
economic theory is a question of faith." What a man of faith! The heretics, on the 
other hand, we doubt...
     Another eloquent testimony is that of the orthodox economist Robert Solow who even 
came to admit that he had taught his theory of economic growth--intensively based on the 
aggregate production function--to the students at M.I.T. "for more years than one 
would like to remember." He also admitted that what he constructed was nothing more than 
an entirely simplified scheme, a "parabola" as Samuelson called it: "My dictionary defines
'parabola' as a 'fictitious narration or allegory through which moral or spiritual 
relationships are typically expounded.' If moral or spiritual relations, why not economic?
A parabola does not ask to be true to the letter, but instead to be well-
formed. Even a well-formed parabola has a limited applicability. There are always 
tacit or explicit assumptions serving as the basis for a simplified story. It may 
not matter for the point being discussed to explain the parabola; that is what parabolas 
make possible. When it does matter, the parabola can be deceptive. In a simplified 
model, there are always aspects of economic life that remain external. Consequently, 
there will be some problems upon which it sheds no light; but even so, there may 
be problems upon which it seems to shed light, but which in fact are propagating an 
error. Sometimes it becomes difficult to distinguish between both types of situation. The 
only thing that can be done is to honorably try to circumscribe the use of the parabola 
to the domain where in fact it is not deceptive, and that cannot always be known in 
     Yet it so happens that simply and plainly there is no domain where the "parabola" of 
the production function would not be deceptive. In effect, if the capital cannot be 
measured, it becomes absurd to construct a mathematical function (that is, with 
quantitative terms) on the basis of itself. Therefore, the "parabola" is empty of 
content. A logically inconsistent theory cannot ever be called scientifically 
valid concerning empirical reality, as Hahn had well recognized when he confessed 
that "when the aggregate version of the Neo-classical theory is used, simplicity is 
obtained at the cost of logical coherence and, in general, these theories deliver 
erroneous answers... The opinion that, despite everything, 'it can work in practice' 
sounds a little fraudulent, and in any event the responsibility to provide proofs falls 
upon those who hold this." Furthermore, when Solow says that "there will be some problems 
upon which it sheds no light; there will be some problems upon which it sheds no 
light; yet even so, there may be problems upon which it seems to shed light, but which 
in fact are propagating an error but even so, there may be problems upon which it seems 
to shed light, but which in fact are propagating an error" it clearly brings to mind that 
drunken man who sought the keys to his house far from where they had actually fallen, 
adducing that in the site where he was looking there was more light. Sincerely laughable 
(if not to make us cry).
     With all this, the Neo-classical production function continues to be taught. In 
economics departments around the world the professors keep training (and besotting)
their "university children" with humorous stories of "Neo-classical parabolas," thus 
transmitting, from generation to generation, those "clumsy thought habits" of which 
Robinson spoke (yes, though you may not believe it all this continues being taught in 
economic theory courses...and the uncritical pupils keep becoming 
     The orthodox position in this respect has already been thoroughly refuted, yet none 
of this has been incorporated in a clear fashion into standard economic theory. The 
strategy of silence rules. Practically no professor or academic talks about these 
problems. Or if they speak, they ignore or "neutralize" them. And the same occurs with 
"over-curious" students. If anyone dares to mention the Cambridge critique in class, she 
will be told it is off the subject or that that will be explained afterwards but 
first they must strive to understand the Neo-classical theory (with this achievement the 
student forgets the question in the short term, subjects her mind to the corset of Neo-
classical theory in the medium term and now will never ask uncomfortable questions in the 
long term).
     To conclude, a very significant datum. Paul Samuelson received the Nobel prize in 
1970 for his "contributions to the betterment of analysis in economic science," Franco 
Modigliani received it in 1985 for his "pioneering analysis of savings and the financial 
market growth," and Robert Solow in 1987 for his theory of growth, entirely based upon the
production function. No participant from Cambridge in England--not even Robinson (?!)
received this distinction.

Things become viscous: "molasses" and the aggregation of capital

     Following the above line, we now analyze the aggregation problem, which is to 
say, that referring to how the different elements can be grouped that enter into 
production of variables K, L and Q to be able to coherently construct the 
     With respect to the aggregation of the product (Q) there is no great problem. 
While the good is homogeneous it will always maintain commensurability: apples plus apples
will give us apples and chairs plus chairs will give us chairs. With regard to the 
aggregation of labor (L) the thing is a little more complicated because in a 
business there are different types of work and workers and not all are homogeneous (an 
hour of work by the engineer is not the same as an hour of work by the accountant or the 
laborer). Nevertheless, even though "we take a wide view" and consider the labor factor as
if it were a more or less homogeneous element summing it in terms of man-hours. However, 
in the case of the aggregation of capital (K) the thing becomes practically 
impossible. Capital is neither homogeneous nor divisible. There is in it an 
irreducible element of incommensurability and, in consequence, it cannot be 
simply aggregated. Therefore, once again the question arises regarding the very 
existence of the production function such as it is approached.
     However, the first Neo-classical authors were already conscious of this problem and 
to solve it postulated the existence of a sort of magical substance that provided capital 
with incredible plastic and malleability capacity: "molasses." Thanks to this "substance" 
capital not only became a multi-purpose and homogeneous good, but also it could be treated
as a flow and, at the same time, as a stock. In this manner, the blessed "molasses" 
functioned like a "philosophers' stone" for orthodox economics: it converted into gold 
its unusable and used up theories and promised to give eternal life to the production 
function. However, Joan Robinson arrived to ruin the party. After her lapidary article 
nobody could allege lack of knowledge of the difficulties that encumbered this type of 
magical resource used to "simplify" reality.
     Yet let us return to the aggregation problem. We had seen that if indeed the labor 
factor could be apparently homogenized into "man-hours" the same could not be done 
with capital given that a basic term of commensurability for it did not even exist. Let us
illustrate by way of example. Suppose that we are in a bakery in which there is a 
computer and an oven. In this case the computer as much as the oven forms part of the 
capital of the enterprise yet they are not the same thing nor have the same price. 
Thereupon, if we assume (as the orthodox economists do) that there is a generic price "r" 
for the computer and the oven by the fact that they form part of the "capital" we are 
tacitly asserting that this capital is some type of homogeneous substance which can be 
added, subtracted and divided, when the fact is that, given their heterogeneity, 
this is not so: an oven divided into two is not an oven, nor even a capital good; half an 
oven plus half a computer is not a new machine.
     But there remains another option: to price in money each one of the elements that 
comprise the capital and later sum the quantities of money. "Eureka, we have found a 
method to homogenize and, therefore, to aggregate capital!" the orthodox economists will 
say. Yes, congratulations. The bad news is that this method of aggregating capital does 
not work being incorporated into a production function! In a production function one must 
include physical units or K and L, not sums of money. Furthermore,
this method of aggregation of capital can result in leading to many absurdities and 
contradictions. Let us imagine, for example, two identical enterprises with the same 
physical endowments of capital and labor, yet which are differentiated by the fact that 
one of them has paid a higher price than the other for the same machinery 
(capital). The stock of capital measured in money is greater in one than in the other: is 
it therefore more productive? Does that allow increasing the quantity of the product 
fabricated per hour? No. Ergo, monetary valorization alone does not allow solving the 
aggregation problem.
     Nevertheless, current microeconomic and macroeconomic texts keep speaking about 
capital as if treating a homogeneous and malleable substance; to capital can be added more
capital, a part can be removed and another added, and it keeps being capital. That deals 
with a lie. A lie upon which basis have been constructed very beautiful and sophisticated 
macroeconomic models (Solow's model, Ramsey's model, Diamond's model, Romer's model, et 
cetera). Yet a lie in the final account.

Murdered with its own sword: mathematics against the economic orthodoxy

     One of the things that the orthodox economists most treasure is the logical rigor of 
their theories, which they achieve, according to them, by means of the mathematization of 
all the economic analysis. "One must always use mathematics to be rigorous, one 
need never fall into discourse," they say.
     However, it is precisely in this respect that it becomes quite ironic the the Neo-
classical economist, who so insist on the use of mathematics to avoid logical fallacies, 
systematically evade the critiques which are made of the very logico-mathematical 
fundamentals of their theories. In order to see that, we return to the traditional 
Cambridge critique concerning the Neo-classical theory of capital. As we have seen, this 
critique was not limited to indicating that the Neo-classical assumptions were forcing 
reality but also--or better, above all--demonstrated that the orthodox theory of 
capital had internal inconsistencies. Nonetheless, the years have passed and, 
despite the vainglorious orthodoxy of "theoretic rigor," the question persists without 
     Next, given that in the Cambridge controversies we have an example of how mathematics
can be used to make logical fallacies evident, we shall present a simple demonstration of 
how the Neo-classical conception of capital is incoherent. In other words, we will kill 
the orthodox school with their own sword.
     With y the output per worker, k the capital per worker; r the 
interest rate for rental of capital; w the wages; and y = f(k) the per 
capita labor production function, we have:

               y = rk + w

Very well, taking the derivative, we have:

               dy = + k.dr + dw

And given that, in theory, "r" is equal to the marginal productivity of capital:

               r = dy / dk

From which, simplifying, we will have capital being defined as:

               k = - dw / dr.............................(1)

However, additionally, we know that:

               r.k = y - w

Therefore, simplifying, we have another definition of capital:

               k = (y - w) / r...........................(2)

     Thus we have two definitions of "k" given by (1) and (2) and they will only be 
coherent if they coincide. Lamentably for orthodox economics, that only happens--as 
Samuelson demonstrated--in the case where all the compositions of capital in all the 
sectors of the economy are equal, which evidently never happens under capitalism (would
anyone be willing to postulate that the composition of capital in agriculture is exactly 
the same as in mining or industry?) The orthodox theory only works for an absurd 
and non-existent case. Yet let us not be ill-mannered, and so excuse ourselves as 
Robinson excused herself: "I am sorry if I give the impression that it does not bother me 
that two exactly equal pieces of equipment can represent different quantities of 
accumulation of capital."

The production function castrated: the sterility of the orthodox theory to explain the 
technological process

     We had seen that one of the essential assumptions for the construction of the 
production function was that the relation between capital and labor remained constant. The
consequence of that? That the orthodox theory remains irremediably "castrated" during the 
moment of explaining the most important and crucial element of production: 
technology. Let us see why.
     By technology orthodox economics understands the given sets of information and
knowledge that can be applied to the production of goods and services, i.e. the 
knowledge held by the firm about the different production possibilities, 
which in turn are determined by the engineers.
     By now one can posit various critiques of this vision of technology. In the first 
place it is inconvenient because it treats (even if it be only "methodologically") as 
static and exogenous something that is essentially dynamic and endogenous. In 
effect: technology is more a process than a result. Even further: it deals with a 
continuous process that develops at each moment within the same enterprise, 
as the evolutionist school of technological change maintains as well as a Neo-
Schumpeterian focus on innovation according to which, as an inevitable 
consequence of the evolution of capitalism, innovation comes to be a systematic 
activity of the large firms with the capacity to invest in R+D (research and development).
     Yet do not think that the endogeneity of the technological factor is only 
something pertaining to large enterprises (if indeed a more conscious, systematic and 
organized mode is found in them). It is valid for all types of businesses. That becomes 
evident, for example, if we begin to see the workers as "human capital" with freedom and 
capabilities instead of seeing them simply as "factors of production" almost comparable 
with raw materials. The workers form a continuous, inevitable and 
constitutive part of the enterprise's technological progress to the extent that 
they keep learning special abilities for executing their work and, therefore, for them 
technology cannot be considered as given (and still less in our times of 
professional ultra-specialization).
     Now, returning to the critique of the orthodox conception of technology we find that,
by defining it as a given stock of information which does not need to be explained,
this paradigm is limited only to describing its impact upon the production function and 
the equilibrium conditions leaving aside that which would be more important to 
know: the origin and the causes of technological change. Thus it is that
Pepall, Richards and Norman tell us that: "The Neo-classical focus does not lack 
weaknesses. Although it indicates the way in which the firm's production plan 
changes in response to changes in inputs and the price of production, in reality it 
tells us little about the way this plan is designed. In other words, it reveals 
little about what happens inside the business, and more specifically the way in which 
the different competitive interests of the administration, the workers and the 
stockholders are reconciled in the design and execution of a production plan."
     Clearly shown in the above is the fact that despite practically all orthodox 
economists recognizing that changes in technology progressively and 
radically alter production they are not interested in developing a consistent 
theory which explains their dynamic and center more upon explaining by means of the 
blessed production function how the utilization of factors is optimized with a 
given technology. An example of that is the already variously cited professor 
Samuelson when in the part referring to the production function in his famous economics 
manual begins by explaining to us that the level of production that can be obtained from a
determinate set of factors "depends on the state of technology" whereby it follows, 
returning to the minutia explicable in class, to say: "yet at any moment there will be a 
quantity of product obtainable starting from given quantities of the introduced 
factors." We see, then, the essence of the strategy (fraud) of orthodox economics: 
to recognize the importance of the important so as later to commence theorizing over 
things without importance.
     Meanwhile, with regard to the orthodox conception of technology it also must be said 
that it becomes inconvenient because it distorts and hides the true nature of business 
technology selection and also abstracts from the intrinsically uncertain, random and 
probabilistic nature of technological change. In effect, the enterprise has no 
certainty regarding its choice, as the Neo-classical theory pretends with its dynamic 
of optimization, yet instead randomly scrutinizes the technology, even within itself, 
developing R&D projects on the basis of its own knowledge and technological learning 
in order to later decide on a basis of satisficing over and above that of 
optimizing. Given this context, even the "advanced" Neo-classical models for 
explaining the dynamic of technological change, like Romer's model, become irrelevant. 
And, it is clear, this drama of sterility is even more evident in Solow's famous model, 
taught as the basis of macroeconomic growth theory in practically all the economics 
departments of the world, now that the conclusion for this model is, paradoxically, that 
the model does not work, so should be the dynamic for the unexplained 
variable A (that includes technology) which will explain growth (do the orthodox 
economists have to commit so much mathematical juggling to arrive at the obvious, that 
technological progress is the fundamental factor for growth?)
     Now then, the assertions of the evolutionary school of technological change 
seem more relevant in this regard than the most sophisticated Neo-classical models. And 
indeed, even though one must always take care with unjustified extrapolated notions from 
the natural sciences to the social sciences, the basic schema of the "theory of evolution"
through random mutation and natural selection, constitutes a schema with great heuristic 
capacity to analyze the way that firms perform their "technological search" in a 
changing, uncertain and competitive environment where they must survive and progress.
In this context, as we have already said, the firm acts more on the basis of 
"satisficing" than of "optimizing." In fact, as the evolutionary economist Sidney Winter 
has shown, the Neo-classical theories of endogenous technological progress on the basis of
businessmen  who optimize the stock of information for production are logically 
inconsistent because they end by implying an ad infinitum regression: "It can be 
said that a determined maximizer of profits will adopt the form of organization which 
requires observation of those things it is beneficial to observe at the moments when it 
is beneficial to observe them: the simple reply is that that choice of an informative 
structure which maximizes profits requires information and it is not evident how the 
aspiring maximizer of profits is to acquire such information. Or which guarantees that she
does not pay an excessive price for this information"; so, at the end of the day one must 
seek "satisficing" and not necessarily "optimizing" conduct since there "should be limits 
for the spectrum of analyzed possibilities, and such limits should be arbitrary in the 
sense that whoever makes the decisions cannot know that they are optimal." It would not 
seem, then, that technological change occurs in the manner suggested by even the most 
sophisticated orthodox models of "endogenous growth."
     Also, from the Marxist viewpoint, with its wider and more pertinent concept of 
"development of the productive forces," the reductionism of the Neo-classical scheme has 
been criticized by simply discussing this as something purely technical without taking 
into account the intrinsically implied historico-social aspect. Arrizabalo writes: "One 
thing is the formulation of a productive workforce, strictly associated with their 
technical production capacity, in an asocial mode and, thus, exclusively related to 
productivity. Another thing, very different, is the economic and thus social category of 
productive forces, a category that goes far beyond a purely technical consideration. 
Certainly the productive forces are based upon the productive capacity, which depends in 
turn on the combinations that can be established between living work and the available 
means of production. Yet in no case are these combinations divorced from the social 
'rules of the game' (the relations of production) that determine which of those 
combinations is actually carried out." It is clear, therefore, that the Neo-classical 
conception of technology is absolutely impoverished and sterile.

With what  shall we produce? Critique from the ecological perspective of
the production function

     Let us imagine for a moment that the production function that orthodox economics 
presents is valid. And then, let us imagine that, in fact, we have to carry out a 
real production process upon its basis. Let us think, for example, of the 
production of a cake. What do we need for it? In accordance with the Neo-classical 
production function--of the general form Q = f(K, L)--we would need the elements 
capital and labor. We gather, then, all the elements of capital (defined as 
the set of instruments utilized for production): pitchers, bowls, vats, pallets, 
oven, molds, knives, etc. Now we gather the elements of the labor factor: basically it 
would be our own workforce (or that of a pastry chef contracted for the term) with all 
the abilities incorporated for making cakes. Then, given a technological configuration, 
that is to say, a relation established between the productive factors (Q = f(.)) 
re-uniting the elements of capital (K) and labor (L) that we have 
enumerated, we should be able to obtain the product, or that is a cake. But we do not 
obtain anything! It is not possible... There must be an explanation...
     We try an intensive incrementing of productive factors: we obtain much bigger vats 
and contract with various pastry chefs whom we instruct to mix more rapidly...yet not even 
thus do we obtain a single cake! "Why?" we ask disconcerted.
     The answer is very simple: nothing is produced because there are no raw materials 
with which to produce! It does not matter how many vats we get nor how many cooks we 
hire nor how rapidly they stir-if there is no batter to mix! And in effect: basing 
ourselves upon the Neo-classical production function, we have gathered together all the 
elements of capital and labor yet have not taken raw materials into account at all.
We have enumerated various things, surely. Yet at no time have we mentioned flour, sugar, 
eggs, etc. Thus, basing ourselves upon the Neo-classical production function, we have 
attempted to be God: we have wanted to create something from nothingness! However, it 
becomes evidently absurd in this context and in any relating to a real productive 
process: one cannot make a cake without cake batter. One cannot produce without raw 
     So then, it is precisely on this basis that the great economist Nicholas Georgescu-
Roegen, father of an ecological focus, presents his critique of the production function 
and of orthodox economics (which he rightly calls "pencil and paper economics"). He starts
by analyzing the physical bases of the productive process and from there jumps to 
viewing the implications of the First Law of Thermodynamics (whereby "Matter is neither 
created nor destroyed, only transformed"): one cannot produce without a material 
basis. Consequently, the Neo-classical production function becomes inconsistent
and absurd for not taking the factor nature into account.
     And it was expected. In the 19th century, the era when the Neo-classical school was 
born, they still believed in the so-called "theory of indefinite progress" and the 
modernists asserted that the resources of nature were endless such that there never
could be a limit to human prosperity. The orthodox theorists assumed this belief and on
its basis constructed the economic theory. Thus, the most essential and 
limiting factor of the economic process was left totally aside: the ecological
factor. Nevertheless, as Max Neef put it well: "There is no economy that would be 
possible exclusive of the services offered by the ecosystem. This is so absolutely 
evident and obvious that is is truly an epistemological scandal that in no 
economics textbook, if one goes to the final word index, can they find the words 
'ecosystem,' 'nature' or 'thermodynamic.' They do not exist! They simply do not 
exist. Why? Because the economics which is taught is conceived as a system closed upon 
itself having no relation with any other system...when obviously it is inserted in a 
larger system that is called the biosphere and around which come all the services 
offered by the elements of that biosphere. Where will the economist be is photosynthesis 
ceases? There would be no economists! What would happen to the economy if suddenly all the
world's bees were to die? There would be no pollination... Yet no economist assumes 
that he must know this... That entire aspect is presented as a gigantic sea of ignorance 
on the part of the economy." In other words, there cannot be economics without 
ecology and orthodox economists have not even acknowledged this.
     "But the problem is easy to solve!" the orthodox economists will say. "We add the 
factor R (natural resources) to the production function, and it's ready!" What 
ignorance! An ignorance only comparable with that also shown by such economists when they 
pretend to have comprehended the process of technological change only because they have 
incorporated a variable A in the production function.
     Let us see. It will be a "Solow-Stiglitz" variant of the production function (what 
they call the artifice with which they have pretended to solve the problem) in a Cobb-
Douglas format which is:

               Q = Ka Lb Rc

               such that: a + b + c = 1

     How a Cobb-Douglas function is treated implies complete substitutability of 
factors, which is to say that one can replace one of the factors with another (or 
others) maintaining the same level of production. But it is precisely there where 
the inconsistency resides.
     Mathematically, if R (natural resources) tends to zero, such a 
diminution can be compensated with increases in K or L maintaining the
same production level. The multiplicative structure of the function permits that. 
However, this becomes inconsistent on the factual plane because if R tends 
toward zero, K and L must necessarily do so sometime. In the first 
place, because they depend on R: the capital goods are products of a previous 
process that already presupposes the natural factor and, in turn, the workforce requires 
natural resources to sustain itself (can anyone imagine what would happen to our 
productivity if we only imbibed the equivalent of one glass of water per day?)
In the second place, because the amount of the product that capital and labor can generate
always and necessarily depends upon the flow of inputs to be transformed (it
does not matter how rapidly the pastry chef stirs or how big the available vat is, for 
without having ingredients for the dough she will be unable to make a single cake).
     So then, the Georgescu-Roegen critique of the production function shows us clearly 
that the economy has ecological limits. And that brings us to a central concept for
analysis: entropy (growing and irreversible decay or disorder) which implies that 
in a closed system (dimensionally bounded) and assuming matter as a packet of condensed 
energy (read ordered or organized, as it is in practice) and every time it is transformed 
(for example, burning wood to ashes and smoke but obtaining light and heat) what we are 
doing at root is disordering it and that is irreversible. And also, and with this the 
explanation is complete, if the scientists of the future succeed in obtaining wood 
starting from smoke and ashes, that which is certain is that the quantity of energy they 
would have to use for that would be greater than that generated by burning it (they, 
knowing that by the law of entropy there is no perfect reversibility, would 
not undertake such an absurd project). Ergo, the benefit from the qualities of natural 
resources has an objective limit and capital and labor cannot forever exploit nature 
because it too is subject to the law of diminishing returns.
     And that is not to mention the problem of the residues and ecological contamination 
that all productive processes imply. In effect, given that--due to the law of 
entropy--it is impossible to arrive at 100 percent efficiency, to produce something 
always and necessarily generates a residue or waste which must be treated. It is to say, 
after making a cake it is needful to clean the kitchen and wash the utensils. And the 
same applies for the planet earth as a whole which, imprudently, we are not doing.
     Nevertheless, orthodox economics has systematically left all this to one side. For 
them the ecological factor is purely exogenous. Now then, etymologically 
economics means "administration of the household." And our house in the last 
analysis is the planet earth. Yet orthodox economics has proved itself--evidently--as a 
poor administrator of it because, by leaving the ecological factor out of the analysis, it
necessarily carries a large part of the blame for the current problem of global warming
which advances uncontrollably operating against our very survival.

A supposition it is necessary to substitute: the assumption of substitutability

     As we have seen, one of the essential concepts of orthodox production theory is that 
of substitution, which is that referring to the possibility of substituting one 
factor for another without changing the level of production. Thus, under this assumption, 
the economic problem was reduced to finding that combination of factors (capital and 
labor) that enables reaching the highest isoquant curve (that is, the greatest production 
possible) given the isocost restriction (that is, the budget utilized by the enterprise 
to contract for the distinct factors of production). In turn, in reference to the theme of
"degree of substitutability," we recall that there were two typical forms of the 
production function: the Cobb-Douglas and that of Leontief. And it is upon those that we 
shall center our analysis.
     Let us see. Between these two types of typical functions orthodox economic theory 
strictly prefers Cobb-Douglas to that of Leontief. Why? Because the former--once 
complying with the mathematical conditions of continuity and convexity--
allows for "continuous substitution of factors" and the intensive application of 
differential calculus, while the second display a zero degree of substitutability and, to 
top the evils, is not derivable - remember that its general form is Q = min(aK, bL)
In other words, the Cobb-Douglas function is a "well-behaved" function--according to the 
same Neo-classical economists--whereas Leontief's function of fixed coefficients would be
a "spoiled" function.
     Yet beyond how the orthodox economists feel with regard to the Leontief function, we 
have to ask ourselves in the interest of scientific realism which is the type of 
production function more consistent with reality. So then, for anyone who has some 
real experience with the phenomenon of production and who has not remained simply 
and fully with what the microeconomics manuals say, it will be evident that reality has a 
"strict preference" for the Leontief production functions. Why? Because, as common 
sense well advises us, the most reasonable is to think that the relationship between 
labor and capital is, in practically the totality of production methods, one of 
complementarity over that of substitutability. A form of production is 
almost never found where one can simply replace capital with labor (or vice versa) 
maintaining the same level of production (we leave it as an exercise for the reader to try
to think of one). Every machine will be in general complemented by a fixed quantity of 
workers that cannot be varied or which can be varied very little. Thus, for example, once 
we have decided how "modern" or technified our bakery should be, the engineers will tell 
us that to use the installations over a period of time t it will be necessary to 
apply an average workforce flow in order to remain within that parameter. In this manner, 
if we attend to the real world, the most probable is that we will not obtain "well-
behaved" isoquants so needed by the orthodox economist to display her preparation in the 
calculus of derivatives.
     Some might object to this point saying that indeed there are some microeconomics 
manuals, such as that of professor Nicholson, which speak of the great importance and 
realism of the Leontief production function. Nonetheless, whoever holds that must also 
concede that in those same manuals, even though they accept the existence of various types
of production functions besides the Cobb-Douglas, they conclude developing practically 
all argumentation on its basis. One repeats, then, in this instance the ingenious 
sophistical gimmick that orthodox economics applies to technological change: to recognize 
the importance of the important so as, nevertheless, to later advocate unimportant 
     It is evident, then, that the orthodox manuals sacrifice the realism of the theory 
in favor of mathematical elegance. And indeed, as Martin Shubik well stated in his very 
heretical article "A Curmudgeon's Guide to Microeconomics": "probably one of the most 
important technical considerations that led economists to adopt the concept of continuous 
substitutability among input factors would be that continuous isoquants (like those of the
Cobb-Douglas type) are easier to form than the discontinuous (like those of the Leontief 
type) since "if one wants to present the theory utilizing calculus it is convenient to 
have curves like a pair of derivatives defined at every point."

The final blow: the sophistry of empirical validation of the production function

     At this point the reader should have lost all faith in the theoretic validity of the 
so-called production function. Nevertheless, it must be said still that various orthodox 
economists hide under the viewpoint according to which the validity of the Neo-classical
theory is an empirical and not a logical question. In particular, what they argue is that 
the cited Cambridge critique is correct in a formal sense but that it has no consequence 
in the real world. "It is true, the theory is inconsistent... Yet it continues being valid
because it still functions," they maintain.
     The empirical proof that normally is used to back up this position is comprised of 
the numerous regressions performed with different Neo-classical production functions in 
which the awaited coefficients have been produced.
     Sato's declaration is eloquent in this respect: "While we live in this world, we 
need not abandon the Neo-classical postulate. In order to reject it, it is necessary to 
demonstrate that this world is imaginary. This demonstration has not been attempted by the
literature... My argument is that the state of the question at this moment tends to 
establish the world in which the Neo-classical postulate dominates... Furthermore, the 
same Neo-classical postulate is the empirically provable principle in the form of 
estimation of the "CES" production function and other varieties. This can cause us to go 
beyond the purely theoretical speculations upon this theme."
     In fact, the confidence which the orthodox economists place in the empirical validity
of the production function is such that it even has infected Mario Bunge himself, who 
maintaining that economics is not a science, even refers, contradictorily, to the Cobb-
Douglas function as "an empirical law."
     Very well, it is precisely here that we wish to exploit to inflict the final blow 
upon the orthodox theory of production. We shall begin with the sacrosanct Cobb-Douglas 
     Let it be a dynamic Cobb-Douglas function (which is, that takes time into account) 
and with constant returns to scale (which means, assuming a form such that if the factor
endowment is multiplied by "n" the production too will be multiplied by "n"):

               q1 = eut KaL1-a.... (1)

Where: Q is the production level, eut is the updating factor 
(t and u are the indices of time and technical progress respectively), 
K the capital, and L the labor. Now, if we assume that, as the Neo-classical
theory postulates, the participation levels of capital and labor in the product are equal 
to their marginal physical products, the coefficient a will be equal to its share 
of the profits and the coefficient (1-a) will be equal to labor's share in the 
national product.
     "But this is precisely what is seen in the great majority of national estimations of 
national production by means of the Cobb-Douglas! The calculated coefficient a is 
equal to the share of profits in the aggregate accounts! The orthodox theory has triumphed
once more and has defeated the Cambridge critique on the grounds of empirical reality!" 
the orthodox economists exclaim. Not so fast... As the distinguished Marxist economist 
Anwar Shaikh has shown in 1974 this result does not need to worry us at all. Let us see 
     If we re-write the Cobb-Douglas production function as output per unit of work, we 

               y1 = eut Ka.................... (2)
Where y and k are the output per capita and the capital per capita. If we 
take the logarithmic derivative of (2) we obtain the standard formula with which dynamic 
Cobb-Douglas production functions are estimated empirically, with △y and 
△k being the rates of growth of the output per capita and the capital
per capita:

               dy = du + (3)

     Curiously a very similar result can be obtained by means of the identities of 
aggregate accounting. If w is real wages and r the profit rate, national 
income is:

               Y = wL + rK..................................................... (4)

Then the output per capita is:

               y = w + rK...................................................... (5)

     Later, if we take the derivative of equation (5) with respect to the returns over 

               dy / dt = w.(dw / dt) / w + kr. (dr / dt) / r + rk. (dk / dt) / k

Now we divide this whole expression by y. If we remember that (dy/dt)y is 
the production growth rate per capita, and the symbol "d" the indicator of the growth 
rate of a variable, we arrive at the following equation:

               dy = (w / y) dw + (rk / y) / dr + (rk / y) / dk................. (6)

This can be rewritten as:

               dy = T + B / dk................................................. (7)

Setting the real share of profits equal to:

               B = rk / y

Such that:

                T = (1 - B) / w + B. dr

     In this manner, the equations (3) and (7) are similar, with both parameters a 
and B representing the percentage of profits. However, the first equation is 
derived from the typical Cobb-Douglas production function and its restrictive assumptions,
while the second is nothing more than a dynamic expansion of the national accounts. 
Consequently, it is no surprise that, when shares in the income are approximately
constant over time and among sectors, the Cobb-Douglas represents a good approach, because
it can be derived from the identities in the national accounts!
     And do not think that this is something exclusive to the Cobb-Douglas. As Simon has 
well demonstrated, the same observations are valid for the much beloved by orthodox 
economists CES (constant elasticity of substitution) production function.
     In consequence, we can conclude that estimations by the Cobb-Douglas and other 
production functions have in no way proved the empirical validity of the orthodox 
postulate. On the contrary, it has been limited to only verifying countable identities 
that are fulfilled in a necessary mode independently of the Neo-classical theory. 
It remains then in the dust, the attempted empirical defense of the production function.


     The objective of this chapter has been to critically examine the orthodox theory of 
the production function. Basically we have seen that:
     1) Starting from the controversy of the two Cambridges the very existence of 
the production function has remained seriously in question since no coherent form of 
measuring capital has been found and thus, it becomes unviable to include it as a 
quantitative variable in the former.
     2) To attempt to resolve the above clinging, as the first Classical economists did, 
to a magical substance called "molasses" which would make capital malleable and 
homogeneous is simply improper because, as we have already demonstrated, there always are 
elements of irreducible heterogeneity that prevent us from aggregating different 
capital goods as if they were commensurable and divisible.
     3) The Neo-classical approaches can lead to inconsistent mathematical 
formulations regarding capital that only match in the absurd and non-existent case 
where the compositions of capital in all sectors of the economy are equal.
     4) By assuming technology as "given," the Neo-classical orthodox focus becomes 
absolutely sterile for explaining technological change, which is perhaps the most 
important element in production.
     5) By not considering the ecological limits and the non-existence of perfect 
reversibility that the law of entropy implies, the production function becomes 
unviable for our own survival. In turn, the pretended Solow-Stiglitz solution simply is 
not workable because its mathematical properties are openly counter-factual.
     6) The Cobb-Douglas production function, on which the orthodox analysis is 
intensively based, is in open contradiction with the greater part of reality where the 
relationship of productive factors is not so much of substitutability but instead of 
complementarity as seen in the Leontief production function which, however, becomes
very problematic with regard to the properties desired by orthodox economics, since it 
offers a zero degree of substitution and does not permit applying differential calculus.
     7) A large part of the attempted empirical proofs of Neo-classical production 
functions like the Cobb-Douglas or the CES are in reality spurious because their 
correspondence with the observed data are provided simply by a casual coincidence
of the identities in the national accounts when those are involved and the factor shares 
are relatively constant over time, which is common.
     All this constitutes a powerful cumulative case against the Neo-classically 
postulated production function. Thus, the orthodox theory of production is nothing more 
than a myth. May it rest in peace.

                        Chapter 3

                            "The main problem for Political Economy is to 
                                   determine the laws that regulate distribution."
                                                David Ricardo, Classical economist
The orthodox theory of distribution

     As we have seen in the previous chapter, in accordance with the concept of the 
production function, to generate a certain quantity of product two factors 
intervene: capital and labor. This product generates, in turn, in the market, an income 
for the enterprise. And it is there where the fundamental problem of distribution 
emerges, to wit: how do we perform sharing of that income among the factors that generate
     For orthodox economics the reply to this (in truth complicated) question is very 
simple: each factor will be compensated according to the value of its contributions to 
production. And how do we measure such contributions? Easy: by means of their 
marginal productivity. We shall explain this.
     In the first place, we should define the concept of productivity. By 
"productivity of a factor" is understood the quantity of product that a unit of it can 
generate. Thus, we can speak of the productivity per worker, per machine, per hour of 
work, etc.
     What, then, is marginal productivity? It is the quantity of additional product
that is obtained by incorporating one more unit of a certain factor, keeping all 
the other factors constant. Mathematically it is obtained in the following manner: first, 
we start with a production function Q = f(K, L) where Q is the level of 
production, K the capital, and L the labor. Later, in order to obtain the 
marginal productivity of a factor, we take the partial derivative of the production 
function with respect to the factor whose marginal productivity we wish to obtain, 
maintaining the other constant. That should be thus because, conceptually, a partial
derivative is that which shows an infinitesimal change in value of a function given an
infinitesimal change in one of the variable which comprise it, maintaining the others 
constant. With this form, in the case of the labor factor we would have that:

               PMgL = ∂Q(K, L) / ∂L
Where: PMgL is the marginal productivity of labor, dQ(K, L) represents the 
increment of production with capital K constant and dL represents the 
increment from the labor factor.
     With that, we already have all the necessary elements for modeling the orthodox 
theory of distribution, that is, for studying how the levels of profits (reward to 
the capital factor) and wages (reward to the labor factor) are determined. Given 
that in the previous chapter we have already spoken sufficiently about the capital factor,
in this we shall center upon the labor factor.
     Without more preambles, let us move to the analysis. How is it, then, that wages are 
determined in orthodox economics? Simple: they are determined like any other price, that 
is to say, in a market equilibrium. In this fashion, there exists for orthodox economics 
something called the labor market wherein the workers are the offerers and the 
businessmen are the demanders, and in which wages (price) and the level of employment 
(quantity) are negotiated.
     Thus, moving to a more thorough analysis, we have on the side of the offer, 
that the workers offer their labor power in a mode consistent with utility theory, 
performing a leisure-income choice of the type:

               Max U(x, l)     s.a : p . x = w . l............................. (1)

Where U(x, l) is a utility function that depends positively on the 
quantity of good x (that is, the greater the worker's consumption level, the 
greater will be her welfare) and negatively upon the quantity of hours l 
dedicated to work (which is to say, the greater the quantity of hours worked, the less 
will be one's welfare). The budget restriction tells us that the expenditure made (p . 
x) will be equal to the labor income obtained (w . l) In this way, the worker 
will offer their labor power following the logic of maximizing their utility subject to 
the budget restriction. Thus then, optimizing, the solution to (1) will be given as:

               UMgL / UMgx = w / p............................................. (2)

     On the demand side, we see that businesses confront a profit maximization 
problem of the type:

               Max Π = p . Q(K, L) - w.L - r.K............................ (3)

Where: Π is the firm's profit level, p is the price of the good 
that is produced and sold, Q(K, L) is their production level with a given level of
capital, w is the reward to the workforce L, and r is the reward to 
capital K which remains constant. Then, optimizing, the solution of (3) will be 
given by:

               PMgL = w / p.................................................... (4)

     Finally, in equilibrium, given that the supply and demand for labor must be equated, 
we shall obtain:

               w / p = UMgl / UMgx = PMgL

     The implications of this result are much more interesting than one might imagine at 
first sight. In the first place, it implies that the real equilibrium wage level
(w / p) is consistent with the needs for consumption and leisure of the workers 
(UMgl / UMgx). And in the second place, it implies that the capitalist pure free 
market system is the fairest system possible from a meritocratic perspective for it
rewards the workers (w / p) in an amount exactly corresponding to their 
contribution to production (PMgL). There was no reason, then, for the good Karl
Marx (along with all the Marxists) to rail against the capitalist system for exploiting 
the workers. Laissez faire capitalism is simply and totally perfect. Yet...can so 
much beauty be assured?

An unproductive concept: the sophistry of "marginal productivity"

     As we had seen at the beginning, the key concept of the orthodox theory of 
distribution is that of marginal productivity since it is starting from that that 
one can evaluate the input of each factor to the production process and, thereby determine
the part of the income generated corresponding to it.
     But, in truth does this treat of a consistent and valid concept? We think not. In 
the first place, because it necessarily depends upon the concept of production
function (the marginal productivity of a certain factor is obtained, mathematically, 
finding the partial derivative of the production function with regard to said 
factor) which, as we have already shown in the previous chapter, is plagued with logical 
and empirical inconsistencies.
     And not only that. Even if we accept the possibility of constructing production 
functions in a consistent fashion, the orthodox concept of marginal productivity would not
be redeemed by that given that in order to obtain the marginal productivity of a factor
--generally labor--it is necessary to assume that the other--usually capital--remains 
constant, which, in general, is factually impossible. Why? Because in actual
production it is almost never possible to isolate the contribution of one factor with 
respect to the other. The utilization of the factors is interdependent.
     For instance, if we were to want to know how only the increases in the labor 
factor influence the growth of production, that is, if we wished to calculate only the 
marginal productivity of labor (PMgL) it is obvious that we must assume capital 
remains constant. Yet can we really ensure that the capital remains constant as against an
increment of employment? Assuming that work is a homogeneous factor (as is assumed in
orthodox economics) an increase in employment would mean increasing the number of workers
per unit of time, which implies that the available capital would be utilized with more 
intensity than what had been habitual before the increment in the employment level.
But then, it would not be remaining constant!
     The orthodox economist could respond this is not so because it is nowhere necessary 
to vary the quantity of capital. But that only shows us that she is not 
understanding the true nature of the problem. In production the amounts of potentially
available capital and labor are not primarily important, but instead rather the 
quantities of capital and labor actually used. If we have a great stock of capital 
and a large number of workers yet do not use them, we simply cannot generate any 
production! Therefore, the relevant concept here is that of utilization more than 
that of availability.
     Having that in mind we can pose the previous argument in a much clearer form: with 
an increase in employment perhaps the fixed capital remains constant, yet not 
its degree of utilization! Consequently, how can we ponder the increment in production
with an increment in the labor factor if it also is changed the utilization of capital? It
truly is a difficult--not to say impossible--task given the continuous interdependence 
between capital and labor that we always observe in reality.
     The distinguished English professor Eric Roll had reason then, in his famous work 
History of Economic Doctrines, to write that: "The notion of a specific 
productivity independently from a factor is an abstraction, and can have no relation to a 
problem as realistic as the justification of a certain level of remuneration. The 
product is the joint result of factors employed in combination, and the 
asseveration that wages are equal to the net marginal product of labor has to be 
considered as only one of the elements of a theory of wages."

A theoretical anomaly quite normal in practice: the Leontief function
and marginal productivity

     As we had explained in the previous chapter, the Leontief production 
functions, which relate the quantities of capital and workforce in fixed proportions, 
if indeed are considered mere "theoretical anomalies" by the orthodox economists, are 
nevertheless the most common in practice. In effect: in the real world it is observed 
that the relationship between the productive factors is more one of complementarity
than of substitution. Capital and labor are strictly interdependent in the 
productive process. Orthodox theory can do little or nothing before the patent realism of 
this assertion.
     Now, as we also had seen the the previous chapter, the Leontief functions do not 
behave at all well in the orthodox production theory. Will they behave better in that of 
distribution? Lamentably no. These functions, just like in reality, are quite maladjusted 
to the entelechies of orthodox economics. Principally because they do not permit obtaining
marginal productivities. What?! Yes, what you heard. If we start from a world where 
production is given in the typical Leontief form Q = min(aK, bL) which is a world 
very similar to the actual, marginal productivity will not exist either for the 
capital factor nor for the labor factor. In effect, mathematically:


     Let us illustrate with an example: if a man (L) is digging a well with a 
single shovel (K), to incorporate a second person maintaining constant the quantity
of shovels, the depth that can be dug per unit of time (PMgL = 0) will not 
increase at all. Why? Because of the constitutive restriction on the production
process to which we are referring: one man, one shovel.
     Thus we see with clarity that, given the constant complementarity between the 
worker and the capital, such a thing as the productivity of labor does not exist 
independently of capital nor the productivity of capital independently of labor. In other 
words, at least in the great majority of instances, marginal productivity as 
conceptualized by Neo-classical economics does not exist.
     We now have, then, analyzed the fundamental concept upon which the orthodox theory of
distribution rests. Now we shall move to analyzing the specific case of the "labor 
market." We shall commence on the side of supply.

A theory that through sloth does not change: leisure and the work offer

     In accordance with the orthodox theory, to decide under what conditions to offer 
their labor power, people confront the sort of decisions known as leisure-income 
decisions where what determines the number of hours they will be disposed to work is 
such which maximizes their welfare equilibrating the hours of leisure with the hours of 
work necessary to get the income with which to finance their consumption.
     Starting from that, as a result of the individuals' leisure-income choices, 
the orthodox theory advances to construct the individual labor offer curve, which 
relates the hours of work that the individuals will offer with the different wage levels. 
Later, adding all the individual labor offer curves, the aggregate labor offer 
curve is obtained, this being that which in its intersection with aggregate labor demand 
determines the employment level and equilibrium wage.
     All this sounds very orderly and pretty, yet there is a small problem... As the 
orthodox theory itself well accepts, starting from a certain point (in general, when too 
many labor hours are being offered) individuals begin to have a much stronger preference 
for leisure than for income and, consequently, are now unwilling to work more hours even 
before important salary increases. Even more: to the degree that the workers' wage levels 
increase fewer work hours begin to be offered. Why? Because the individuals need the 
leisure time to spend and enjoy the income that they obtain from their work. Thus, if 
indeed at the beginning they have a great incentive to exert themselves for better 
remuneration, the moment shall arrive when they commence to value their leisure hours more
than the increments in their wages and, in consequence, will offer fewer hours of labor. 
To understand this logic in more simple terms: one works to live, not lives in order to 
     Now then, if it occurs that individuals behave such as we have just described them 
(and as the orthodox theory fully accepts for analyzing leisure-income decisions) we shall
have to accept that individual labor offer functions do not only proceed in a growing 
direction, which means, as positive functions of the type: "the more the wages, the more 
the hours of work offered," but instead that at a certain point they will cure backwards, 
ending with a shape similar to that of an inverted "C." This is shown in the following 
graphic where w  represents the wage levels and L represents the labor hours


     Yet what is the problem with it? A large problem to tell the truth. Given that the 
market aggregate labor offer curve is obtained by adding the individual work offers it 
will follow that, if these are sloping backwards, the former will present many 
irregularities, now sloping backwards or forwards, generating many points of intersection 
with the aggregate demand curve and, therefore, breaking with the assumed existence of a 
unique and stable equilibrium in the employment and wage levels of the labor market.
     But not only that. Even were we to accept that the labor offer theory of orthodox 
economics is well constructed, one would have to say that it merely deals with a fiction 
proper to the Neo-classical world of the "Alice in Wonderland" type for it is more than 
evident that in the labor markets of real capitalist societies the number of labor 
hours depends practically not at all upon individual "leisure-income choices" but instead 
more on institutional restrictions (think of the 8-hour regime) or upon business 

Is the notion of free and competitive labor markets pertinent? The
institutionalist critique

     As we have seen, the orthodox theory of distribution is based upon the notion of 
"labor markets," that is to say, spaces (not necessarily physical) in which 
businesspersons (demanders) and workers (offerers) mingle to transact employment and wage 
levels in a free and competitive context.
     Yet does this constitute a pertinent notion? Our opinion is no, and we are very 
solidly and decidedly supported by the institutionalist school. Let us see their 
     In the first place, we have the phenomenon of collective bargaining and the 
unions. With regard to this it is interesting to indicate the context in which the 
institutionalist labor focus originated. The institutionalist theory of labor 
markets emerged during the decade of the 1940's in the United States, at a moment when
the syndicates were growing rapidly in that nation and centralized collective bargaining 
was being promulgated. That caused certain economists to consider that the orthodox 
theory of wages had ceased being realistic and relevant. Why? Because collective 
determination of wages in the presence of unions was very far from competitive, this being
above all a qualitative and not merely a quantitative difference. And indeed
the unions are fundamentally political and not so much economic institutions, that act in 
a context of "pressure plays" among the government, the businesspersons and the workers 
themselves following a logic of negotiation over one of optimization.
     As a consequence of the foregoing, the wage comes to be more an administered 
wage than a market wage. And in effect, given this context of collective 
bargaining, the wages become a fruit of conscious human decisions and now not from 
impersonal market forces. Or in any event, as the institutionalists say, instead 
of it being the salary that adjusts to the supply and demand for labor, it is the supply 
and demand for labor which adjusts the wage.
     The second critique by the institutionalist economists of the orthodox theory of 
distribution is based upon the famous theory of the dual labor market. In accord 
with this theory--originally proposed by Doeringer and Piore--there exist two well-
differentiated types of labor markets: primary and secondary.
     The primary labor markets are, by definition, where the "good" work positions 
are found. Their characteristics are: 1) stability and security, 2) high and growing 
wages, 3) constant labor training and education, 4) opportunities for advancement on the 
scale of positions, 5) utilization of advanced and capital-intensive technologies, and 6) 
the existence of effective and efficient unions.
     On the contrary, the secondary labor markets are those where the "bad" 
workforce posts are found. Their characteristics are: 1) instability (because of high 
worker turnover), 2) low and relatively stagnant wages, 3) lack of labor training and 
education, 4) non-existent scales of positions or having few possibilities for 
advancement, 5) use of superseded labor-intensive technologies, and 6) the non-
existence or precariousness of unions.
     Why does this comprise something problematic for orthodox economics? Simple: because
it contradicts that postulate whereby the justice of capitalist distribution is 
"demonstrated," namely, that each worker is paid according to her productivity. And
if indeed duality exists in the labor markets (or, at least, in a large part of 
them) we shall find that wages are now not only and primarily determined by 
individual productivity of the workers but rather instead by the type of labor 
market to which they belong (primary or secondary).
     Perhaps an orthodox economist can object at this point that even accepting the 
existence of duality in the labor markets one need not negate the mobility of the workers 
since it may very well be the case that a worker belonging to a secondary labor market 
increases her productivity and moves to the primary. Obviously this case can occur, and on
occasion does occur. But it is the exception, not the rule. And even more so when 
the characteristics of the secondary labor markets are inter-related and have mutual 
feedback. In effect: as a consequence of the low level of wages paid in this type of 
market, the businessmen have no great incentives to introduce labor-saving technologies 
and, consequently, the productivity of the workers stalls together with their wages (not 
to mention the case where this type of technology is introduced but the wages do not go up
in order to thus obtain greater "profits"). And not only that. The presence of a stagnant 
technology from then on diminishes the opportunities and incentives for workers to improve
their qualifications. Thus, it is not so simple for a worker under these conditions to 
"ascend" to a primary labor market.
     Finally, the third line of critique by the institutionalists has to do with the 
existence of the so-called internal labor markets. An internal labor market can be 
defined as an administrative system of an enterprise that is guided by a set of intra-
institutional rules and procedures to establish prices and allocations of the labor 
     Thus, in accordance with this focus, even were we to accept the orthodox theory of 
the setting of wages via supply and demand we would have to say that its validity ends at 
the enterprise's door, that is, exactly where this theory ought to apply. Why? 
Because from the door inwards the most "universal" and "apodictic" laws of supply and 
demand are immediately replaced, as we have already said, by an entire series of internal 
rules and procedures to determine the positions and salaries of the employees.
     Any economist who may have had the opportunity to know real businesses will 
notice that the existence of those so-called internal labor markets is not a mere 
"bureaucratic anomaly" but instead deals with a widely extended phenomenon in business 
organization and administration. The main reason for that is the need which firms 
(especially medium and large ones) have to reduce labor turnover. In the first place, 
because the replacement costs for personnel usually are quite high (not thinking only of 
monetary ones) and, in the second place, because on investing in the specific 
qualifications of their workers the businessmen are conscious that they should stabilize 
the employment in order to obtain a better and sustained return for these investments in 
human capital.
     So, taking as a fundamental referent "free" and "competitive" labor markets in the 
sense that orthodox economics does is nothing more than believing in a theoretical fiction
having nothing to do with reality and that in the final account obscures and complicates
its correct comprehension. And that is well-known by the university professors of 
economics who, on one side, in the shelter of classes, speak of the sacrosanct "free" and 
"competitive" labor markets and, on the other, when leaving the hall, do not confront the 
daily perspective of being displaced from their work by another equally capable person 
willing to work for a lower salary. Thus, in practice, though it may be in an unconscious 
manner, not even they themselves take as a central referent what orthodox theory says...

To each according to their contribution? The multi-product case

     On reading the above critique surely the woke reader will have taken note of an
important detail: if in the internal labor markets the workers are not paid in accordance 
with labor supply-demand but instead more based upon rules and administrative procedures, 
there is no reason to suppose they are paid in correspondence with their marginal 
productivity and, it follows, nor must one assume that capitalist distributions 
are necessarily just.
     In what follows, we shall demonstrate this point mathematically using the 
scheme of orthodox economics itself. For that we shall start from a joint or multi-
product production function, that is, one whose basis is formed not from a single 
product but instead various. Perhaps the reader accustomed to the mono-product 
production functions presented in microeconomics and macroeconomics texts will suspect 
this point of departure. Yet there is no reason. In the first place, because the joint or 
multi-product production functions are perfectly possible in the orthodox theoretical 
scheme. And, in the second place (and this one interest us the most) because they are the 
preferences of reality. In effect, anybody who has not remained solely in the 
textbooks and has been able to study real businesses will have seen in 
practice that what is most common is not that a single homogeneous good is 
produced but rather instead that a whole series of differentiated goods and/ or services 
are, each with its proper price.
     Thus, we have Qi = f(L, K) different goods and/ or services 
produced by the firm, each one with its respective price pi. On the work 
factor side, we denote this with Lj, with j being the business' department, 
occupations or categories. Now wj wage units are paid according to departments or 
occupations and zj rates per worker. On the capital factor side, to simplify, we 
measure it directly as a function of its cost as Mk.
     With this data we shall have the following function for profits:


Where the incomes I are given by the quantities of each good sold multiplied by 
its price and the costs C for the labor costs (wages and benefits) in each 
department together with the costs of capital.
     Now, assuming that we are in the short term, with the capital factor constant and the
labor factor variable, we derive that the businessperson can only maximize profits 
varying the quantity of labor (the price of the product cannot vary because it is "given" 
by the market). Mathematically that will imply equating to zero the derivative of the 
profit function with respect to total labor (the initial L of the joint production 
function). Operating with this equation we obtain that the result of the maximization 
with respect to total labor is given by:


which is actually the formula for payment of wages in the modality of "joint 
production" with social benefits.
     Now, to correctly analyze the marginal productivity we have to consider the labor 
L from two points of view: one, which we have already explained, as a function of 
the m departments, occupations or categories (j) of the enterprise; and 
another, as a function of the quantity of work incorporated into any of the n goods 
and/ or services that the firm produces. Thus, it will follow that:


Then, replacing the corresponding terms of (2) into (1), we derive that the equation for 
the marginal productivity under the modality of joint production will be:


Where the first term is the value of the marginal productivity of labor considered for a 
specific product and the second, the remuneration (wages and benefits) for labor applied 
by specific department and product.
     The implications of this last expression are truly demolishing for the Neo-classical 
distribution theory. And indeed, in accordance with this, it is no longer necessary 
for the businessperson to pay his workers in a specific department or area in accord with 
their marginal productivity. Why? Because for condition (3) to be realized, deduced 
from maximizing profitable conduct, it suffices that the businessperson equate the joint
sum of value for the marginal productivities according to the labor incorporated  into
each one of the commercialized goods and services (dLi / dL).
     In this form, what matters is the equating of the sum of values of the marginal 
productivities to the sum of the wage (and benefit) units considered,  not 
necessarily that each be paid "according to their contribution" (although it might be the 
case that this results, but that would only be by chance or through an ex-
ante administrative policy having nothing to do with the orthodox dynamics of the 
labor market). Or it may occur, to illustrate with an extreme case, that the group of 
workers who effectively contribute 80 percent of the production are only paid ten percent 
of the wage total and that the group who only contribute 20 percent are paid the remaining
90 percent without thereby violating the logic of business optimization which the orthodox
theory proposes. It is enough simply that the sum of salaries be equated with the sum of 
the productivities evaluated, independently of how such wages are distributed among the
people who participated in the productive process.
     How will they determine, then, the wages for each of the business' departments? Most 
probable is that it will be done according to the institutionalist dynamics of 
collective  bargaining, dual labor market and above all internal rules and 
procedures, in which hierarchical power relations and pressure tactics
weight more than the criteria and principles of social and distributive justice.
     In conclusion, the "marvelous" meritocratic distribution system of orthodox economics
fails precisely in that case most common in reality, to wit, the case of joint production 
and by departments, for then it cannot be assured that each worker shall be paid 
according to their marginal productivity. Productivity is disassociated from wages and,
in consequence, all the discussions fall to the ground concerning just distribution under

Is the labor factor merely a cost? A critique from Keynesian and neo-Keynesian 

     Within the schema of profit-maximization of orthodox economics the labor factor, just
like the capital factor, is considered above all as a cost for the businessperson. 
Clearly shown thereby is that, in the so-called "factor choice to minimize costs" that 
orthodox economics postulates, the businessman makes the best decision when she locates 
the lowest level of costs that a certain volume of production is allowed to 
generate, with her function for minimizing costs:

               CT = w.L + r.K

The matter seems sufficiently obvious: given that the labor factor must be compensated 
with a wage, this should be considered primordially as a cost. Yes, will it be only a 
cost? Of course the orthodox economist will respond, no and adduce that the labor factor 
is not only a cost but also a productive factor which, in union with the capital, 
generates the product. However, there are many economists who consider the matter to go 
far beyond that.
     In the first place we have the Keynesian economists. They start from the 
notion of the fundamental psychological law enunciated by Keynes and according to 
which "when real income increases, consumption also increases, although not as much as 
income." In this mode, if they increase one's salary, if in fact he will not spend 
everything, his consumption level will increase. The consequence? That an increase in the 
level of real wages of the workers will imply not only an increase in business costs but 
also will have a synergistic macroeconomic effect since, upon causing the increase 
in consumption among the great mass of workers, it will stimulate aggregate demand for 
goods and services and, therefore, also production. And who will benefit from this 
increase in production? Why (in addition to the economy in general) the businessmen  
     Another group of economists who question the orthodox scheme of minimization of costs
with respect to the labor factor are the neo-Keynesian economists. Their basis is 
the notion of efficiency wages. What are efficiency wages? They are a wage level 
such that it stimulates persons to improve their levels of efficiency and productivity in 
their work. In this instance it follows an inverse logic from that of the Neo-classical 
orthodoxy: it is not that workers are paid little because they are less productive but 
instead that they are less productive because they are paid little.
     According to Romer, the existence of this type of wages is due, basically, to three 
     In the first place, to that a high wage can contribute to increasing the effort of 
the workers when the enterprise cannot control its throughput due to a lack of adequate 
mechanisms for supervision of the productivity.
     In the second place, a high wage also can contribute to improving the capacities of 
the workers at an enterprise by affecting specific aspects that cannot be controlled 
because they occur in a context of imperfect and asymmetric information. That can be the 
case, for example, in the processes of personnel selection. Thus, if we assume that the 
reserve wage of the qualified workers is greater and the business decides to pay wages in 
excess of the market equilibrium, it will attract the more capable workers and, therefore,
increase average labor productivity.
     Finally, a high wage can stimulate a feeling of loyalty in the workers and induce a 
greater effort. Or the contrary, if the workers have the perception that their 
remuneration is inferior to that due they could quit the company, reduce their level of
effort, and resentment can even result in acts of sabotage or negligent behaviors.
     Evidently such a logic has its limitations for it cannot deny that in every way 
productivity is one of the factors that influence the determination of wages (not 
to mention the fact that by doubling the pay of a person this will not necessarily result 
in a doubling of productivity for were this so, it would be sufficient to pay one 
infinitely in order for them to be infinitely productive) but in any case it puts an 
extremely important consideration on the table, to wit: that a person works better when 
they feel well and find themselves in good conditions. But given that the wage level has 
to do with that, it is evident that these are not a mere "cost" but also can be considered
in a certain sense as an investment in human capital.

The final blow: Sraffa's devastating critique of the orthodox theory of distribution

     In the year 1960 the Italian economist Piero Sraffa, founder of the Neo-Ricardian 
school, publishes one of the most feared books in the history of orthodox economics. Yes, 
in effect we are referring to his work Production of Commodities by Means of 
Commodities : prelude to a critique of economic theory.
     Sraffa's principal contribution is this work is to demonstrate that the 
distribution of the economic surplus into profits and wages is above all a social 
phenomenon that is not necessarily dependent upon production. More specifically, what 
Sraffa demonstrates is that the distributive variables (profits and wages) do not in 
themselves depend on the methods of production, nor are resolved with a derivative of the 
production function, nor necessarily correspond with the marginal productivities of the 
factors. In this manner, the problem of the distribution of the economic surplus 
between workers and owners, if not already outside of the field of economics itself, at 
least is so regarding production.
     Yet how is it that Sraffa comes to this surprising conclusion? Consistent with his 
project of actualizing the approaches and focuses of the classical theory in order 
to criticize the Neo-classical theory, he begins by analyzing the problem of 
distribution centering upon the concept of the surplus, that is to say, the income 
generated in the process of capitalist production and re-production that the
owners of capital obtain and which should be divided into salaries and profits.
     Starting from there they construct a linear model of production by which it is
possible to determine the structure of relative prices and of one of the two distributive 
variables (level of profit or wages) with the other variable and technology given 
exogenously, this latter being represented by the physical quantities of the individual 
goods necessary to produce the diverse merchandise.
     As a result of this approximation Sraffa revives Ricardo and Marx's iron law of 
wages. In effect, resolving the system of relative prices in his model confirms that 
the relationship between wages and profits is effectively inverse according to the

               r = R . (1 - w)................................................. (1)

Where r is the level of profits, w the wage level and R the surplus 
(income) to distribute.
     It is obvious why in this expression we say that the relation between wages (w)
and profits (r) is inverse. Given a level of surplus R to distribute, the 
greater are the wages the less will be the profits, and while the profits are greater, 
the wages will be less. The only difference from David Ricardo and Karl Marx is that here 
the wage is paid with part of the surplus, something like in the case of Marx where 
surplus value is defined dividing only the constant capital (c) and not with the 
sum of the constant capital and the variable capital (c + v).
     Now, as Foncerrada aptly observes, "it is important to notice that in Sraffa's scheme
it is not defined which of the distributive variables should be fixed. This means that 
the system remains open to accept an independent theory of wages, such as all the 
classical authors had, furthermore providing an opening--insofar as w is 
paid with part of the surplus--for admitting modern theories about the payment of 
certain compensations to the workers and employees, the non-salaried in general, with
part of the surplus product. A surplus which originally, in the theory, was solely 
utilized for paying the owners of the means of production. Or, in the same fashion, 
one is open to add an exogenous theory of the type of profit to the system. This 
also offers the possibility, in the modern economy, where there is great mobility of 
capital, of allowing a theory of profits that can be integrated into the system. In other 
words, Sraffa's distributive parameters, not being predetermined, offer a system open 
to theoretical constructions concerning their determination.
     Thus then, as can be gleaned from the foregoing, Sraffa's scheme provides us with a 
more open and realistic model than the Neo-classical for analyzing the distribution 
problem as it really is: a primordially social phenomenon.
     Yet Sraffa's scheme not only offers us constructive possibilities but also 
some very interesting destructive implications (for orthodox economics, that is). 
For if this focus is correct, then now there is nothing sacrosanct about the 
distribution of income for it, instead of reflecting technical relations of 
productivity, will reflect social relations of production determined by the 
relative power of the different groups in society (though, and it is important to 
note, that too is in some measure restricted by the technical limits of production). In 
this way, given a technological framework, the distribution of the net product or social 
surplus will be open in its determination to multiple social forces and, 
 consequently, now will no longer be treated solely as a "technical" matter.
     Yet even if we remain only with the mere technical aspect the orthodox theory 
continues to be highly questionable for there still persists the famous problem of 
"technics reversing" signaled by Sraffa. The reswitching of techniques or 
double-switching of techniques denotes the possibility that a certain technics can 
be more profitable than all possible other technics for two or more values separated by 
profit rate even though other technics may have been more profitable at intermediate 
levels. From that one deduces the also famous capital reversing, which is the 
possibility of a positive relation between the value of the capital and the profit level.
     Why does all this become so inconvenient for the Neo-classical economic theory? 
Simple:  because that assumes that a reduction in the type of interest would lead to the 
use of more intensive capital techniques, and Sraffa, by proving capital reversing 
and reswitching of techniques as theoretical possibilities, casts such a 
supposition to the ground. Specifically, Sraffa demonstrated that that elementary relation
of orthodox economics did not have to be so: starting from an initial equilibrium 
(r0, K0, L0) a reduction in the price of capital
(from r0 to r1) makes its employment more profitable 
at the expense of the labor factor (r1 < r0, K1 > 
K0, L1 < L0) but successive reductions can reverse 
this situation, making a more labor-intensive technology profitable (r2 < 
r1, K2 < K1, L2 > L1).
     The conclusion is immediate and serious: orthodox economics cannot ensure the 
existence of an inverse and monotonic relation between the demand for a factor and its 
price. Thus, the grand implication of the reversion of technics for the marginalist focus 
is that, inasmuch as there ceases being a general relation between the profit rate and the
quantity of capital that is utilized, the possibility ends of using the profit rate as 
an indicator of the capital intensity, that is, it no longer functions as an index to 
the scarcity of the capital amount, and it remains in doubt as an instrument for 
allocating resources. From this, Sraffa concludes that: "Investments in the direction 
of the movement of relative prices, confronted with unvarying production methods, cannot 
be reconciled with any notion of capital as a measurable quantity independent of 
distribution and of prices."
     This critique was so convincing that Paul Samuelson himself, a distinguished member 
of the orthodox team in the famous "Holy War" regarding capital to which we have referred 
in the previous chapter, had to recognize that: "The phenomenon of the reversion to a very
low interest rate on a set of technics that had only seemed viable at a very high 
interest rate suggests more than an esoteric technicality. It indicates that the
simple stories of Jevons, Böhm Bawerk, Wicksell, and other Neo-classical authors 
cannot be universally valid. So, as Maurice Dobb said, the reversion of technics 
"gives the 'coup de grace' to any notion of a production function and hence to the 
identical idea of marginal productivity as a determinant of the gain."


     The object of this chapter has been to critically examine the orthodox theory of 
distribution. Basically we have seen that:
     1) The notion of marginal productivity itself can be questioned showing that 
it is almost impossible to calculate it in empirical terms because it proves unviable to 
isolate the contribution of one factor with respect to another in the real productive 
     2) Simply and clearly marginal productivity does not exist when dealing with the 
production modality most common in practice: the Leontief function.
     3) The backward curvature of individual labor offers beginning at some wage level 
places into question the uniqueness of the equilibrium in the labor market and, 
furthermore, the leisure-income model has almost no relevance before the institutional
restrictions of the contracting regimes of the real world.
     4) The notion of "free" and "competitive" labor markets becomes light and even 
insubstantial if we contract it with the approaches of the institutionalist school with 
respect to collective bargaining and dual and internal labor markets.
     5) When the relevant multi-product case is examined, that is to say when more 
than one good is produced, it is found that it is no longer necessary for each 
worker to be paid in accordance with her individual marginal productivity, which 
then opens the door to unjust and arbitrary forms of distribution as the requisites that 
the orthodox theory imposes are fulfilled.
      6) To consider wages as mere business costs is excessively reductionist if we 
compare it to the Keynesian (synergistic macroeconomic effects of stimuli to 
effective demand) and neo-Keynesian (efficiency wages) visions.
       7) By means of the Sraffa critique it was demonstrated that the 
determination of profits and wages ended by dissociating from production as a purely 
technical phenomenon and, thus, remained open to the influence of multiple social forces 
and the implied power relations.
     All this constitutes a powerful cumulative case against the Neo-classical 
vision concerning capitalist distribution. Accordingly, the orthodox distribution theory 
is nothing more than a myth. May it rest in peace.

                        Chapter 4
                        THE MYTH OF PROFIT MAXIMIZATION

                            "Businesses behave as if rationally seeking to maximize 
                                   their expected profits and possessing complete knowledge
                                   of the necessary information to achieve such a goal."
                                                Milton Friedman, Nobel Prize 1976
The orthodox theory of profit maximization

     In the first chapter of the present book we analyzed the theme of consumer 
rationality. Now, we shall approach the subject of the rationality of the firm.
     The firm, in the capitalist system, is defined above all as the basic 
unit of production. In other words, it concerns "an organization which transforms 
factors into products." With regard to how it does that we have already spoken in 
the two previous chapters. Here we shall be occupied with why. That will carry us 
to the question of the business' objective.
     What is, then, the objective of businesses? A complicated question. Yet again 
orthodox economics has a simple answer: the goal of enterprises is to maximize 
     Such a response seems quite logical. The owners seek to obtain the maximum possible 
profits from their enterprises and these, given that they exist solely and 
exclusively to serve their interests, will seek such a goal. At this point professor 
Nicholson explains that "this focus assumes that the decisions of the business are taken 
by a sole, dictatorial administrator who, in rational fashion, pursues an aim which, 
generally, consists in maximizing the economic profits (or gains) of the business."
     But, what do enterprises do to maximize profits in the Neo-classical scheme? Well, as
always: by means of marginalist analysis, which means, applying differential calculus. We 
shall see how.
     We start from the profit function. These are constituted as the difference between 
the total income and total costs that the firm has in selling and producing a 
specific good, respectively. Thus, the profit function is given by:

               B = I(p, q) - C(q).............................................. (1)

Where B is the profits, I the total income (being a function of price 
p and quantity sold q) and C the total cost (being a function of the 
quantity produced q, which also is equal to the quantity sold).
     Now in order to maximize function (1) we apply the First-order condition, that is, we
equate the derivative of the profits function with respect to quantity, to zero (we take 
the quantity as the variable because the price, at least if we assume perfect 
competition, if given exogenously by the equilibrium of supply and demand in the 
market for the good in question).

               dB / dq = dI(q) / dq - dC(q) / dq = 0........................... (2)

     But since in this case we are analyzing the variation in total income (I) and 
the total costs (C) as a consequence of a variation in the production level 
(q) we derive that dI(q) / dq will be the firm's marginal 
income (IMg) and dC(q) / dq, the marginal cost (CMg). Therefore:

               dB / dq = IMg - CMg = 0......................................... (3)

     From which, finally, we obtain the golden rule for the maximization of 

               IMg = CMg....................................................... (4)

Which tells us that the production level by which the enterprises will maximize profits 
will be that equating the marginal cost with the marginal revenue.
     We can easily understand the above in an intuitive manner: given a marginalist 
scheme, if the owner-manage wishes to maximize profits she will adjust her production to 
the point where she can no longer augment her profits. In this way, while the marginal 
benefits of producing one more unit are positive (BMg = IMg - CMg > 0), she will 
produce additional units up to the point where, if it continues, losses are incurred 
(BMg = IMg - CMg < 0). We are referring, then, to the point where marginal profits
are zero and the golden rule IMg = CMg is fulfilled.
     Likewise it is important to note that in the case of perfect competition--where the 
marginal income, or that is the additional income which the enterprise obtains by selling 
one more unit of the product, equal to the price--the general rule will be the following: 
"A profit-maximizing business should set its production at the level where the marginal 
cost is equal to the price."

No to the "mechanical optimizer"! The Schumpeterian conception of the entrepreneur

     As we just saw, analogously to the case of the consumer, Neo-classical orthodoxy 
postulates a model of mechanistic rationality that reduces the labor of the businessman 
a mere exercise of optimization: they simply should produce there where the marginal cost 
equates to the marginal revenue to maximize profits.
     This sort of conception of the economic problem as a mere optimization problem comes 
from the very definition of economics used by the orthodox Neo-classical 
economists. Thus, following Robbins, they propose that "economics is the science that 
studies human behavior as the relationship between certain given ends and scarce 
means susceptible to alternative uses." Here means and ends appear as given and, 
therefore, everything is reduced to a technical problem of allocation. However, to think 
in this way is to ignore that which the Austrian economists have correctly identified as 
the fundamental element of the economic phenomenon: human action. In effect, human
action is essential and constitutionally free and creative and, consequently, not 
circumscribed merely to "given" means and ends but instead is defined precisely by 
discovering and creating new means and ends.
     The latter is especially true for the businessperson. And precisely there is how 
Joseph Schumpeter, one of the most distinguished Austrian economists of the 20th century,
approached his visions of the entrepreneur. In particular Schumpeter conceptualizes the 
entrepreneur essentially as an innovating businessperson. In fact, such is the 
importance which Schumpeter gives to this innovating character of entrepreneurial activity
that he does not conceive the businessman as a "person" or "role" but instead more like a 
function that exists only in the act of innovating: "Whatever the type may be, it 
is only entrepreneurial when it actually brings new combinations into practice, and 
loses that character insofar as it turns into negotiation, when one begins to exploit 
others as they exploited him... The entrepreneurs belong, therefore, to a special type, 
and their conduct is the reason for a very significant number of phenomena... It is 
precisely this 'doing,' this 'putting into practice,' without which possibilities are 
dead, in which the function of the leader consists."
     Thus, then, there is a clear distinction between the mere administrator and 
the authentic entrepreneur: the administrator adjusts passively to the market 
conditions, and the entrepreneur actively creates new market conditions; the administrator
behaves like her competitors, and the entrepreneur outstrips her competitors; the 
administrator operates quasi-bureaucratically, while the entrepreneur innovates.
     With this understood anyone can see that the Neo-classical theory is nothing more 
than a theory about "mechanical administrators" and not about the dynamic 
entrepreneur. But it is this latter that is truly relevant for studying economic 
change and, therefore, the evolution of the economy. And it is precisely there 
where the great limitation of the orthodox theory resides since it is based simply upon 
optimization and the analysis of comparative statics. Schumpeter very elegantly explains 
it: "The theory in the first chapter (he refers to the orthodox theory) describes economic
life from the viewpoint of the tendency of the economic system towards a position of 
equilibrium, a tendency that offers us the means for determining prices and quantities of 
goods, and which can be described as an adaptation of the data existing at the moment...
Nevertheless, the position of an ideal state of equilibrium in the economic system, never 
reached, despite the constant struggle to attain it (naturally in an inconsistent form) 
changes because of the change in the data. And the theory lacks defenses before this 
latter... It cannot predict the consequences of discontinuous alterations in the 
typical way of doing things; nor can it explain the origin of such productive revolutions, 
nor of the phenomena that accompany them. It can only investigate the new equilibrium 
position following the realization of the alterations. And our problem is precisely the
occurrence of the 'revolutionary' changes, the problem of economic development in a very 
strict sense."
     In this fashion, if one is solely interested in studying the dynamic of "an 
unimportant storefront" they can follow the Neo-classical theory and the method of 
comparative statics. Yet if they are more interested in understanding the relevant 
disruptive changes in the present context of the Third Industrial Revolution what 
they should do is to abandon the sterile scheme of orthodox economics for indeed the world
changes radically... So we should also radically change our theoretical schemas!
     Yet Schumpeter's theory contains an epistemological implication even more destructive
for Neo-classical economics, a true monument to "creative destruction" at the theoretical 
level if we only know how to understand it. In Neo-classical economics everything 
is structured as a function of equilibria: equilibrium between marginal revenue and 
marginal cost, equilibrium between supply and demand for goods, equilibrium between the
supply and demand for factors, etc. Even more: everything moves as a function of 
equilibria. If there is some change in the exogenous data the economy simply adjusts 
towards a new equilibrium. In other words, the economy advances "from equilibrium to 
equilibrium." However, what Schumpeter is correctly telling us is that in the development 
of the economy there is an essential element of innovation that has a dynamic such 
that breaks the "circular current." It is about the businessman who not only discovers 
but also is even capable of creating new economic opportunities transforming the 
economic environment around him. He does not adjust passively to a supposed "equilibrium" 
but instead actively generates disequilibria, which, when they are on the verge of 
becoming "equilibria," will be newly "disequilibrated" through innovation. Thus, in 
reality the economy advances "from disequilibrium to disequilibrium" and, consequently, 
the notion of equilibrium as a structure of the economy is destroyed. What then remains
of Neo-classical theoretization... Understood properly, few words.

"Animal spirits": the problem of uncertainty

     The orthodox theory having established that "the goal of the enterprise is to 
maximize profits" the question of temporality necessarily arises, that is to say: for what
period do we maximize profits; for the present or for the future?
     The question is in no way trivial. It might well occur that the owners do not wish 
for short term utilization to increase at the expense of the long term, and vice versa, 
and even may not have a clear perspective in this regard. Nevertheless, for variety, 
orthodox economics will have quite a simple response to such a complex difficulty. In the 
words of Pepall, Richards and Norman: "We should adapt our usual hypothesis that 
businesses maximize utility to signify that firms maximize the present value of 
all actual and future uses... In the case of problems of a single period this is 
identical to the hypothesis that firms simply maximize their utility." Ergo, the 
businesses maximize the present value of all the uses generated throughout their 
period of operation.
     The implication of this is that for the orthodox scheme of profit maximization to 
keep functioning one must necessarily assume that the businessmen  deal with 
and complete information. Why? Because if we do not have perfect and 
complete knowledge of the future and of all the variables which affect such 
decisions we cannot make optimal decisions much less obtain maximum profits.
Thus Friedman in his defense of the orthodox theory must say that businesspersons, in 
their rational pursuit of maximum profit, act "as if they possessed the complete 
knowledge of the data necessary to achieve such an end."
     Yet, does this fulfill the cited condition in reality? Evidently not. In the real 
world we all (businessmen are not an exception) act with incomplete information. We
are not omniscient. We shall never have perfect knowledge of all the variables and 
conditions that affect our decisions and even less, perfect knowledge of the future. 
Therefore, we confront the problem of uncertainty.
     It was precisely this problem which the great English economist John Maynard Keynes 
took as his starting point to analyze the dynamic of business decisions. In particular 
Keynes distinguishes two types of uncertainty. The first is called probabilistic 
uncertainty and is that which occurs when we can model some future scenarios and 
assign them certain probabilities of occurrence. In this scheme the statistical-
mathematical models function reasonably. The other type of uncertainty is fundamental
uncertainty. Here things are fundamentally uncertain and to assign them specific 
probabilities becomes inconvenient and even ridiculous, such that the statistical-
mathematical models break. In this respect Keynes writes: "The game of roulette is not
subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being
drawn. Or, again, the expectation of life is only slightly uncertain... The 
sense in which I am using the term (fundamental uncertainty) is that in which the 
prospect of a European war is uncertain, or the price of copper and the rate of interest 
twenty years hence, or the obsolescence of a new invention, or the position of private 
wealth-owners in the social system in 1970. About these matters there is no scientific 
basis on which to form any calculable probability whatever. We simply do not know.
     Evidently the orthodox theory is associated with and even circumscribed by the first 
type of uncertainty. In effect, in the significantly few occasions where this problem is 
incorporated (be in in game theory or other schemas) only well-identified possible 
scenarios with well-determined specific probabilities are considered. Yet this type of 
methodology leaves absolutely aside what constitutes the true problem of the 
businessperson (and those who are businessmen, and not orthodox economists, know it 
well): that they constantly have to make decisions in which there are fundamentally 
uncertain relevant variables.
     This is even more relevant insofar as it not only affects particular decisions 
within this or that business project but also the decision with respect to the 
enterprise's mission itself. Why? Because in this case, in order to estimate the 
yields, the businessperson must project herself more into the future and, in consequence, 
the uncertainty increases. Thus, as Keynes said it well, "we have to admit that our basis 
of knowledge for estimating the yield ten years hence of a railway, a copper mine, a 
textile factory, the goodwill of a patent medicine...amounts to little and sometimes 
nothing". Therefore, investment decisions will depend in large part upon the changes 
in the optimism or pessimism with which the businessmen view the present and future 
conditions and opportunities for obtaining profits. To designate these "changes in the 
soul"  which affected entrepreneurial decisions Keynes coined the term "animal spirits," 
wanting to highlight by that that such changes can have very little rational basis.
     Despite its pertinence and plausibility the orthodox economists have tended to reject
the notion of animal spirits as relevant for economic analysis arguing that it, by 
invoking something irrational, lacks explicative power at the scientific level.
     Now then, perhaps said critique was worthy in the day when Keynes had vaguely 
formulated the notion but today it no longer is, at least, is much less so. Thus, as with
the case of the consumer and as we shall explicate further below, advanced paradigms such 
as behavioral economics, experimental economics and neuro-science are untangling the 
specific mechanisms that allow rationally explaining (and even predicting) the 
"irrationality of certain business behaviors.
     Possibly the orthodox economists want to minimize these elements asserting that 
their importance is "marginal." And in effect: confronted by the difficulty of modeling 
fundamental uncertainty there exists the temptation (and convenience) of ignoring it or, 
at least, minimizing its importance. Nevertheless the analysis of it and its implications 
is more important than ever. At least so claim George Akerlof and Robert Schiller, both 
Nobel prizewinners, in their book Animal Spirits: how human psychology drives the 
economy. The central thesis of this book is that "the fundamental economic problem of 
the world is actually the amazing loss of confidence of business" because of the "chaos in
the financial markets which began in 2007 and accelerated until September of 2008." Then, 
given that this "erosion of animal spirits" feeds on itself increasing the pessimism and 
distrust, it will be necessary for "the multitude of plans that are being discussed for 
attacking the global crisis to be judged paying attention to the unknown and inexplicable 
effects they may have upon confidence and 'animal spirits' which Keynes identified 
generations ago." Yet, it is clear, that will not happen if we continue believing in the 
orthodox theory of business rationality.

Maximize profits or minimize losses? The problem of risk

     The problem of uncertainty that we just finished analyzing leads us inevitably to 
consider another important problem for the enterprise's decision, namely: the problem 
of risk. This basically consists in that the businesspersons, by always acting 
under uncertain conditions, constantly confront the possibility that their 
actions do not achieve the awaited results. In other words, their decisions always imply a
     The consequences of this for the orthodox model of business rationality are truly 
destructive. And in conditions of risk the businessperson's rationality will be applied 
more toward guaranteeing a minimum level of reasonable profits or minimizing 
losses than to maximizing profits. This is for three reasons.
     First, through the direct relations that exists between profit and risk. The 
businessmen know well that if they want greater profits they will have to assume greater 
risks. Thus, to seek maximum profits would also imply assuming maximum risk.
Yet since practically nobody wants to do that we would then find that businesspersons 
would not necessarily be guided towards the maximum possible but instead would accept a 
reasonable level of net income in accordance with market conditions (think of the cases of
economic crisis). There is no reason, then, to think that the businessperson must act in 
conditions at maximum, that is solely a theoretical possibility.
     Second, because of the stability which businesses require to be able to plan. In 
effect: every enterprise needs to conserve a minimum level of profits in order to 
be able to carry its plans to completion. In the opposite case, if it always seeks the 
maximum profit, it may result in having an excessively fluctuating utilization 
level and, consequently, it will be extremely difficult for it to realize long-term plans 
because of financial uncertainty. Ergo, one must not only keep in mind the utility but 
also the stability and security. And so the Japanese economist Shigeto 
Tsuru, after having reviewed various instances of real businesses, comments that:
"It became clear that the essential determining criterion of the firm's behavior was more 
that of stabilizing profits for a certain sufficiently long period of time. Even more 
recently, an amendment has emerged in the sense that the goal of the firms should be aimed
at 'maintaining a position of stability for a long period.' In other words, it means that 
in the description of the firm's behavior the term, maximization of security is more exact
than the term, profit maximization."
     Third, since the administrators are more punished for incurring losses than 
rewarded for obtaining profits. Effectively, given the context of separation 
between administration and ownership (whose implications for the orthodox theory we shall
examine later) the enterprises' administrators are more interested in avoiding losses than
in getting the maximum profit. Why? Because while the directors and executives do not 
receive the profits that might result from assuming greater risks (those go to the 
investors) yet can be fired if they incur important losses. Consequently, they will try to
perform their work efficiently obtaining an acceptable level of profits for the investors 
but would not necessarily strive for the maximum profit for that could also put their own 
work stability in danger.
     In this manner if, as often occurs, the maximization of profits increases the risk 
of losses, the administrator, for considerations of fundamental interest (her own 
employment), simply would not risk betting on it. And even more if dealing with a large 
enterprise having power over the market. Therefore Paul Samuelson himself concedes that 
"when the firm comes to have considerable size providing some control over prices, 
it can allow itself to loosen its maximizing activity a little." Or what the orthodox 
economist Carl Kaysen says: "Whereas in a very competitive market the firm has no 
alternative but to seek maximum profits, because the alternative to that is profit 
insufficient to guarantee its survival, in a less competitive market the firm can choose 
between seeking maximum profits or contenting itself with some 'acceptable' profit while 
aspiring to other objectives."

The behavioral economy returns to the fore: the problem of perspective

     According to what we have seen, businessmen always and necessarily act 
in conditions of risk and uncertainty. Now then, these conditions are not simply 
incorporated into the businessmen's decisions without first having been 
subjectively evaluated. And it is precisely here where the behavioral economist 
returns to the fore with the so-called "theory of prospects."
     The theory of prospects was raised for the first time by the psychologists 
Daniel Kahneman and Amos Tversky, in a famous article in 1979 titled "Prospect Theory: an
analysis of decision-making under risk." The principal thesis with this focus is that the 
businesspersons do not really make their decisions on the basis of reality but 
instead more on the basis of perceptions of the latter, presenting systematic 
biases (pessimistic and optimistic) in their evaluations. In this manner, in the 
real world businesspersons act with frequently erroneous subjective models 
which are not corrected even with the furnishing of new information. And indeed, like it 
or not, in the final analysis human beings (the businessmen are no exception) act and 
decide upon the basis of beliefs.
     Yet do not think that the cognitive biases incorporated into beliefs are only 
influential in the perception of information: they also are influential in its mode of 
processing. In effect: more than dealing with a mechanistic optimization scheme of 
complete rationality the business decision process is constituted like a mental 
process of intuitive estimation in which the scenarios and probabilities are 
simplified. That is to say, given limited rationality, and to save time and effort 
in decision-making, the businessmen have to base themselves upon a series of empirical or 
heuristic rules which if indeed they simplify the process also lead to systematic errors. 
"The beliefs are expressed in phrases of the type, 'I think that..., the opportunities 
are..., it is improbable that...,' etc." Occasionally, the beliefs regarding certain 
events are expressed in numerical form as probabilities. We propose that people rely on a 
limited number of heuristics which reduce the complicated tasks of calculation of 
probabilities and of prediction of values to much simpler operations of estimation," write
Kahneman, Slovic and Tversky. What is curious is that not even those "much simpler 
operations of estimation" are carried out in a coherent fashion: in fact the majority of 
people make estimates of probability that do not accord with the laws of 
probability (Bayesians).
     There are, then, no such things as the "rational expectations" that orthodox 
economic proposes. The businesspersons are not gods and, in fact, like any mortals, it 
often occurs that they "trip over the same rock," which means, that they are mistaken 
about it.
     Thus, following this line of investigation, the psychologists have observed that when
risky decisions are made the businessmen are particularly averse to the possibility of 
even a small loss and need  a high yield to compensate for it. In turn, they have found 
that in various cases this is due fundamentally to pessimistic adaptive biases such
that the pain of the loss seems to depend also upon what followed previous losses. Once 
the businesspersons have suffered a loss in general they become even more averse to 
suffering anew.
     Yet there also exist positive biases. For example, the psychologists have found that,
just as it is known that players are willing to bet large sums of money when luck is in 
their favor, also investors feel more disposed to run the risks of falls or changes in 
market conditions after they have enjoyed a series of unexpectedly high profits. If then 
they suffer a loss, at least they will have the consolation of knowing that in general 
they are doing well.
     In this manner, thanks to the approaches of behavioral economics, we find that the 
great problem of the orthodox theory of business decision is that it assumes the 
businessman is primarily a sort of calculating being who makes her decisions 
on the basis of objective considerations when in reality she, in relating to the 
world through her mind, displays systematic cognitive biases in her 
evaluations and appears influenced  by subjective factors in her decisions. That, 
in turn, conduces to anomalies that systematically distort the assumed efficiency of the 
markets as the behavioral economist Richard Thaler has shown repeatedly in his column 
"Anomalies" published in the Journal of Economic Perspectives between 1987 and 1990
in which he documented various real instances of economic conduct which contradicts
that postulated by Neo-classical economics.

The broken plates of a divorce: the problem of agency

     In the first stages of capitalism the administrator was not distinguished from the 
proprietor, enterprises were small and principally family property. Yet later, with the 
advent of the great anonymous societies and the system of shareholders, there occurred an 
irremediable "divorce" between control and ownership. And not only that, they lead from 
being individuals to being collectives: the set of investors would have the 
ownership and the group of administrators or management would have the 
control. This is a genuinely characteristic fact of of modern economic society...
yet it would seem that orthodox economics has not even found this out.
     That is no exaggeration. Indeed, as Gordon well depicts, "for the majority of 
economists (especially the theorists) the businessman is still the manager-owner." 
And in effect: one of the most famous microeconomics manuals in the world, that of 
professor Nicholson, clearly tells us that "it assumes that the decisions of the 
firm are taken by a single dictatorial administrator."
     But why have the orthodox economists maintained an assumption so distant from 
reality? Simple: because it allows them to operationalize their theories. The assumption 
that ownership goes together with management is not only expedient but also 
necessary for the theoretical and mathematical exercises of orthodox economics with
respect to business activity to function without problems. Therefore, this assumption 
has to be included.
     However one must question this procedure of accommodating assumptions not to reality 
but instead to the requirements of technology. As Bunge says: "It is clear that the 
commandment 'Thou shalt Maximize' is mathematically convenient, since it can be easily 
formulated as a problem of calculating derivatives. Yet economics ought above all to 
represent reality instead of constituting itself as a pretext for playing with 
     Once this is established, we move to a more detailed analysis of the implications the
"divorce" between ownership and administration has for economic theory. Here one must 
commence by stating that this separation between ownership and administration has clear 
advantages: it permits changing ownership without interfering with the operations of the 
company and also that professional administrators are contracted. Nevertheless, it also 
creates problems if the goals of the administrators and owners are not the same. The 
danger is evident: if the administrators are better informed than the investors about 
profit opportunities or if their actions are not observable by the investors, they will 
tend to pursue their own interests or to proportion their efforts to the detriment of 
profit maximization.
     These conflicts between the goals and interests of investors and administrators cause
the so-called agency problem or the problem between the principal and the 
agent. The investors are the principal, the administrators are the agent. But wherein 
does the problem lie? In that the agent can pursue a project or make an investment that is
in her interest yet which does not necessarily maximize the profits of the principal.
     The foregoing leaves the orthodox economists in a very uncomfortable situation. The 
great institutional economist John Kenneth Galbraith illustrates this with quite a 
suggestive example: "...if the traditional commitment to profit maximization is to be 
upheld, they (the administrators) must be willing to do for others, specifically the 
stockholders, what they are forbidden to do for themselves. It is on such grounds that 
the doctrine of maximization in the mature corporation now rests. It holds that the will 
to make profits is, like the will to sexual expression, a fundamental urge. But it holds 
that this urge operates not in the first person but the third. It is detached from self 
and manifested on behalf of unknown, anonymous and powerless persons who do not have the 
slightest notion of whether their profits are, in fact, being maximized. In further 
analogy to sex, one must imagine that a man of vigorous, lusty and reassuringly 
heterosexual inclination eschews the lovely, available and even naked women by whom he is
intimately surrounded in order to maximize the opportunities of other men whose existence 
he knows of only by hearsay."
     However, the investors have devised two very ingenious solutions for this so-called 
agency problem. Lamentably, they deal with partial solutions which, therefore, do 
not redeem the restrictive orthodox postulate of maximization of profits since for 
it to be fulfilled it is necessary for the solution to be total for only 
thus will be maximizing interest of the owners be identified with the administrators' 
conduct. Let us examine these two solutions.
     The first attempted solution was for the owners to sell part of their stock to the 
administrator at a fixed rate such that she also will be interested for the enterprise to 
maximize its gains. Nevertheless, although that provides strong incentives for the manager
to exert effort to make the correct decisions, it also exposes her to considerable risk. 
We recall that the gains of the enterprise depend not only upon the manager's efforts but 
also on exogenous costs and the clashes of demand. As a result the income flow of the 
administrator will be variable and imply a risk, which will reduce her well-being if one 
is dealing with a risk-averse person. Therefore, even if this measure would contribute to 
the administrator procuring greater profits it will not cause her to seek the 
maximum because that would imply a very large risk.
     The second solution that has been proposed is the constitution of a directorate to 
whom the investors delegate the function of hiding what things are actually being done in
regard to their interests. Thus, the work of the directorate will be to control the
administration so the latter will concern itself solely and exclusively with the goal that
interests the investors: the maximization of profits. The problem is that we still must 
respond to the troubling question concerning who "controls the controllers." If the 
investors do not practically know the real conditions under which their companies 
operate and delegate to a directorate the fiscal work of the managers: how can they 
know with certainty that they are performing their labor in the best manner possible at 
all times (which is what the orthodox theory would require)?
     Only two alternative exist: either to be controlled by other, higher directorates or 
to be controlled by means of external audits. Regarding the first alternative it must be 
said that it is simply unworkable as an effective solution because the investors will 
still have the same problem with the new directorates, such that they would have to name a
third group to control the second one and so on ad infinitum.
     Regarding the second alternative we hold that even if it comprises an important 
advance it does not entirely resolve the problem. The external audits are not nor can be 
completely continuous and, furthermore, as good as they might be, nothing assures us--not
even competition  between auditing firms--it will be realized in the most efficient 
possible manner because the problem of information persists, and even more in 
this case, will result in being asymmetric (the internal agents know more than the 
external), imperfect (the auditors cannot have perfect knowledge of the enterprise 
and even less of the market conditions in which it acts) and incomplete (it often 
occurs that information tends to be hidden from the auditors to avoid problems). 
Therefore, the orthodox postulate of profit maximization remains seriously in question.

Consequences of technological change: the power of the technostructure

     As we have seen in the second chapter, orthodox economic theory considers technology 
as something given to the enterprise in an exogenous fashion and which, 
therefore, does not enter into business decisions. However, as we also indicated there, 
under contemporary capitalism the opposite situation seems to prevail.
     In effect: we find ourselves in an historical phase characterized by the complexity 
of the productive processes in which technology is a crucial element. Businesses 
constantly require more control and management of the technology to be applied to their
productive processes and, in consequence, see the necessity of developing 
endogenously by means of an internal system. But who will comprise this system?
Obviously not the managers or the group of administrators who are more occupied with 
decision-making than in developing technology, but instead rather the set of agents, 
technicians and engineers specialized in the different concrete activities of the 
enterprises and that Galbraith baptized with the name of "technostructure."
     We shall cite his own words:  "With the rise of the modern corporation, the emergence 
of the organization required by modern technology and planning and the divorce of the 
owner of the capital from control of the enterprise, the entrepreneur no longer exists as 
an individual person in the mature industrial enterprise. Everyday discourse, except in 
the economics textbooks, recognizes this change. It replaces the entrepreneur, as the 
directing force of the enterprise, with management. This is a collective and 
imperfectly defined entity... It includes, however, only a small proportion of those who, 
as participants, contribute information to group decisions. This latter group is very 
large; it extends from the most senior officials of the corporation to where it 
meets, at the outer perimeter, the white and blue collar workers whose function is to 
conform more or less mechanically to instruction or routine. It embraces all who bring 
specialized knowledge, talent or experience to group decision-making. This, not the 
management, is the guiding intelligence--the brain--of the enterprise. There is no 
name for all who participate in group decision-making or the organization which they form. 
I propose to call this organization the Technostructure."
     Thus, we find that the profound changes operative on the technological conditions of 
production also have affected the structuring of the enterprises with regard to 
organization. Specialized knowledge and its coordination have become the decisive factor 
for economic success. But that requires that men work in groups. Ergo, the power begins to
pass to these groups. Or, put differently, because of the endogenization of 
technological change, an important change has been generated in the very power 
relations of the enterprise: the technostructure has been empowered.
     Fine, fine, but how does this erode the orthodox postulate of profit maximization? In
the following manner: if the members of the technostructure have ever greater decision-
making power in the enterprise they may also influence the latter's objectives 
themselves and nothing assures us a priori that their interests will 
necessarily coincide with those of the investors who, as we have seen, find 
themselves in the most remote circle of the great enterprise. The atomization of ownership
in the form of thousands of stocks will make it impossible for their owners to impose 
their goals upon the members of the technostructure such that the companies will 
tend (subject to certain restrictions, clearly) to basically pursue the goals of the 

A true inconvenience: the possibility of seeking other goals

     "Few tendencies can so suddenly undermine the fundamentals of our free society as the
acceptance by the functionaries of the great anonymous societies of a social 
responsibility other than obtaining the greatest amount of money possible for the 
stockholders," said Milton Friedman. Very well, in the previous section we just threw 
light on the possibility that the members of the technostructure pursue ends different 
from the maximization of profits for the investors. Yet what are those ends different from
profit maximization that the technostructure might pursue?
     According to Galbraith there will basically be two: "first, to minimize the risk of 
loss, and therewith of damage to the autonomy of the technostructure, and secondly, to 
maximize the growth of the firm." We shall analyze these two objectives.
     In the first place there arises the question of why the members of the 
technostructure seek a secure level of profit even when they do not directly perceive any 
of it. Basically one could say that they do it for strategic reasons. It happens that the 
effects of the large and small gains in the technostructure are not symmetrical. When 
profits are slight or when there are losses, the technostructure becomes vulnerable to 
external influence and loses autonomy then the investors, on feeling that their profits 
are not being maximized, might request greater intervention by the board or even solicit 
an external audit. Instead, when profits exceed a certain level, their increase does not 
mean much regarding the autonomy and security of the technostructure. Given the 
asymmetry of information, the investors will believe that their gains are being 
reasonably "maximized," and consequently will allow the technostructure to "work in 
     Approaching now the second objective: why do the members of the technostructure want 
the enterprise to have a maximum growth rate (given the financial limitations, clearly)? 
Simple: because that is the  best means of expanding their power and influence. A business
that depends upon growth and technological development is a business which depends on the 
     And not only that. The expansion of the enterprise is also very important for the 
technostructure because only thus can its members ensure their position in it. A 
progressive technology signifies labor positions and promotions for the technologists. 
Declining production instead means the contrary. Therefore, the members of the 
technostructure will be interested in continual growth in the production, even to the 
point of justifying a relatively unprofitable expansion.
     Yet, why does all this comprise an "inconvenient truth" for the orthodox theory? 
Because it opens the door for business to influence society in such a way that seeks, at 
least in part, to expand the power and influence of the technostructure. In effect: "it 
also reflects the underlying reality which is that the modern corporation has power to 
shape society. And this power does not disappear when the businessman, following 
the advice of economic traditionalists, proclaim that their only purpose is profits. It 
can be used to pursue profits. But this is an exercise of power. There is also 
power to pursue other goals... Power is used, as might be expected, to serve the 
deeper interests or goals of the technostructure, for this possesses the power." And what 
is most worrisome is that there is nothing to assure us a priori that that 
influence will necessarily be positive or result in the welfare of the individuals.
However, to tackle this question is something which exceeds the limits of the present 

IMg = CMg: and where is the evidence?

     According to what we had seen at the start of this chapter, for orthodox theory 
businesspersons maximize their profit by producing up to the level where the marginal 
revenue (IMg) is equal to the marginal cost (CMg). Why? Because the 
businessmen, given that they want to obtain the maximum profits, will keep increasing 
their production up to the point when they can no longer obtain additional profits which 
is only fulfilled when the marginal revenue from selling one more unit of the product is 
equal to the marginal cost of producing it (IMg = CMg).
     So explained, it seems very reasonable to think that businessmen actually act 
following this rule. There is no student of economics who would not say to herself: "Of
course, if I were a businesswoman I would adjust my production in this manner." 
Nevertheless, as we have already seen, there are various reasons to doubt whether it 
occurs this way in the real world. And even were we to accept that the only goal of
a businessperson is to maximize profits that does not imply they necessarily act as if 
they actually did so (which is what Friedman and other orthodox economists 
profess) for one would still have to resolve the non-mechanical problems, the uncertainty,
risk, perspectivism and agency (not to mention the technostructure's empowerment and 
     However, and to the orthodox economists' misfortune, there still remains one 
important question to pose: the question of empirical evidence. Introspectively (that is, 
from the perspective "What would I do if I were the impresario?") it seems very reasonable
to think that business rationality consists of maximizing profits. Lamentably, to science 
it does not suffice that for some or many persons a certain theory seems intuitively 
correct yet instead it is always necessary for it to present empirical evidence of 
its affirmations in order to be considered scientific.
     So then, does clear empirical evidence exist that enterprises actually 
maximize profits in accordance with that proposed by the Neo-classical orthodox scheme? 
The answer is no. The maximization of profits as it is presented in orthodox economics is 
more a deductive abstraction than an empirical reality.
     In this respect the words of the prestigious economist Shigeto Tsuru are eloquent: 
"Since the end of the 19th century, it has been customary to present the theory of the 
firm basing it on the abstract principle of profit maximization. An affirmation of 
elementary economics like that asserting that "a firm determines the quantity it will 
produce as the point where the marginal revenue is equal to the marginal cost" derives in 
reality, mechanically, from the application of that principle. And even though the 
theorists kept having confidence in such abstract affirmations, those economists 
endowed with an empirical mentality have begun to examine, especially post-War, basing 
themselves on demonstrations of the actual behavior of firms and have established that no 
business approached its production plan in terms of equating marginal revenue and 
marginal cost and that, in any event, even dispensing with the technical jargon on the 
economists relative to the marginality of this or that, the number of firms which 
calculate the maximization of profit was relatively small."
     Perhaps an orthodox economist with practical experience advising firms will object: 
"That is false. Often I have been contracted to study the structure of costs and benefits 
for various businesses in order to estimate the optimal production level by means of 
microeconomic analysis." Notwithstanding, such an objection only evidences a lack of 
precise comprehension concerning the type of predictions about reality which the orthodox 
theory ought to make in case it is correct. And if indeed the orthodox principle of profit
maximization were true this would imply that, by the fact of using a principle itself 
incorporated in the rationality of the businessmen, would apply in a direct and
mechanical mode to the dynamic entrepreneurial activity and, thus, it would be 
absolutely unnecessary to contract with advisers to re-apply it!
     It is, then, necessary to distinguish very carefully the "being" of the "should be" 
when approaching this question. The problem is not that the enterprises 
should or should not maximize their profits (which is part of a discussion 
that exceeds the limits of the present work) or to analyze the truism that businesspersons
perform their work seeking a profit but more whether in reality they do or do not 
maximize profits following the dynamic that orthodox economics postulates. And it 
would seem that reality tells us they do not do so. Yet given that scientific theories 
are posed (or should be posed) to explain how reality is and not how it should 
be, we find that the scientific value of the orthodox theory becomes wholly 
questionable in this respect. It is clear that scientific theories must perform a 
simplification of reality in order to study phenomena, but the problem with the orthodox 
theory is that it does not create an "innocent simplification" of the businessperson but 
instead a gross caricature of her.


The object of this chapter has been to critically examine the orthodox theory of the firm.
Basically we have seen that:
     1) The vision of the businessman as essentially a "mechanical optimizer" sins of 
sterile reductionism with the Schumpeterian theory of the innovating entrepreneur 
being more plausible and pertinent in this respect.
     2) Businesspersons do not act "as if they possessed complete knowledge of the 
necessary data" but instead in conditions of uncertainty which often cannot be 
modeled in an exact manner and, thereupon, the "animal spirits" of Keynes are invoked.
     3) Since there is no certainty the businessmen  always act under conditions of 
risk and, therefore, their rationality may consist more in guaranteeing a minimum 
level of reasonable profit than in maximizing the profits since that would imply assuming 
too much risk.
     4) As the theory of prospects presents it, the businessmen  do not act 
directly upon the basis of reality but instead upon a basis of perceptions held about 
reality such that, like the consumer, they are affected by cognitive biases that vitiate 
the assumed "rational calculus."
     5) With separation between ownership and control comes the agency problem 
and, consequently, there now is nothing to ensure a priori that the actions of the 
managers correspond perfectly to the goals of the investors given that the means for 
correcting them only have a contingent and partial effect so that the Neo-classical 
postulate of profit maximization is unredeemed.
     6) The greater complexity of productive processes has led to the empowerment of 
the technostructure and that too erodes the postulate of profit maximization for 
reasons similar to those displayed in the problem of agency.
     7) Given the above the possibility of pursuing other goals occurs and the 
members of the technostructure in particular might be more interested in the stability of 
the gains and expansion of production than in maximizing the benefits of outsiders.
     8) There is little or no empirical evidence that businesses actually produce 
at the point where the marginal cost compares to the marginal revenues, which is exactly 
what the Neo-classical theory maintains.
     All this constitutes a powerful cumulative case against the Neo-classical 
postulate of the maximization of profits. Thus, the orthodox theory of the firm is nothing
more than a myth. May it rest in peace.

                        Chapter 5
                        THE MYTH OF COMPETITIVE MARKETS

                        "No economic order, without incurring very grave 
                              consequences, can dispense with utilizing, in one form or
                              another, the supreme power of competition."
                                        Friedrich von Wieser, Austrian economist
The orthodox theory of competitive markets

     As already announced in the title, the present chapter will discuss competitive 
markets. Let us begin by defining what a market is. A market is constituted above 
all as a system by which economic agents gather with the object of buying and/ or selling 
goods and services. Specifically, the buyers are seen as "demand" and the sellers as 
     We turn now to the concept of a competitive market. A competitive market is 
one in which many buyers (demand) and many sellers (suppliers) of goods and services 
participate; the sellers compete to be preferred by the buyers, and the buyers, in turn, 
compete for access to the limited offer of goods and services available in the 
     Yet how are the decisions of buyers and sellers in the market coordinated? How are 
the quantities sold ensured to equal those demanded? Well by means of a very ingenious 
mechanism: the price system. Prices coordinate the decisions of the producers and 
consumers in a market. High prices discourage consumption but incentivize production. Low
prices stimulate acquisitions yet discourage production. In this manner, a "bidding" game 
is occurring between sellers and buyers by which an equilibrium price is being 
established that, by simultaneously satisfying the desires of both, will finally equate 
the quantities offered to those demanded.
     For orthodox economics this coordination occurs subject to the famous model of 
supply and demand. In this model the basic elements are the also famous supply and 
demand curves. The supply curve shows us the quantities of the good and/ or service 
that the enterprises are willing to offer at a determinate price level. It has a 
positive slope: the higher the price the higher the quantity the sellers wish to offer. 
The demand curve, on the other hand, shows us the quantities of the good and/ or service 
which the consumers are willing to buy at a determinate price level. It has a negative 
slope: the greater the price the lower the quantities that the consumers will want to buy.
     And how are the equilibrium prices and quantities determined. Simple: at the 
point where the supply and demand curves cross. Graphically:


This equilibrium will vary when there are changes or displacements in the supply and 
demand curves, which would occur when there were variations in the factors that affect the
supply and/ or the demand. Among the factors that will affect supply we principally have 
the costs, the technology and the conditions of production. Meanwhile, among the principal
factors that will affect demand we will have the consumers' tastes and preferences and 
their income level.
     Now then, given this dynamic of supply and demand in the market, how is it that the 
businesses, which together comprise supply, determine their production level? In the 
orthodox scheme they do so according to the model of perfect competition. This is 
the fundamental model of orthodox economics since starting from it are constructed all the
other models for analyzing the market.
     Like every model, that of perfect competition is based upon a series of assumptions. 
To wit, these are the following:
1) Assumption of atomicity of the agents: There are many small buyers and 
2) Assumption of homogeneity of the good: A single homogeneous product is 
3) Assumption of the absence of market power: The enterprises cannot influence the 
market price.
4) Assumption of perfect information: All the agents know the relevant variables 
which affect their decisions;
5) Assumption of free entrance and exit: There are no restrictions on the entrance 
or exit of enterprises in the market.
     And how does this model work? In their well-known manual Samuelson and Nordhaus lay 
out for us in a very brief and exact way the key ideas for the functioning and dynamic of 
this model:
     1) In conditions of perfect competition there exist many small businesses, 
each one of which produces an identical product (assumption of homogeneity of the 
good) and is too small to affect the market price (it follows that we say in this 
situation of perfect competition that the enterprises are price-takers: they have 
to accept the price which the market has determined).
     2) The perfect competitor is confronted by a totally horizontal demand curve (as a 
competitive industry it consists of businesses that are small in relation to the market, 
each one's demand curve segment being nothing more than a very small segment of the 
industry demand curve and thus appear as a totally horizontal curve).
     3) The additional income obtained from each extra unit that is sold is, accordingly, 
the market price (in other words, the marginal revenue is equal to the price).
     We now have, then, sufficient elements to be able to establish how a competitive 
enterprise determines its level of production. As we had seen in the previous chapter, and
supposing that the businesses are profit maximizers (something we already questioned) they
will determine their optimal production level at the point where the marginal cost 
CMg) is equal to the marginal revenue (IMg). Now, given that under perfect
competition the marginal revenue is equal to the price, we shall have the following 
"rule for an enterprise's supply under perfect competition: A business should 
maximize profits when it produces at the level where marginal cost is equal to the price."

The fallacy of free and competitive markets: the planning system

     As one gathers from the eloquent quote from Wieser at the beginning of the present 
chapter, for the orthodox theory the "supreme power of competition" is constituted as the 
very basis of any efficient "economic order." One should deduce, then, that the 
indispensable basis of an efficient capitalist system must necessarily be 
competitive markets. But, is that what the history of capitalism shows to us? It would 
seem not. Let us see why.
     At the beginnings of industrial capitalism, that is, in 18th century England there 
did exist more or less free and competitive markets. In effect: there were many buyers and
many sellers, the enterprises were small, they had no great power over the market, the 
products were relatively homogeneous, etc. That was the best way to organize the economy 
is that era since the previous models--feudal and mercantilist--had demonstrated their 
inefficiency in the production of wealth, which, with the ascent of the bourgeoisie, had 
become the principal economic preoccupation. However, the costs of efficiency were high: 
various small enterprises went bankrupt unable to resist the difficult competitive 
conditions of the market. As Galbraith said: "The road towards obtaining growing 
efficiency would require that the losers lose in reality." Nevertheless, it was a price 
that the men of that time were willing to pay. And indeed "in a world that had been poor 
for so long nothing was more important than to obtain an increase in wealth. The remedy
--to liberate men from the restrictions and protections of the feudal and mercantilist 
society and allow them to act for themselves--was sound, as was already becoming manifest.
That was not a compassionate world. Many suffered and many were destroyed beneath the 
severe and unpredictable authority of competition and the market. But many had always 
perished for one or another reason. While now, some began to flourish. This was what had 
to be kept in mind. Now danger and disgrace were not considered, since they had always 
existed, but instead opportunity was considered."
     Nonetheless, towards the end of the 19th century (more or less starting in 1870) with 
the Second Industrial Revolution, a radical change in attitude occurred. Those same small 
businesses which in past times "began to flourish" started to grow, strengthen and 
consolidate. The age of monopolistic capitalism had arrived. In effect: now the 
enterprises were sufficiently large, produced in mass, applied technology ever more 
intensively and handled great investments. Thus then, would it be reasonable to think that
these enterprises would continue submitting with pleasure to the iron discipline of 
competitive markets? Obviously not. They are large enterprises and have much to lose, 
needing safety. Yet, given that to trust all these things to the market would be 
like entrusting them to chance, it was necessary that they commence having control 
over the market itself. And "in addition to deciding what the consumer will want 
and will pay, the firm must take every feasible step to see that what it decides to 
produce is wanted by the consumer at a remunerative price. And it must see that the labor, 
materials and equipment that it needs will be available at a cost consistent with the 
price it will receive. It must exercise control over what is supplied. It must replace the 
market with planning." This is how the "planned system" is born.
     Under this system the large enterprise possesses a logic and dynamic completely 
different from that of the small competitive enterprise. As Galbraith says, "in addition 
to deciding what the consumer will want and will pay, the firm must take every feasible 
step to see that what it decides to produce is wanted by the consumer at a remunerative 
price. And it must see that the labor, materials and equipment that it needs will be 
available at a cost consistent with the price it will receive. It must exercise control 
over what is supplied. It must replace the market with planning." Consequently, far from  
being controlled by the market, the business has done everything possible so that the 
market remains subordinate to its planning goals.
     For one more connected to reality itself than to the microeconomics textbooks 
the fact that actual capitalism is more related to a "planned system" comprised of large 
enterprises with market power than to a "competitive system" of small enterprises without 
market power will seem a truism. Yet it is necessary to say currently that the contrary is
taught as the fundamental epistemic referent in the great majority of economics 
departments throughout the world.
     We see, then, that the orthodox theory of competitive markets, by remaining almost
the same confronting a tremendously different world, had ended becoming an 
antiquated theoretical piece, worthy of being studied only as part of the history 
of economic thought. Indeed one cannot study capitalism after the Second Industrial 
Revolution with an economic theory that only takes into account that of the First. A 
theoretic revolution is also necessary. If the configuration of the phenomenon changes, 
the theory should change. Objectivity, which is the ultimate goal of science, 
implies conforming to the reality of the object. If orthodox economics does not 
care to, that is already its problem...

Everyone against everyone? The law of duality

     One of the central suppositions of the orthodox theory of competitive markets is that
there exist many buyers and many sellers who compete among themselves. Very well, that 
there exist many buyers who compete among themselves by means of their monetary votes to 
get part of the limited offer of goods we can accept without great problems. However, that
there really exist many identical price-taking enterprises who compete among themselves we
must, at least for the great majority of instances, reject.
     And indeed anyone who knows something about industrial organization knows that
the structure of competition between today's enterprises resembles more a vertical 
positioning scheme with leaders easily identifiable than a horizontal dynamic of 
free competition between identical and equipotent enterprises.
     That is thus principally because of the so-called law of duality. According 
to this "law," enunciated by the "gurus" of marketing Al Ries and Jack Trout, eventually 
every market becomes a race with two participants. What is the implication of that? That, 
contrary to what is propounded by the orthodox theory of competitive markets, competition
between businesses is not a competition of "all against all" but instead more of a 
staired competition in which two enterprises, called leaders, who compete 
strongly between themselves and many followers who more than competing among themselves
limit themselves to maintaining their market position and, at most, to strategically and 
hopefully watch the leaders.
     This already puts the orthodox theory in check given that it is constructed (and 
taught) almost in its totality upon the basis of the other horizontal-competitive schema. 
However, this "law" has a still more corrosive consequence for such a focus, namely: that 
that situation of concentration of competition into two (or maybe three) 
leader enterprises will almost inevitably eventually result as a consequence of the
very dynamic of competitive markets.
     Ries and Trout explain it to us in the following manner: "At the outset, a new 
category is a staircase of many steps. Gradually the staircase becomes a matter of only 
two steps. In batteries it is Eveready and Duracell. In photographic film, Kodak and Fuji.
In car rental, Hertz and Avis. In mouthwash, Listerine and Scope. In hamburgers, 
McDonald's and Burger King. In sport sneakers, Nike and Reebok. In toothpastes, Crest and 
Colgate. When long-run marketing is considered, it can be shown that the battle usually 
terminates in a titanic struggle between too giant players; normally the old brand of 
confidence and the aspirant."
     And not only that. So strong is that "law" that, when the market is mature and the 
two leaders already well-positioned, in fact the great majority of attempts to displace 
them fail. One could say it follows a pattern of the "law of the excluded third": in a 
consolidated market there is practically no space for a "third leader," that being almost 
a contradictio in adjecto.
     Ries and Trout give us a very good example of this last with the case of the United 
States market in sodas: "In 1969, there were three great brands of a certain product. The 
leader had about 60 percent of the market, the number two brand 25 percent and the number 
three had six percent. The rest of the market included as many private brands as minor 
brands. The law of duality suggests that these shares in the market are unstable. 
Additionally the law predicts that the leader will lose market share and that the number 
two will gain it. 22 years later, the market share of the leader dropped to 45 percent. 
The number two brand has 40 percent and number three has three percent. The products are 
Coca Cola, Pepsi-Cola and Royal Crown Cola, respectively; yet the principle applies to 
any sort of brand... Look what happened to Royal Crown Cola. In 1969 Royal Crown Cola 
revised its system of franchises, 350 bottlers, and employed the ex-president of Rival Pet
Foods, a veteran of Coca-Cola and Pepsi. The company retained Wells, Rich, Greene, a 
powerful New York publicity agency. 'We will go out to kill Coca-Cola and Pepsi,' said 
Mary Wells Lawrence, director of the agency, to the Royal Crown bottlers. 'I hope you 
excuse the expression; but we are going to cut their jugular.' And the only thing killed 
was Royal Crown. In a mature world, third place is a difficult position."
     Obviously these results are not predetermined. The so-called "law of duality" does 
not deal with a physical law. Yet in any event it is based on profound 
observations. Thus Jack Welch, the legendary president and CEO of General Electric, some 
years ago had said that: "Only the businesses which are number one or number two in their 
markets can win in an ever more competitive world. Those who could not were re-organized,
closed or sold." Is this at all compatible with the image of a multitude of small and 
competitive enterprises that orthodox economics has sold us? Is it right that economists 
keep formulating those topics using referents which are openly negated by the biggest 
businessmen, that is to say, the most relevant actors in the phenomenon of the study 
itself? It would seem not. Yet let us keep analyzing...

Market and power: the social structures of the economy

     Another of the essential assumptions in the orthodox theory of competitive markets 
and, specifically, the model of perfect competition is that all the participant 
enterprises are identical in their size, share, cost structures, and price-taking 
condition. In other words, that they are equipotent (having equal power). And what 
is the result of that? A very paradoxical one to tell the truth: that the businesses, 
given that they have the same power but at the same time are too small to have individual
influence upon the market results, end by being impotent (lacking in power) and so
have no option but to serve the needs of society in a mechanical fashion. And that would 
be precisely the great "magic" of the market: that the power of competition finally 
annuls all the power of the businesses.
     Yet, is that relevant or does that focus at least become pertinent for analyzing the 
reality of existing capitalism? Evidently not, for reality tells us something not only 
different but openly contrary to that postulated by the theory: enterprises 
are not equipotent and even less so, impotent. Furthermore: they not only have market
power, meaning capacity to influence prices instead of being limited to price-taking, 
but instead they have ever more power over the market, that is, capacity to mold it
as a function of their goals and interests in place of humbly submitting to it. The 
orthodox theory speaks in its models of im-perfect competition (one sees here that 
the idea of perfect competition is the "touchstone" for all theoretical development), of 
the power of the market, yet never touches power over the market, which is 
much more relevant.
     Curiously one of the theorists who has been most devoted to scientifically studying 
this phenomenon was not an economist but instead a sociologist: we refer to the renowned 
French sociologist Pierre Bourdieu. According to Bourdieu, before being constituted as an 
essentially neutral and participative space in which vendors and buyers meet, markets are 
"fields of force," that is to say, "socially constructed fields of action where 
agents possessing different resources gather to have access to exchange and to 
conserve or transform the active force relation."
     In this "force field," very far from being uniform and competitively distributed, 
the true struggle is limited to a small number of powerful rival enterprises
which, instead of reacting passively to a "market situation," are in the process of 
actively molding it.
     And not only that. Such a capacity of molding the market conditions is exercised by 
the enterprises as a function of an interactive and hierarchical structure. 
Thus, "dominant is whoever occupies a position in the structure such that the structure 
acts in their favor. The dominant firms exercise their pressure over the dominated and 
the latter's strategies by means of the weight that that structure possesses, more than 
through the direct interventions which can occur: they define the regularities and 
at times the rules of the game, imposing the definition of the trump cards most 
favorable to their interests and modifying the entire milieu of the other enterprises and 
the system of restrictions which weighs on them or the horizon of possibilities that they 
offer them."
     That is to engage in power relations. And there, seemingly, orthodox theory 
does not enter (or does not want to enter). Power relations in the market are always 
variables "exogenous" to it and therefore cannot "contaminate" their "immaculate" analysis
with such things. But we "heretics," on the other hand, are not afraid of "getting our 
hands dirty"...

Disappearance of the invisible hand: the birth of strategic thinking

     The foregoing brings us directly to the question of strategic thought, to 
wit, that referring to the need enterprises have to formulate their plans for achieving 
their objectives in the market yet keeping in mind that the other enterprises also are 
doing the same. Or, as Dixit and Nalebuff would say at the beginning of their book, 
"strategic thought is the art of gaining on an adversary knowing that she is trying to do 
the same."
     Now a little history. As we know, the First Industrial Revolution, occurring in 
England at the middle of the 18th century, did not have much influence upon strategic 
thought. That was due principally to even though this period was marked by intense 
competition between industrial enterprises virtually all of them lacked the power to 
influence market results to a relevant degree. In fact, the chaotic markets of this era 
led economists like Adam Smith to describe the forces of the market as an "invisible hand"
which in large part remained beyond the control of the particular enterprises.
     Later, with the Second Industrial Revolution, occurring in the United States at the 
end of the 19th century, one began to see business strategy as a way to give form to the 
market forces and, thereby, of influencing the competitive environment itself. The 
"invisible hand" of Adam Smith began to be progressively replaced by what renowned 
historian Alfred Chandler Jr. denominated the "visible hand" of the professional 
administrators and, consequently, "strategic thinking" was originated.
     This situation was ever more consolidated to the degree that capitalism advanced. The
Sixties years witnessed the birth of diverse consulting practices concerning strategy and,
what is more, according to a study performed by the Stanford Research Institute, by
1963 the greater part of the great companies in the United States had already established 
planning departments.
     The guru of administration Peter Drucker was right, then, when he criticized orthodox
economic theory for treating the markets as impersonal forces, out of the control of 
organizations and of individual businessmen now that, in the present era, the era of the 
great corporations, management "implies the responsibility of trying to give shape 
to the economic environment, beginning and carrying out the changes in that environment."
     We see then, in this point like the three previous ones, that the expansion of the 
competitive capitalist market has generated tendencies evidently contradictory to Neo-
classical orthodox theoretization since the latter is based upon mechanistic 
optimization--when dealing with environments of perfect or imperfect competition--
as against the understanding of nature and access to industrial planning. It 
happened, then, that the discretionary power of the economic agents acquired a decisive 
importance and the mechanistic conceptions of the market ceased being relevant (not to 
mention those of the atomists).
     Given this, economic theory could not support that nascent reality and enclosed 
itself in the cult of the absolute free market, a mathematically pure and immaculate god 
who, behind the heavens of scientific abstraction, was free of all the mortal 
contingencies of historical development of the economy. Starting from that the economists 
imposed a methodological line which necessarily did without the study of the historical 
evolution of the economic structures. Such a situation persisted until our own days and 
explains in large part why orthodox economic theory is seen increasingly in contradiction 
to the facts of the real world. Therefore, it is not exact to see that orthodox economics 
is ahistorical; it is clearly anti-historical!

Some scissors that should be cut: the supply and demand curves

     During the second half of the 19th century there was a very strong debate among the 
economists, namely: whether the "value" of goods was determined by their costs of 
production or from the utility (well-being) that the consumers obtained. The first thesis 
was maintained by the classical economists (Adam Smith, David Ricardo and Karl Marx) while
the second was maintained by the marginalists (Jules Dupuit, Carl Menger and Stanley 
     So then, at the end of the century the British economist and father of the Neo-
classical school Alfred Marshall terminated this debate by means of his ultra-famous 
model of supply and demand. According to it, it is the forces that act behind 
supply and demand which determine the value. They should be conceived like two blades of a
scissors: it is useless to ask which of the two is that which cuts (and thereby the 
denomination of these curves as "Marshall's scissors").  Behind demand is marginal 
utility, reflected in the demand prices of the buyers; and behind supply will be 
marginal costs.
     We now shall pass to a critical analysis of the supply and demand model or, if one 
prefers, to "cut Marshall's scissors." In the first place it must be said that it is 
supported more by an abstract mathematical deduction than by the empirical
study of reality. In effect: perhaps the majority of students in the first phases of 
economics think that supply and demand curves are the consequence of empirical induction,
yet the truth is that the manner of drawing them is purely theoretical. In the real world 
neither supply and demand curves nor equilibrium prices are observed but instead only 
determinate prices at determinate moments. Consequently, to assume that the prices of 
the products we encounter in the supermarket or the warehouse arrive determined by supply 
and demand and therefore demonstrate the validity of the model is nothing more than to 
fall into a petitio principii or fallacy of circular reasoning (that is to 
say, we presuppose what we wish to demonstrate).
     And not only that. If it is true that the prices of the goods which we find in the 
supermarket or the warehouse come to be determined by supply and demand, why is it that, 
in general, they are so stable? This question is tremendously pertinent. It is that were 
it true that supply and demand are what determine prices one would expect those to be 
exceedingly unstable and changing. Why? Because the factors that are behind supply and 
demand are extremely changeable. In effect: behind supply we have the costs, the 
technology and the conditions of production and, in the case of demand, we have the tastes
and preferences of the consumers and the level of incomes. Whoever tells us (even in the 
name of the sacrosanct céteris páribus assumption) that these factors remain
constant simply lives on another planet (or is constructing an empirically  irrelevant
     We shall move now to analyzing the supply curve. Here we must begin by indicating 
that not even in the orthodox theory do supply curves always exist. In monopolies no 
supply curve exists. Nor in the different models of oligopoly. It only exists under 
perfect competition and monopolistic competition (competition between firms with market 
power who have similar but not identical products).
     Yet even those models are based on arbitrary assumptions, since they assume 
decreasing marginal returns in order to construct the marginal cost curves that, 
according to the orthodox Neo-classical theory, are identified with the supply curve 
starting at its growing segment. However, empirical research suggest that it is frequently
the case that firms have constant marginal returns, even increasing, and excess 
established capacity, such that the supply curve might be horizontal or backward-
bending, which could cause it to have more than one intersection with the demand curve 
and, thus, that there is more than one market equilibrium!
     And there is still more. As Sraffa demonstrated in 1960 in his work Production of 
commodities by means of commodities, given that "the prices of goods depend upon the 
methods of production and on distributive variables and by changing these prices of the 
goods can move in any direction, the marginal cost curve has no grounds to form the 
supply curve, because it is not feasible to construct a curve of offers of goods."
     Now, we direct our darts towards the demand curve. According to the orthodox theory 
the demand curve of a market results from the summing of the individual demand curves, 
assuming constant and clearly defined preferences. Yet that seems clearly unreal. Few of 
us could say with security how much we would consume of a certain good at various price 
levels and even less what will be our preferences day after tomorrow.
     Yet even if we were to accept these unrealistic assumptions, there is no reason to 
suppose that all the individual demand curves have the same slope (the individuals are not
clones!) and so the summation of them very probably would have abrupt discontinuities in 
the form of a saw. Resulting in there being no way of ensuring a priori the 
existence of a unique crossing point with the supply curve, nor that the resulting prices 
would be equilibria.
     We see, then, that if indeed the supply and demand curves have come to form part of 
the stock of common sense of many a careful analysis of them reveals this is far from 
evident. So then, if indeed the factors behind supply and demand influence (though 
not necessarily determine) price formation there is no reason to suppose that they do so 
deterministically as a function of the mechanism of supply and demand as the orthodox 
economic theory proposes.
     In fact, the renowned behavioral theorist Dan Ariely has shown in his book 
Predictably Irrational a large part of what we consider "equilibrium prices and 
quantities" can be due not actually to an equilibrium of supply and demand but instead 
more of an arbitrary coherence created in our mind. "The basic idea of arbitrary 
coherence is this: that despite initial prices (such as those for the pearls of Assad) 
are 'arbitrary,' once those prices have become established in our minds, they give form 
not only to present prices but also to future prices (this makes them 'coherent')."
     Similarly, after performing various studies and experiments, Ariely lashes out 
against the orthodox theory saying: "While the standard economic focus assumes that the 
forces of supply and demand are independent, the type of determinative manipulation which 
we have shown here suggest that they are, in fact, dependent. In the real world, the 
baseline (mental) derives from the promotional prices suggested by the manufacturers, the 
publicity prices, the promotions, the introduction of products, et cetera - all of which 
are variables on the supply side. It seems then that instead of the willingness of the 
consumers to pay influencing the prices, the causality is in a way inverted and it is the 
market prices themselves that influence the consumers' willingness to pay. What this 
means is that demand is not, in fact, a force entirely separate from that of supply." 
Yet if supply and demand now are not totally independent now Marshall's "scissors" with 
their two "blades" becomes meaningless. And that is truly problematic...

Extreme unrealism and contradictions: analysis of the assumptions of the perfect 
competition model

     There is no doubt that the perfect competition model is the fundamental model 
of the Neo-classical theory. However, as it is studied in introductory economics courses, 
its crudity cannot pass unnoticed: its assumptions are not realistic. We shall analyze 
them one by one:
     1) Assumption of atomicity of the agents: There are many buyers and many 
sellers. Concerning the unreality of this assumption we have already fully dealt at the 
beginning, especially in discussing the "law of duality." Thus, we shall not expound 
further upon it.
     2) Assumption of homogeneity of the good: Products, understood as the good or 
service as it arrives to the consumer (that is, including its size, form, quality, design,
conditions of sale, et cetera) are identical. Such a supposition is absolutely necessary 
for the model of perfect competition because only if it is fulfilled can it be assured 
that a single market price will exist and, what is more, that the firms will have no 
alternative but to be price-takers. In effect, if the product, such as it arrives to the 
consumers, is identical to the rest, no firm will want to charge more than the market 
price--since then all the consumers would buy it from the other businesses--nor less than 
it - since then it would have lower profits.
     Evidently all this has very restrictive implications. In the real world there are 
almost no enterprises that manufacture absolutely identical products. Perhaps there may be
some exception, as for example the electricity which is distributed to the households. Yet
the norm is to the contrary. The differentiation of products predominates, whether 
it be in size, form, quality, or design. And furthermore, if we follow the famous approach
of the economist Harold Hotelling of considering the spatial location as an 
important differentiating element of the product, we inevitably have to conclude 
that the assumption of a homogeneous, that is to say identical, product is intrinsically 
absurd. For indeed the spatial location is always relevant: the greater the spatial 
distance measured between the consumer and the product's point of sale, the less will be 
the effective relevance that the latter has for her. Therefore, the seller who is closer 
will have a certain "market power" and will be able to charge the consumer a higher price 
(as often occurs with the small sales outlets that locate near or even within university 
communities). Consequently, the only way of ensuring that the products are effectively 
entirely identical, as the perfect competition model requires, is to make all points of 
sale located in exactly the same place! This now is not a problem of mere "realism," but 
instead of logical consistency.
     3) Assumption of absence of market power: The enterprises cannot influence 
the market price. The only competitive variable which they can control is their quantity 
of production. Therefore, they have no alternative but to submit to the market price in 
order to develop their level of production at the point where this equates to their 
marginal costs. In other words, they have no option but to be price-takers.
     The unrealism of this assumption leaps to view: in reality businesses almost always 
see price as one of their principal competitive weapons. But, in fact, what is most 
curious about this assumption are the paradoxical implications to which it leads. In 
effect: the model of perfect competition, by assuming identical, price-taking firms 
with no market power, necessarily implies a system of clone-like businesses that do not 
actually interact among themselves but instead are limited to informing themselves about 
market prices to later revise production quotas (in a more equitable mode, certainly: 
equal quantities to identical firms). In other words, thus formulated, the model of 
"perfect competition" implies that enterprises simply do not compete!
     This had already been well noted by the distinguished economist Oscar Morgenstern 
when he wrote: "The common sense meaning (of the word 'competition') is one of combating 
others, of fighting, of trying to put oneself ahead, or at least of preserving one's 
place. It suffices to consult any dictionary in any language to see that this term 
describes a rivalry, fight, struggle, etc. It becomes difficult to understand why this 
word should be used in economic theory in a form that contradicts ordinary language."
     Thus, to speak of absence of market power is in reality to have a very 
limited vision of the matter (if indeed one has any). Competition, true competition
and not the deceitful (not only "simplistic") caricature which the microeconomics 
manuals present, is the mother of monopoly and oligopoly. The small businessman always 
dreams of obtaining a place among the large ones. The businessmen only behave in this 
passive and price-taking way assumed by orthodox economics when there is no choice but to 
do so and, in the event they have fallen into this situation, will always seek a way to 
leave it so as to increase their profits, even if that implies violating the sacrosanct 
rules of the "competitive" game. Yet it does not seem that that has much weight in the 
economics manuals which treat market structures (whether of perfect or imperfect 
competition) as something already given where the agents limit themselves solely to
optimizing their objective functions.
     4) Assumption of perfect information: All the agents know all the relevant 
variables that affect their decisions. Clearly this assumption is a requisite no less 
"strict" (read unreal) than the previous ones. It implies that all the world has available
(or can costlessly obtain) all the relevant information to make their decisions. Buyers 
and sellers should know with certainty the exact price of the product and its 
characteristics (quality, size, spatio-temporal disposition, et cetera).
     Very well, what is habitual is that we individuals do not have all the relevant 
information and to obtain it will be very costly (whether in terms of money, time, effort,
emotional stress, et cetera) or even impossible. We do not have complete 
information. Even less do we explore all the possibilities. In effect: most times we 
limit ourselves to considering the products that we habitually buy in the 
establishments where we habitually gather and at the prices they habitually
have. All being humans, the agents who act in the market (be they producers or consumers) 
are more "creatures of habit" than "mechanical and rational optimizers."
     And not only that. The perfect competition model, by assuming that every enterprise 
knows with certainty the exact price at which they will be able to sell their 
products and the exact quantity they are going to sell leaves aside one of the most
important elements that affect the business decision: uncertainty. Yet, as we have 
seen in the previous chapter, uncertainty is an essential characteristic of the 
economic process and to subtract something essential from a phenomenon does not 
leave one with a "simplified phenomenon" but instead simply erases the phenomenon
(that the orthodox economists do not truly abide by the epistemic distinction now between 
simplification and distortion is not our problem)...
     5) Assumption of free entrance and free exit: There are no restriction on the 
entrance and exit of firms in the market. Capital is always available to be invested and 
anyone can do so. Industrial plants can be installed or uninstalled in an immediate 
     The unreality of this assumption is more than evident. Firms cannot enter nor exit 
the market from one day to the other as if dealing with a hotel. First, because that 
implies costs. And not only direct economic costs but also transaction costs 
(think, for example, of all the bureaucratic paperwork for it that must be done). Second, 
for obvious technical reasons: industrial plants cannot be installed or uninstalled in an 
immediate fashion.
     Another powerful reason to postulate the unreality of the assumption of free entrance
and exit is the existence of the well-known barriers to entry. A barrier to entry 
is any limitation (legal, economic or institutional) that impedes the incorporation of new
enterprises into a specific industry. Among the most common barriers to entry we have the 
licenses, the patents, the exclusive control of resources, and economies of scale. Such is
their importance that Michael Porter himself considers them explicitly in his famous Model
of the Five Competitive Forces.
     We see, then, reasons in excess to conclude that the model of perfect competition is 
terribly unrealistic. And this does not deal with a mere "simplification of reality" as 
the orthodox economists pretended but instead that it is a scheme which is in open 
competition with reality! It is one thing to take a certain distance from reality 
and another very different is to adopt the contrary. It becomes, then, ingenuous to 
expect useful predictions from such and unrealistic model and even less coherent 
explanations of how reality functions starting from it. And here we have not only echoed 
the truism that the model is not realistic but we also have indicated various points which
put seriously in question its epistemic coherence and pertinence themselves.
We shall pursue that.

A terribly imperfect theory: logical inconsistencies of the perfect competition 

     As we know, the perfect competition model is the central part of the economist's 
education. In fact, when the young economist recognizes a diagram in which appear a supply
function and a demand function, there immediately activates in her mind everything she 
has been taught concerning perfect competition and its attractive implications. 
However, as we just saw, it deals with a tremendously unrealistic model. Yet that is not 
the worst. In fact, as we shall show below, the model of perfect competition has many 
important logical inconsistencies.
     Thus, for instance, one of the great logical inconsistencies incurred by the perfect 
competition model is that which confounds a small influence with an absolutely non-
existent influence. For if it indeed is true that, because of their situation as price-
takers, none of the firms having the capacity to influence the price, the summation of 
their null influences cannot be greater than zero!
     Precisely analyzing this is what the great heterodox economist Steve Keen has argued,
that under perfect competition the demand curve of an individual company is not 
horizontal, as orthodox economics proposes, but instead equal to the market demand curve,
since if we sum any number of flat curves, the result will be a flat (horizontal) curve 
and not one having a slope. But given that the market demand curve in the Neo-classical
model has a slope, this requires that the individual demand curves of the firms also have 
a slope.
     Be that as it may, in any case it becomes clear that if we consider that many firms 
exist the influence of each of them upon the market price cannot be zero. Anyone can 
confirm this by means of a simple exercise: 1) calculate the equilibrium price in a 
numeric example of the model of perfect competition with a number "n" of businesses in the
equilibrium, 2) now remove one of the firms from the initial quantity "n" and return to 
calculate the equilibrium price. Does it coincide with the first?
     We see, then, that the perfect competition model leaves unresolved the relation 
between the number of firms and the competitive (price-taking) activity. That in a 
numerical exercise we can calculate the number of firms which fit in a competitive market
tells us nothing about the number of firms for which "market power" is negated in the real
     Even so the most theoretical orthodox economist could respond that in his most 
rigorous algebraic formulation the perfect competition model does not exactly assume the 
existence of "many" buyers and "many" sellers but more the existence of infinite 
buyers and infinite sellers, such that, by being dispersed among an infinity of 
enterprises, the market power of each one of them will be null.
     To this we must respond that the existence of infinite enterprises is an absolute 
factual impossibility for there cannot be a real infinite multitude. And not only that, 
but it carries us to various logical absurdities. For example, if having infinite 
enterprises in the initial situation it happens that because of changes in the market 100 
of them should leave, how many will remain? Well, still an infinity (infinity - 100 = 
infinity), that is, the same quantity as at the beginning!
     In synthesis, the model of perfect competition is not only unreal, but also absurd.
Failed recursion: the "false Messiah" of successive approximations

     Let us return now to the question of the unreality of the perfect competition model. 
How do the orthodox economists confront this lack of realism? Simple: they minimize it 
saying that all scientific models are unrealistic to some degree. However, as we have 
already said, the model of perfect competition is not a mere innocent 
simplification of reality but instead is openly in contradiction to reality.
Yet the orthodox Neo-classical economists still have a reply. The say: "This model is only
the basis and principle of our research program. Later, starting from that we shall 
proceed by elaborating other more realistic models of perfect competition, with market 
power, differentiated products, barriers to entry, and uncertainty. The student only must 
have patience. Little by little, to the extent she advances in her coursework, she will 
begin seeing ever more realistic models." We have here, then, the great method of 
recursion which orthodox Neo-classical theory has discovered for its unrealism: the method
of successive approximations."
     The first thing that must be said with regard to this is that in reality we are 
dealing with a giant fraud. In effect: during the first phases of their career the 
students are made to believe that they will be studying ever more realistic models, yet 
later, once the models of imperfect competition (monopoly, oligopoly and monopolistic 
competition) have been explained in passing, courses in economic theory return to being 
more unrealistic and abstract. Anybody can verify this by referring to any advanced 
microeconomics or advanced macroeconomics text. Accordingly Martin Shubik, in his famous 
article "A Curmudgeon's Guide to Microeconomics," reports that "the textbooks are rare 
which bother to indicate to the students that there are various different institutional 
forms with which an enterprise can operate. The more elementary is the textbook, the more 
probable that it contains information about different forms of organization. However, 
whenever our study becomes advanced, we do not bother to differentiate between 
General Motors and a small bakery. There are different institutional forms in Samuelson's 
basic text, but not in his Foundations."
     Yet even leaving this aside, it must be said that the orthodox approach of successive
approximations to reality starting from unrealistic models utilizes an absolutely 
unfortunate strategy because, by so proceeding, it concludes by converting reality to a
sort of "special case" of the theory!
     And not only that. The method of successive approximations, if indeed it can be 
appropriated for systems in which the parts are not intrinsically interrelated, can never 
do so for complex or holistic systems, in which the elements in fact are 
intrinsically interrelated and possess emergent properties. Now then, as the
economists of the Austrian school have repeatedly observed, this is what occurs with the 
structures of competition and the market. In these the information, the risk, the 
uncertainty, the technology, and the relative power of the participants should 
never be considered as exogenous elements that later can be introduced into 
the system maintaining the previous basic structure intact because, when the system has an
holistic structure with emergent properties, every time a new element is added the 
entirety of the system is reconfigured anew.
     It is precisely because of the foregoing that the orthodox Neo-classical theory can 
never construct sufficiently realistic models not even through its method of successive 
approximations. By always maintaining the same deterministic structure it can never
construct "open models," but can only move from one closed system to a slightly bigger 
closed system. The standard mathematical formulation, if indeed it allows playing 
theoretical ping-pong and formulating amusing exercises, sterilizes any 
intent towards holistic analysis, which is what is really suitable for the 
structures of competition and the market. Thus Shubik, referring to the model of 
duopoly (competition between two firms with market power) declares that "Personally, I
like the theory of duopoly. I like it better than crossword puzzles. Nevertheless, if 
I forget the distance that separates the very simplified models which we study from the 
actual firms and markets in our society, it will cause great damage to myself and to my 
     Finally, with respect to the method of successive approximations, to tell the truth, 
we find that in the process of constructing our (supposedly more realistic) new models, 
the majority of times many of the false previous assumptions are maintained and, what is 
more, new false assumptions are added with the goal of ensuring the deterministic-
mathematical "closure" of our system. In this manner, falsehood upon falsehood are 
accumulated and the promise of eliminating the false assumptions is never fulfilled. 
Therefore, the method of successive approximations, or successive closures, perhaps should
be called the "method of successive falsehoods." But what is certain is that it comprises 
a "false messiah" for it does not redeem the orthodox theory of competitive markets from 
its lack of realism. And nor does it redeem the young economics students who want to 
better understand reality and end being swindled by their professors (who in turn were 
swindled when they were students).


     The object of this chapter has been to critically examine the orthodox theory of 
competitive markets. Basically we have seen that:
     1) The single idea of a planning system puts seriously into question the 
pertinence and relevance of the notion of competitive markets since in that type of 
scheme, because of the very necessities which the industrial system imposes, enterprises 
feel compelled to substitute planning for the market in order to obtain stability and, 
thereby, their operational capacity.
     2) Likewise, the law of duality, which postulates that eventually every market
will become a race between two participants, makes practically unworkable the idea of 
atomicity of competitive agents.
     3) Under the actual conditions of capitalism the firms not only have market power but
also power over the market, which is much more important yet even so the orthodox 
theory passes over it.
     4) Strategic thinking, which implies the capacity of the firms to directly 
mold the conditions of their environment, displaces Adam Smith's "invisible hand" 
replacing it with the "visible hand" of the managers of the large enterprises.
     5) The famous model of supply and demand remains seriously challenged by the 
conceptual difficulties of coherently specifying the supply and demand curves, with
important empirical anomalies like the generic stability of prices and the 
possibilities of mere arbitrary coherence as have been noted by behavioral 
     6) The principles assumed by the model of perfect competition (atomicity of the 
agents, homogeneity of the good, absence of market power, perfect information, and free 
entrance and free exit) are not mere and innocent "simplifications" of reality but instead
are in open contradiction with it and, consequently, conclude by obscuring and 
making its comprehension difficult.
     7) Problems of logical consistency are also found given that, seemingly, a 
very small influence is confused with a non-existent influence in reference to the 
capacity of the firms to affect the price in the perfect competition model, as well as 
other questions related to the factual impossibilities of infinites and the slope of the 
market demand curve.
     8) The method of "successive approximations" is highly questionable since it results 
in converting reality to a sort of special case of the theory, does not correctly 
capture the holistic ontological structure of the phenomenon of the market and 
continues to maintain absolutely unrealistic and arbitrary assumptions solely in 
order to conserve the mathematical apparatus.
     All that constitutes a powerful cumulative case against the Neo-classical 
postulate of perfect competition and the mechanistic structuring of the market in terms of
supply-demand. Ultimately, the orthodox theory of competitive markets is nothing more than
a myth. May it rest in peace.

                        Chapter 6
                        THE MYTH OF MARKET EFFICIENCY
                        "As every individual, therefore, endeavours as much as 
                              he can both to employ his capital...such that its produce 
                              may be of the greatest value...He generally, indeed, neither
                              intends to promote the public interest, nor knows how much 
                              he is promoting it...He intends only his own gain, and he is
                              in this, as in many other cases, led by an invisible hand 
                              to promote an end which was no part of his intention...By 
                              pursuing his own interest he frequently promotes that of the
                              society more effectually than when he really intends to 
                              promote it."
                                                Adam Smith, father of Economics
The orthodox theory of market efficiency

     In this chapter we shall broach the theme of the efficiency of markets. As opposed to
the previous chapters we shall not treat only one but instead two formulations of this 
theme, to wit: the Neo-classical and the Austrian.
     We commence with the Neo-classical. According to the Neo-classical school the concept
of efficiency corresponds with Pareto optimality, which "is present when 
there is no means of reorganizing production or consumption such that the satisfaction of 
any person is increased without reducing the satisfaction of another." And when is this 
achieved? Well when "the sum of consumer and producer surplus are maximized."
     We just introduced two new concepts: consumer surplus and producer surplus. 
Consumer surplus is the extra value obtained by persons consuming a good compared 
to what they have paid for it. For its part, producer surplus is the extra value 
producers receive by selling a good compared to the marginal costs incurred to produce it.
     And now, the key question: what economic system is that which maximizes the sum of 
consumer and of producer surplus? "Well the system of perfectly competitive markets!" the 
Neo-classical economists will respond. Thus we have, for example, one of the great 
representatives of the Neo-classical school, Paul Samuelson, who tells us: "One of the 
most profound results in all economics is that perfectly competitive markets 
assign resources efficiently." Why? Because in them "every firm has chosen its level 
of production such that the marginal cost equates to the price" wherein, under equilibrium
(P = CMg) the final consumer will be willing to pay that price which exactly covers the 
producer's costs and, therefore, a situation will result in which "the economy extracts 
the maximum quantity of production and satisfaction from its resources" thereby 
maximizing the economic surplus (consumer surplus + producer surplus). Graphically:

However, in what refers to this focus, it is necessary to make one important 
clarification: for Neo-classical economics the concept of efficiency has nothing to
do with equity. "Even if the economy is efficient, this does not imply anything 
with respect to the justice of the distribution of income." And indeed according to 
the orthodox Neo-classical conception, for efficiency to exist it suffices that society 
as a whole obtains the maximum possible welfare from its resources, independently
of how this may be distributed.
     We turn now to the focus on market efficiency held by the Austrian school. According 
to them markets are efficient because, on the one hand, being founded upon consumer 
sovereignty, it always procures maximum satisfaction for them, distributing production
in the most efficient mode possible; and on the other, because with all the "dispersed 
knowledge" concentrated in the prices, it allows producers and consumers to coordinate 
their plans in a spontaneous and rational manner.
     In order to explain the first point we base ourselves on the approach of Ludwig von 
Mises, one of the most prominent mentors of the Austrian school. According to Mises, the 
capitalist free market system is the most efficient of any imaginable for, being  based 
upon "consumer sovereignty," it only offers the producer one way to become rich: serving 
the consumers. We have here the hard discipline of the market.
     In his famous treatise Human Action (1949) Mises illustrates this in quite a 
suggestive manner: "The direction of all economic affairs is in the market society a
task of the entrepreneurs. Theirs is the control of production. They are at the helm and 
steer the ship. A superficial observer would believe that they are supreme. But they 
are not. They are bound to obey unconditionally the captain's orders. 
The captain is the consumer. Neither the entrepreneurs nor the farmers nor the 
capitalists determine what has to be produced. The consumers do that. If 
a businessman does not strictly obey the orders of the public as they are conveyed to him 
by the structure of market prices, he suffers losses, he goes bankrupt, and is thus 
removed from his eminent position at the helm. Other men who did better in satisfying the 
demand of the consumers replace him." In this way, Mises continues, on the difference 
between economic and political power: "A 'chocolate king' has no power over the 
consumers, his patrons. He provides them with chocolate of the best quality and at 
the cheapest price. He does not rule the consumers, he serves them. The consumers...
are free to stop patronizing his shops. He loses his ’kingdom’ if the consumers prefer 
to spend their pennies elsewhere."
     We have here, then, the essence of the "invisible hand" of which Smith spoke at the 
beginning of the chapter: the egoistical businessman who cares nothing about 
the needs of his neighbors and is only concerned to make more money ends, by virtue of
consumer sovereignty, behaving like a saint, since the only way he has to make more
money is by producing and selling those goods that the consumers most desire and need, in 
other words, caring about the needs of his neighbors. In this manner, seeking only 
one's individual welfare results in providing, without intending to, the social 
welfare in the most efficient mode possible.
     Now, to explain the second reason why the Austrian school postulates the intrinsic 
efficiency of markets we shall follow one who, in the opinion of many, is the most 
important and recognized of the liberal Austrian economists: Friedrich von Hayek. 
According to Hayek the fundamental problem of the economy is that of coordination
and the fundamental element for this to occur in a rational and efficient manner is 
information. In this schema, there can only be perfect coordination--and, 
therefore, maximum efficiency--where there is perfect information.
     So then, very much to the contrary of the Neo-classical economists, Hayek rejects 
(and very decidedly, to be sure) the assumption that "practically all of us deal with more
or less perfect knowledge," in other words, the assumption of perfect information. 
Yet, how then to demonstrate that the market system is the most efficient? In quite an 
ingenious way: appealing to the "marvel" of the price system as a synthesizing mechanism 
for the "dispersed information." In his very famous 1944 work, The Road to Serfdom,
he writes: "The very complexity of modern conditions makes competition the only method by 
which a coordination of affairs can be adequately achieved. There would be no difficulty 
about efficient control or planning were conditions so simple that a single person or 
board could effectively survey all the facts. But as the factors which have to be taken 
into account become numerous and complex, no one centre can keep track of them. The 
constantly changing conditions of demand and supply of different commodities can never be 
fully known or quickly enough disseminated by any one centre. Under competition--and 
under no other economic order--the price system automatically records all the relevant 
data. Entrepreneurs, by watching the movement of comparatively few prices, as an engineer 
watches a few dials, can adjust their activities to those of their fellows...This is 
precisely what the price system offers under the regime of competition and something 
which no other system can, even potentially, realize."
     Pursuing a similar perspective to the standard theoretical scheme the hypothesis 
of efficient markets proposed by Eugene Fama of the University of Chicago became 
dominant, according to which active prices in the financial markets would tend towards 
their fundamental value given all the publicly available information. Ergo, not only the 
markets for standard goods and services but also the financial would be efficient and, 
consequently, the stability of the whole economy would be assured. Any crisis, therefore, 
could only be caused by an "unexpected exogenous shock" but never would come from the 
functioning of the market system itself.

The markets are not omnipotent! The problem of market failure

     As we had seen, according to the Neo-classical theory "the virtues of the market 
mechanisms are only fully operative when the checks and balances of perfect
competition are present." In this line, to the degree that the markets depart from the
ideal of perfect competition they will not obtain full efficiency and, in the end, will 
generate "errors." As Samuelson and Nordhaus example, the principal market failures
are three. Specifically:
     1) Imperfect competition: When a firm has market power in a specific market 
(for example, has a monopoly wit respect to a patented medicine) it can elevate the price 
of its product over above its marginal cost (P > CMg). The consumers will purchase 
a lesser quantity of goods than they would buy in a situation of perfect competition 
(where P = CMg) and, therefore, will reduce their welfare.
     2) Externalities: They emerge when some of the secondary effects of production
or consumption are not included in the market prices. For instance, we think of a coal 
plant which emits contaminating smoke. That obviously reduces the social welfare, for it 
causes damage to the surrounding environment and upon the health of the people. However, 
given that such social costs are not incorporated into their private costs, the 
enterprise will not have these in mind and will generate a higher level of production than
consistent with the social welfare.
     3) Imperfect information: The orthodox theory of efficient markets assumes 
that the buyers and the sellers have perfect information with respect to the goods and 
services that they buy and sell. It supposes that the consumers know perfectly the quality
and characteristics of the goods (for instance, which cars are junk or which medicines are
effective). If that does not obtain, that is, if there is imperfect information, the 
decisions taken by the agents will not be optimal and, in consequence, the maximum 
social welfare will not be reached.
     Anyone can find all these market failures (and even others) very well explained in 
the manuals of orthodox economics. However, the pertinent question here is: how frequent 
are these market failures? Can we accept that "externalities" are not so frequent at 
least on a grand scale. But with regard to "imperfect competition" and "imperfect 
information" we have to say that they occur almost always! And indeed, as we have seen, 
imperfect competition and market power are not mere "anomalies" as if perfect competition 
were the norm, but instead they comprise structural characteristics in the 
evolution of capitalism! Furthermore, with regard to the assumption of perfect information
and omniscient agents we find that this is so unrealistic that Samuelson himself feels 
obliged to accept that "it becomes evident that reality itself is far from this idealized 
     What is the implication of all that? A truly enormous implication. It means that if 
we accept the Neo-classical theory of the efficiency of markets the obvious conclusion 
will be that capitalism is structurally inefficient! The shot backfired on the Neo-
classical economists: seeking to legitimate actual markets by means of ideal
models they ended up demonstrating that, at least if we stick to the latter's restrictive 
assumptions, the former are extremely inefficient! Not even Marx made such a strong 
critique of capitalism...

Efficiency for what? The uncomfortable question of content and goals

     Today efficiency has become an absolute value. Anybody who disputes the sanctity of 
marriage or the validity of the social norms will be heard although it be unwillingly; by 
contrast, if one disputes the social necessity or efficiency, she will be 
immediately dismissed as a pariah.
     Yet perhaps we ought to re-evaluate this sort of attitude. Efficiency is not an 
absolute value. It is always relative; relative to the goals it pursues. It 
only acquires its content with respect to the proposed ends. Thus, a certain action
or policy can be perfectly efficient for one objective yet very inefficient 
for another. An automobile can be a very efficient means for moving through the city, but 
absolutely inefficient for doing so upon a mountain.
     This clarification might seem trivial. Nevertheless, it is of prime importance in 
this context because, in fact, the great majority of economists speak of economic 
efficiency as if they dealt with an absolute and neutral value, without ever
explaining the goals with respect to which this is defined. "The free market is the most 
efficient way of organizing an economy," they only say, without any specification of 
with respect to what it has that efficiency. Thus, by way of argumentum ad 
náuseum, the orthodox economists keep introducing this idea into our minds, so 
depriving us of the possibility of contemplating wider or more desirable alternatives of 
social choice than those of simply market arrangements.
     Thus, we should always keep in mind that markets can be very efficient and rational 
for certain ends, and very inefficient and even irrational for others. Let us consider for
example the goal of economic security. Obviously the free markets of perfect 
competition do not constitute an efficient instrument for achieving this objective given 
that economic uncertainty is greater the more unchecked the competition and the 
smaller the firms as we saw in detail in the previous chapter in explaining the emergence 
of the "planning system." Yet it not only concerns economic security. The same can also be
said, in certain contexts, with respect to other goals such as ecological 
conservation or social justice. And it is precisely keeping in mind this 
latter, which has much to do with the general welfare, that we perform our critical 
analysis of the Neo-classical concept of efficiency.

A not at all optimal criterion: Pareto optimality

     Without detours: what is the specific concept of efficiency used by the Neo-
classical school? Well, it is Pareto optimality. According to this concept an 
economy will be efficient insofar as it jointly obtains the maximum possible welfare from 
the resources available to it in a situation where it cannot increase any individual's 
welfare without diminishing that of another.
     This concept of efficiency, which at first sight appears neutral, is subtle enough 
that it should be analyzed very carefully. In the first place, one must begin by noting 
that it is based upon an individualistic conception of society. In effect, 
according to it, social welfare (or utility) is nothing more than the sum of individual 
utility. Yet one could very well have an organicist conception of social welfare 
and consequently have no motive whatsoever for considering Pareto-efficiency as a 
desirable economic objective. It is not the object of this book to determine which of the 
two visions is correct. Yet it suffices to mention this in order to demonstrate that the 
Paretian concept of efficiency is not neutral.
     And not only that. The concept of Pareto efficiency is not innocuous either since, by
considering social welfare only as a whole, its sets aside a problem as important 
as that of inequality. In effect, given that all which matters is the sum 
total of individual welfare it could well occur that ten percent of the population 
controls 80 percent of the resources and the other 90 percent only the remaining 20 
percent and even so we would speak of a fully efficient economy. Even further:
it that poorest 90 percent of the population were to die...of hunger let us say, and their
20 percent of the resources were to become the property of the richest ten percent, that 
society's efficiency, in accordance with Pareto's criterion, would increase (the dead 
individuals now not entering into the calculation)!
     We see, then, that the criterion of Pareto efficiency, by not taking the problem of 
inequality into account, can lead us to justify truly irrational (if not immoral) 
situations. But we have no reason to necessarily accept such a concept. We could 
preferably propose another more complete concept of efficiency in which equality is
incorporated (such as in some countries where the growth index of the GNP is adjusted with
the Gini coefficient, that measures the degree of economic inequality). There 
exists, then, no insurmountable disjunction between efficiency and equity, 
as the orthodox economists profess. More accurately there exists a disjunction between 
equality and the Neo-classical concept of efficiency. Yet, as we have said, we do 
not have to accept that concept.

Efficiency for whom? Market and exclusion

     One of the principal arguments of the liberal economists as well as Neo-classicals 
such as the Austrians to defend the efficiency of markets is that they are constituted as 
a sort of democracy. Thus, for example, we have von Mises who writes that: "The
market comprises a democracy, in which every penny gives the right to one vote." The 
direct consequence of that is economic efficiency. In effect, the consumers vote with 
their money so that production will be oriented to satisfy their needs and, thus, the more
important and urgent these are, the more disposed they will be to pay for those goods and 
services to be produced to satisfy them. Then the businessmen, on seeing the opportunities
for gains, will orient their offers in that direction and generate economic efficiency. 
And it could not be otherwise because in this environment "a major investment of capital 
and labor would only be opportune if it enabled attending to the most urgent
of the still unsatisfied needs of the consumers."
     Now then, can it be true that the market is constituted as a "democracy"? We think 
not. Why? Because democracy is (or, at least, should be) an inclusive and participatory 
institution, and the market, on the other hand, is essentially exclusive. In 
effect, by guiding itself through "monetary votes" to distribute resources, the market is 
not really interested in serving the consumers but rather instead in serving the 
solvent consumers.
     This can be very clearly shown by means of a supply-demand graphic:
As we can see, at the equilibrium production level (Q1) the supply does 
not manage to cover all the demand, that is to say, all the consumers who  
need the product, but instead only the group of consumers who would pay a price 
greater or equal to the equilibrium (P1) for the good. There remains, 
therefore, a segment of unfilled demand which we have indicated in the graphic by a 
thicker line.
     And orthodox economist will immediately respond that such a situation is completely 
natural and rational. It is obvious that the consumers in the "unfilled demand" segment 
have a less urgent need for the good since they are less willing to pay for it and, 
therefore, it would be a very inefficient use of resources for the enterprises to attend 
to it, given that to produce such additional units of the good they would have to incur 
marginal costs greater than the price that these consumers would be willing to pay for 
     This reasoning contains some truth and much that is false. The true part it contains 
is quite innocent. Obviously if I like chocolates greatly and another person not so much, 
I will be willing to pay more for the chocolates and it will be rational and efficient, 
given the costs, for the market to satisfy me before the other person.
     Now we shall examine the part that is a lie. This is in no way innocent. In effect, 
market demand not only comes from what the people "are willing to pay" but rather 
instead by what the people "are willing and can pay." In this fashion, it is not 
enough for me to have a need for the market to take it into account; it is also 
necessary that I have the means (acquisitive power) to be able to express it. If I do 
not have that the market simply will not attend to my need however urgent it may be. All 
that matters are the monetary votes. The market is guided by them, not by the greatest 
need. The businessmen produce in order to gain a profit, not for amusement or for 
charity. Therefore, it can well occur that a rich man's cat drinks the milk which a poor 
child needs to survive or that sanitary resources are assigned to advanced 
biotechnological research designed to benefit 2000 persons in the whole world, while a 
thousand times more (children primarily) die of dysentery due to the sole fact that 
they do not have sufficient (monetary) "votes" for the "voice" of their necessity 
to be heard in this "democracy" of the market.
     Does this mean that the market does not work? No. Entirely the contrary. It is 
functioning perfectly! What? Of course it is! It is doing what it knows how to do: put the
goods in the hands of those who have the monetary votes. We have here the "miracle" of its
efficiency! Maybe the reader can now better understand why we had given such importance to
the "uncomfortable" question of the content and goals of economic efficiency. If we say 
that the meaning of rationality and efficiency for the economy consists in 
"efficiently administering the resources in order to satisfy the human needs it 
results that, at least in its present state, the free market economy is terribly 
irrational and inefficient! (See, for example, the reports published 
annually about poverty, hunger and/ or inequality by institutions such as the UNDP and 
the FAO.)
     We see, then, that the orthodox theorem of market efficiency is intrinsically 
conditioned by the problem of inequality in the distribution of income. In fact, given
this context, one can only speak of full efficiency of the competitive free market if we 
assume a perfectly egalitarian distribution of income! Otherwise the quantity of monetary 
votes will not express in an exact way on the demand curve the intensity of the needs and/
or preferences of the consumers. Yet this is precisely what happens in reality.  
There are many "voices" who cry very loudly yet which are not heard by the market...

Fair injustice? The fallacy of "prior votes" and the "meritocratic scale"

     The great majority of liberal economists, especially the Austrians, know and accept 
that inequality of income conditions the capacity of the consumers to have the voice of 
their necessities heard in the "democracy" of the market. Nevertheless they do not believe
that this destroys efficiency. All to the contrary: it is precisely because of the 
inequality in the distribution of incomes that the markets are genuinely efficient. They
justify this conclusion upon the basis of two reasons. Let us examine them.
     The first reason is because "if indeed it is certain that, in the market, the 
consumers do not all dispose of the same number of votes," given that "the rich have more 
suffrage available than the poor," such inequality "is merely the fruit of previous 
voting." In effect, given that "within a pure market economy one is only enriched who 
knows how to attend to the desires of the consumers," the inequality of incomes will be 
nothing more than the consequence of the highest rewards the consumers will give to those 
who know how to please them and the lowest (or non-existent) which they give to those who 
do not know how to please. In this manner, "the consumers determine not only the prices of
the consumer goods, but also the prices of all the factors of production, setting the 
incomes of those who operate in the domain of the market economy: it is they, not 
the businessmen, definitively, who pay each worker their salary, the same for the famous 
movie star as for the miserable beggar.
     Meanwhile, the second reason why the liberal economists postulate inequality as an 
essential condition for market efficiency is because they consider that the greater income
levels of certain agents are a reflection of the diligence and effort which they put into 
earning them. Under this perspective if the executives, businessmen or high level public 
functionaries receive higher incomes than the workers, operatives or lesser employees it 
is because that constitutes the fair return for the investment in "human capital" which 
they made during their period of professional formation. It has been thanks to their 
effort and perseverance that they have managed to study, specialize and be licensed, while
their peers preferred to enter directly into the labor market. Therefore, it is logical 
and just, now that their long formative road has been completed, that they experience high
revenues, to compensate for all those sacrifices in the halls of school and the university
(including Masters and doctorates).
     Now we shall analyze these two reasons. Obviously, they contain some truth. However, 
given our purposes, it becomes more interesting to reveal their lying part.
     Regarding the first argument we find that, if we analyze it dynamically, it 
becomes inconsistent. In effect: even were we to accept that the initial "voting" of the 
market compensates everyone to the extent that they have served the consumers, once this 
is realized, by changing the distribution of incomes, prices would deviate from the 
optimal initial equilibrium and never more return to attain it. In this form the voting 
capacity of the consumers would always be conditioned by the results of the previous vote 
and the only way of ensuring distributive efficiency will be to "delete and start anew" in
every period, that is, equating the incomes every time!
     However, such a criticism is not the most important. This is that if, as Mises 
recognizes, "the rich can deposit more votes than the poor," we shall have the productive
resources being more oriented to satisfying the "superfluous needs" (a term which, by the 
way, is in itself a contradictio in adjecto: to speak of superfluous needs is 
almost like speaking of unnecessary necessities!) of the former than to satisfy the more 
peremptory and urgent needs of the second. Or that is, the nourishment will 
leave the poor nations where people die of hunger in order to go to those of higher 
incomes where the people die of obesity. Can one possibly call this a rational 
     We move to the second argument. According to this the greater incomes of certain 
individuals is constituted essentially as a "compensation" for the sacrifices that they 
had to make to be able to develop and, in this fashion, accumulate "human capital." In 
other words, it is "compensating" the opportunity cost which they had to assume by 
dedicating themselves to study instead of making money working. The big problem with this
affirmation is it is only supported by the fact that each individual compares these 
options with others available to him and not with the material situation of the other 
individuals. It can well happen that the sacrifice of the existing notary public
--whose work requires, in general, very little effort--may have consisted in not having 
gone out for amusement on Saturdays so as to keep study books of Law, while that of the 
existing garbage collector had been in reality not studying (not to speak of 
amusement) through having to work (possibly collecting garbage since then) in order
to bring a little money to his poor home. The notary decided not to have fun so as to 
study, correct. Yet could we possibly say perhaps that the garbage collector 
decided not to study in order to be able to work? No, he could not choose 
not to study, but simply had to work!
     Also, would it be true that the market rewards the individuals who have sacrificed in
order to develop professionally? Not necessarily. A large portion of the time 
opportunities are lacking. A clear demonstration of that is the well-known movement of 
the "indignant," principally comprised of professionally and intellectually highly 
qualified persons in the most prosperous capitalist nations of the world (Europe, United 
States) who protest their societies for not offering them work opportunities despite 
their effort and development. And some of them have doctorates and many academic 
accomplishment, yet even so are unemployed. Thus, we see that not always is "She who 
studies prevails" fulfilled.
     And not only that. Even when she triumphs is is very probable that someone else 
appropriates a large part of her triumph. Effectively, in a capitalist society the most 
efficient and capable are not necessarily on top but rather instead, in general, those who
hold the economic power; allowing them, when they are inefficient and incapable 
(and even when they are not) to outsource the efficiency of others--more efficient 
and capable--by means of the wage system of labor and, in consequence, 
appropriating their achievements. What better example of that than the boy who 
inherits, without the need for any work nor effort, the multi-millionaire firm of 
his father and is limited to periodically charging very high dividends generated as a 
result of the intensive labor of a very efficient and well-trained army of 
managers and engineers.

Destroying a dogma: the fallacy of consumer sovereignty

     "The consumer is so to speak, the king... Every consumer is an elector who 
utilizes their vote to have the things made which he desires." With these solemn 
words the renowned United States Nobel prizewinner Paul Samuelson defines the principal
article of faith in the credo of the orthodox economist: the sacred doctrine of "consumer 
sovereignty." The importance of this dogma for orthodox economics is such that to 
demonstrate its falsity should bring down its whole doctrinal edifice concerning the 
efficiency of markets. And it is only if the consumers are sovereign that the free 
market "gives persons what they really want" and that, therefore, the resources 
are efficiently administered.
     The reason, then, is clear why "in the market economy consumer sovereignty is 
always assumed: only if the consumers are sovereign can it be said that free 
market capitalism is the only system that we are in - paraphrasing the slogan 
of Friedman-"free to choose."
     Now then, in existing capitalism are the consumers really the "owners" of the system?
Are they really free to choose? We definitely see they are not. Why? Principally 
because of what we shall call the "production system of necessities."
     The system of production of necessities is constituted as an intrinsic and 
necessary process in the development of advanced capitalism by virtue of the planning
imperative. In point of fact, as Keynes explained, there are two prime movers of 
capitalism: greed and fear. So then, if that is so we find that, on one 
hand, because of greed, businessmen will always seek to increase their profits and,
consequently, expand their sales; and, on the other, because of fear, they will 
see the need for planning and even--to the extent possible--controlling all the 
variable that can affect their position, growth or security. This implies that they should
not only plan the supply variables (which is obvious) yet instead above 
all, also to the extent possible, the variables of demand. And why above 
all the demand variables? For it is precisely those which imply the most risks 
for the attainment of the business objectives enumerated (positioning, growth and 
     In effect, if the consumers were truly sovereign, the continuous and very 
fickle changes in their tastes and preferences would always put the enterprises in 
a situation of unsupportable uncertainty. Ludwig von Mises himself said that the 
consumers "are egotistical and implacable bosses, capricious and fickle, difficult 
to please. Only their personal satisfaction concerns them. They are interested neither in 
past merits nor in rights to be obtained someday. They abandon their customary 
providers whenever someone offers them better or cheaper things." Therefore, it 
becomes evident that sovereign consumers are the greatest enemies of the
security, stability and power of a firm. If the consumer rules the 
enterprise cannot rule. Ergo, for the latter to rule the former must first be 
"killed." However, that would be like suicide since one would be killing the "chicken who 
laid the golden eggs": if there are no consumers the "reign" of business fades because 
they will have nowhere to operate. What alternative then remains? To manipulate 
them. A "parliamentary monarchy" is thus created in which the consumer "rules but 
does not govern," where the governing of the economy is delegated to a powerful 
Parliament comprised of great oligopolistic enterprises who constantly seek to "direct" 
     It follows that marketing and publicity have become such important 
elements of actual capitalism: they are the instruments for manipulating the 
consumer. That is no exaggeration. We have for example Ries and Trout who in their 
book The 22 Immutable Laws of Marketing, considered a sort of "Bible" or marketing,
tell us that the battle of the market "if not a battle of products, but one of 
perceptions" and that "marketing is manipulation of those perceptions."
     Not inexplicable, then, is the omnipresent publicity bombardment to which we 
are subjected daily nor the tremendous importance which brands have assumed today. 
Yet do not think that these are separate elements. They are indissolubly united. And 
indeed, as Naomi Klein correctly says, "we should consider the brand as the essential 
meaning of the great modern enterprise, and publicity as a vehicle that is utilized to 
transmit that meaning to the world" for "when the names and the characteristics of the 
products were decided, publicity provided them the means for speaking directly to the 
possible consumers."
     In this manner, we see that the advent of the technological society, the propagation
and influence of the communication media, the development of publicity, the sales 
strategies, the planning system and the predominance of oligopolistic and monopolistic
market structures, the supposed "sovereignty" of the consumer remain, to say the least,
undermined. It would be absurd to think that the great enterprises such as Microsoft, Nike
or Coca Cola are nothing more than humble and passive servants of the consumer. Only a 
fool could think that the object of the publicity is solely "informative" when the 
overwhelming evidence shows us that it is essentially "persuasive." Or perhaps the 
girls who come out in bikinis in the beer commercials are elements informative of the 
quality and characteristics of the product?
     The single fact that the needs of the consumers are ever more manipulated and 
exacerbated by publicity and sales techniques demonstrates that their preferences are not
completely autonomous. At this point someone could object that this is not entirely true 
since any individual is free to negate the influence of the publicity if they so desire. 
In a way they would be right. Yet one must keep in mind that the manipulation of 
necessities is not directed principally at the individual, but instead to the masses, 
such that it does not result in a large loss of sales that a single individual salvages 
their liberty and autonomy as long as the majority can be manipulated.
     We encounter, then, an economic system that ultimately inverts its rationality from 
firms occasionally producing what we need to, we come to need what they produce! Thus, the
"general rule, with fewer exceptions than we imagine, is that if they produce it we shall 
buy it."
     Consequently, the idea of an absolutely sovereign and autonomous consumer is no more 
than a myth. And even more so in a society where a businessman can say: "Our job consists 
in discovering what that guy does not know he needs, yet does need, and later ensure that 
he knows what he needs and that we alone can give it to him." Who now is that businessman?
Well nobody less than Bill Gates, the creator of Microsoft! The great Austrian economist 
Joseph Schumpeter was right, then, when he wrote that, in a process as important and 
constitutive of the capitalist dynamic as is creative destruction, it is 
the producer, and not the consumer, "who initiates the economic exchange, even educating 
the consumers if necessary...teaching them new things, or things which differ somehow
from the already existent, to need." Sovereignty of the producer, gentlemen; not of 
the consumer.

Competition leads to efficiency? John Nash vs. Adam Smith

     We shall now analyze the famous idea of the "invisible hand" formulated by Adam 
Smith, who is considered as the "father of economics." According to Smith, the basis of 
economic efficiency is found in competition. Instead of worrying themself about the 
general welfare, each agent should be concerned only with their individual welfare and act
according to that in the market system. In this fashion, as by the action of an 
"invisible hand," the maximum social welfare will be obtained in a manner even more 
efficient than if it had been consciously sought. Therefore, the best type of economic 
organization is one founded upon competitive individualism, that is to say, the pure free 
market system.
     However, such an idea was already mathematically refuted by John Nash, who in 
1994 got the Nobel prize for his contributions to so-called game theory. So then, 
specifically, what Nash discovered was that in a non-cooperative framework, in which each 
of the agents acts in an individualistic way can easily lead to situations where, 
considering that the others also act on the basis of the same logic, they now do not want 
to unilaterally change their course of action yet at the same time are not maximizing 
their joint welfare. In other words: there can be inefficient non-cooperative 
equilibria. And this implies that Adam Smith was mistaken: competition does not always
lead to efficiency.
     The Argentine economist Walter Graziano comments in this regard: "All this can seem 
hard to understand. But it is not. At root, if well understood, Nash's discoveries imply a
truism. For instance, taking the case of fútbol. Imagine a team in which all its players 
intend to shine with their own light, play forward and make the goal. More than team-
mates, they will be rival among themselves. A team with these characteristics will be easy
prey for any other who applies a minimal logical strategy: that the 11 members assist each
other to defeat the rival. Who does the reader think will be the winning team? Even when 
the first team has the better individualities, it is probable they will shipwreck and 
that, even individually, the members of the second team will perform better. This, neither
more nor less, is what Nash discovers, as opposed to Adam Smith, who suggests that each 
player 'do his thing.'"
     Perhaps economists in general have not considered this in all its profundity and 
implications for the orthodox theoretical scheme. Yet this has certainly not been the 
case with those who wield the economic power. Indeed for a long time they have known that
to increase their "welfare" and power they have to base themselves more on 
strategic alliances than on "cut-throat competition." It follows that in the 
existing global economic system not merely the multinationals but actually the multi-
national conglomerates predominate, that is, a set of very powerful enterprises who 
associate (not always in an explicit or contractual mode) vertically and horizontally to 
expand their position of domination. If instead of seeing names of brands we were to see 
names of owners we would be more conscious of this. There is an enormous concentration
of ownership at the global level. And orthodox economic theory more than informing 
seems to blind us to seeing that. And perhaps there are those who wish for us to remain 
"blinded" before this reality, but to study that exceeds the material of the present 

An uninformed argument: the market as socializer of information

     We now reach the last of the arguments of the Austrian economists in favor of the 
efficiency of markets: the argument that prices are socializers of "dispersed 
information." As we already said at the start, the principal defender of this argument is 
the Austrian economist Friedrich von Hayek. According to Hayek markets achieve a "marvel" 
of economic coordination by virtue of the price mechanism. It is not necessary for the 
agents to know perfectly all the market variables to make a rational and 
optimal decision but only that they see those indices called "prices" as 
synthesizing in themselves all the existing dispersed information.
     To better illustrate this, Hayek offers us a suggestive example: "Let us suppose that
in some part of the world a new opportunity has emerged for the use of some primary 
material, for instance, for tin or that one of the sources for its supply has been 
eliminated. For our purpose, it is not important--and the fact that it has no importance 
is in itself important--which of these two causes has provoked the shortage of tin. All 
that the consumers of tin need to know is that part of the tin which they consumed is now 
being employed more profitably somewhere else and, consequently, they should economize on 
its use. The great majority of times they need not know even where their most urgent 
necessity has been produced, or in favor of what other needs they should prudently direct 
the supply... All this occurs without the great majority of those who contribute to 
effecting such substitutions knowing the original cause of those changes. The whole acts 
as a market, not because some of its members have a vision of the entire field, but 
instead because their limited individual fields of vision overlap sufficiently for the 
pertinent information to be communicated to all through many intermediaries."
     First it must be said with respect to this that even if we accept the efficacy of 
prices as socializing mechanisms of dispersed information the problem of social 
justice is not at all solved for the market continues being (and even more 
efficiently) in service not to the greatest need but instead to the most monetary votes.
     The foregoing can be clearly demonstrated by turning Hayek's example around. Let us 
suppose that in some part of the world, let us say in a desert in the Middle East, a new 
opportunity has emerged for the use of a primary resource, let us say water, because a 
wealthy sultan is willing to pay a large sum of money in order to have a gigantic personal
aquatic park. The only thing that the thirsty inhabitants of the desert mentioned must 
know is that part of the little water they had available is not utilized with greater 
profit elsewhere. The great majority of them do not even need to know where the more 
urgent need was produced, or in favor of what other necessities they now have to 
dehydrate (or even die). It is enough that they know that the market distributes 
everything in the most efficient manner. And this not because the sultan knows the 
needs of the desert inhabitants nor because the inhabitants of the desert know the 
"needs" of the sultan, but because the limited individual fields of vision overlap 
sufficiently for the "work and grace" of prices as "synthesizers of dispersed 
information." Thus, we arrive at the curious case where thousands of persons have to die 
of thirst so that a rich sultan can frolic in his pool... Can this possibly be a 
rational situation?! Is this the vaunted efficiency to which the free market leads?!
     Yet that is not all. The Hayekian theory of prices as synthesizers of dispersed 
information starts with the assumption that their formation is a "spontaneous" and 
"natural" outcome of the free play of the market. Nevertheless, this assumption is not 
only questionable but openly false. The market is not "spontaneous order" as Hayek 
professed. Under existing capitalism it refers above all to an administrative 
order. Therefore, the assumed "market prices" are in reality--in the majority of 
cases--"administered prices," formed not by the "free play" of supply and demand 
but rather instead as the result of the politics of pricing (a tremendously well-
known term among administrators and tremendously unknown to economists). In what do the
politics of pricing consist? In fixing the prices in an ex-ante manner as a 
function of the goals of the enterprise. Thus, in general, "the need to expand sales 
which are the sine qua non of growth will argue, generally, for low prices. At the 
same time, depending on the nature of cost behavior, demand and the problems of demand
management, the need for earnings to finance growth will argue for higher prices. No 
rule can be laid down as to the result. It seems likely that prices will most often be 
set by an industry at a level that provides for an established  payment to stockholders 
and covers the investment requirements (with some margin of safety) of the expansion 
that is possible at that price." No mechanism is seen here for synthesizing "dispersed 
information" to be put in the service of agents for them to make their decisions. We 
have here the explosive consequences of the "planning system" for the Austrian argument. 
And, as Galbraith said, "Controlled prices are necessary for this planning. And the 
planning, itself, is inherent in the industrial system. Whoever denies is and keeps 
maintaining that prices are essentially "transmitters of information" simply 
suffers from chronic "disinformatitus."

Endogenous explanation of the crisis: Minsky's hypothesis of financial instability

     As we have seen at the end of the first section, following the line of Fama's 
hypothesis of efficient markets, standard economic theory converged upon the idea 
that the free market capitalist system was essentially stable. The "new economics" had 
signified, then, "the end of the economic cycles." Thus, for example, we have the great 
macroeconomist and 1995 Nobel prizewinner Robert Lucas who in 2003 said: "Macroeconomics
was born as a separate discipline in the decade of the Forties, as part of the 
intellectual response to the Great Depression. The term then referred to the body of 
knowledge and experience we awaited that would prevent the recurrence of such an economic 
disaster. My thesis here is that macroeconomics in that original sense has been 
successful: The central problem of the prevention of a depression has been resolved, for 
all practical purposes, and has in fact been resolved for several decades.
     However, not "several decades" but instead only five years later, this affirmation 
was shown to be absolutely ridiculous: the financial crisis of 2008 cast to the 
ground the hypothesis of efficient markets and the idea of the stability of the capitalist
system. Nonetheless, some orthodox economists clung to the idea that it dealt only with an
"exogenous shock," considerable, yet exogenous. Of that, we have as evidence the following
declaration made by Blanchard and other relevant economists in 2010: "The crisis has 
demonstrated that great adverse shocks can occur and do occur. In this crisis, 
these shocks came from the financial sector, but they can come from any part in the 
future - the effects of a pandemic upon tourism and commerce or the effects of a large 
terrorist attack in a large economic center." Or this is, what Blanchard and company are 
saying is that the financial crisis of 2008 whose effects are still not resolved is, in 
its epistemological framework, comparable to the effect which an extraterrestrial invasion
would have on the economy. A devastating phenomenon, yet merely "exogenous."
     Then no, Mr. Blanchard, the financial crisis is not merely an "exogenous phenomenon" 
but instead demonstrably endogenous, that is to say, emerged from the dynamic 
itself of the functioning of the financial markets. And that can be proved using 
Minsky's financial instability hypothesis.
     Hyman Minsky was a post-Keynesian economist whose ideas were cast aside in his time 
for being considered "too radical" whereas at present (posthumously) he has become very 
famous insofar as his hypothesis concerning financial instability seems to explain the 
present crisis quite well. In fact, there have been few economists who have discussed the 
subject of crisis so seriously. Already in 1982 he wrote: "It is necessary to have an 
economic theory which makes the great depressions one of the possible state into which our
type of capitalist economy can propel itself."
     Specifically, Minsky begins by considering that economic agents basically can take 
three financial positions:
     1) Hedge: Here the investments are financed such that all the payment 
obligations can be satisfied independently of the flows generated by the investment. The 
principal as well as the interest payments are assured for the due course.
     2) Speculative: In this case the agents bet on the future variations in the 
price of the goods. The income flows generated by the investments are sufficient to cover 
the interest payments but the payment of the principal is not ensured.
     3) Ponzi: In this situation the flux of obligations to pay is greater than 
the flux of incomes derived from the investments. The agents have to go ever more into 
debt in order to pay their debts, the final solution being the sale of shares to obtain 
liquidity with which to cover the payments given that the re-negotiations of the debt is 
ever more difficult.
     Very well, given this framework, Minsky's hypothesis is the following: that starting 
from a situation of financial stability (hedge) economies will tend, because of 
their own dynamic, to positions of financial instability (speculative and 
ponzi) where they will reach a point of general insolvency with the consequent 
fracturing of enterprises and banks that that implies, this being the so-called "Minsky 
moment." In the words of Minsky himself: "The first theorem of the financial instability
hypothesis is that the economy has financing regimes under which it is stable, and 
financing regimes in which it is unstable. The second theorem of the financial instability
hypothesis is that over periods of prolonged prosperity, the economy transits from 
financial relations that make for a stable system to financial relations that make for an 
unstable system."
     To understand why instability is generalized in the system one must start by 
understanding what happens in the boom phase. First, financial stability reigns 
(predominance of the "hedge" position) and expectations are positive. Because of just that
the economic agents are confident of their capacity to cover payments (solvency) 
and that future earnings from their investments will be more than sufficient (an 
optimistic calculation of the marginal efficiency of capital). Meanwhile, the banks, 
considering the bonanza environment and given the vast quantity of funds that they have 
available to loan, are more lax at the moment of applying restrictions. Although certain 
reticences on the part of the lending agents might appear, the economic solidity 
characteristic of the boom phase results in diluting it; the solidity of the system
gives the agents confidence that it will not fail and, in consequence, they begin 
to take more risky positions ("speculative" and "ponzi") which, paradoxically, contribute 
to making more fragile the system (paradox of debt). Thus, the optimistic 
expectations lead the firms to overestimate the earnings from their investments and
for the banks to underestimate the possibility of nonpayment of the obligations.
     In this way, it begins to occur systematically that the agents will be unable 
to cover their payment obligations since these exceed the earnings obtained. Initially a 
solution will be sought by re-negotiating the debt yet later or sooner the agents will 
have to sell their shares to obtain liquidity, a process that initiates a deflationary 
episode which, finally, unleashes the crisis with the subsequent collapse of enterprises 
and banks.
     Thus then, stability generates instability, the solidity of the 
system makes it fragile and the optimism opens onto pessimism. We 
have here Minsky's great contribution: an endogenous explication of the financial
crises under capitalism. And this came from a heterodox post-Keynesian focus, not from the
Neo-classical orthodoxy. In fact, Minsky himself is very clear in his rejection of the 
latter with respect to this point: "The abstract model of the Neo-classical synthesis 
cannot generate instability. When the Neo-classical synthesis is constructed, the shares 
of capital, the financial provisions centered around the banks and the creation of money, 
the restrictions imposed by the payment obligations, and the problems associated with 
knowledge concerning uncertain futures are all assumed as foreign. For economists and 
political actors to make things better we need to abandon the Neo-classical 
     We definitely require more complex analyses that clearly incorporate the phenomenon 
of disequilibrium and instability in the financial markets. Sometimes the orthodox 
economists seek to artificially escape from this by bringing up the famous Walras 
law, according to which if "n - 1" markets are in equilibrium, then the 
nth market also should be in equilibrium. John Hicks himself explains that 
this is used in the very famous IS-LM model, a "touchstone" in the teaching of 
macroeconomics, to ignore the market for loanable funds: "One need not concern themself 
with the market for 'loanable funds'... If there are two 'markets' in equilibrium, the 
third should also be. Thus, I conclude that the intersection of the IS and the LM will 
determine the equilibrium of the system as a whole."
     Yet the truth is that Walras' law "cuts both ways": if there is disequilibrium in 
one market, then at least one other--or perhaps all the others--will be in 
disequilibrium. Therefore, Minsky's financial instability hypothesis, by very 
seriously positing the possibility of endogenous disequilibrium in the financial markets, 
puts in dire straits the theoretic corpus of standard macroeconomics which is structured 
upon the basis of the notion of equilibrium in the markets. In consequence, Blanchard's 
statement that "the state of macro (theory) is good," uttered in 2009, that 
is after the explosion of the crisis, is absolutely out of place.


     The objective of this chapter has been to critically examine the orthodox theory of 
the efficiency of the markets. Basically we have seen that:
     1) The so-called market failures are not "anomalies" but rather instead the 
dominant characteristics of the existing capitalist market system.
     2) The idea of efficiency is not neutral but instead always and necessarily 
appears as a function of certain specific ends and, ultimately, can become contradictory 
toward other ends. In this mode, the affirmation "the markets are efficient" means nothing
unless one makes explicit with respect to what are they efficient.
     3) The notion of Pareto optimality as an ideal of efficiency turns out to be totally 
fraudulent for, by only taking aggregate well-being into account, leaves aside a question 
so essential for the social welfare as the problem of equity.
     4) Far from being a democracy, the market in reality is an essentially 
excluding mechanism since instead of directing itself towards the greater need it is 
directed to the most "monetary votes" which, given the inequality in the distribution of 
income, do not necessarily reflect the greater need.
     5) The arguments about "previous voting" and the "meritocratic scale" are easily 
refuted by demonstrating that the first is dynamically inconsistent and that the second 
does not keep in mind the previous socio-economic conditionings defining the individuals
at the moment of choosing between studying and working.
     6) The orthodox dogma of consumer sovereignty becomes unsubstantiated now that, 
because of what we have called the "planning imperative," the production of 
necessities has become a structural requirement of capitalism.
     7) John Nash's mathematical demonstration regarding the possibility of 
inefficient non-cooperative equilibria in a free market framework leaves baseless 
the Smithian idea of the "invisible hand," according to which competition leads to 
     8) The Hayekian justification of the efficiency of markets seems arbitrary and 
deceitful because it can end by legitimating clearly irrational situations (such as
the people who die of thirst in the desert so that a sultan can have his aquatic park) 
and, furthermore, the hypothesized "synthesizers of dispersed information" prices do not 
exist but rather administered prices which are consciously managed by the 
     9) Nor is the hypothesis of efficient markets fulfilled and, in light of the present 
crisis, Minsky's financial instability hypothesis, according to which the crisis 
can be generated from within the market system itself without it necessarily having to 
correspond with "exogenous shocks," seems more reasonable.
     All this constitutes a powerful cumulative case against the Neo-classical 
postulate of efficient markets. Thereby, the orthodox theory of the efficiency of the 
markets is nothing more than a myth. May it rest in peace.

                        Chapter 7
                        THE MYTH OF GENERAL EQUILIBRIUM
                    "The notion of a social system moved by independent
                         actions in search of different objectives compatible with a final
                         coherent state of equilibrium, is undoubtedly the most important
                         contribution that economic thought has contributed to the general
                         understanding of social processes."
                               K. Arrow and F. Hahn, general equilibrium theorists
The orthodox theory of market efficiency

     In this chapter we shall analyze the model that constitutes the very nucleus of the 
orthodox theory; the model which, to quote Weintraub, sustains the rigor and logical 
consistency of the macroeconomic theories and the works of applied microeconomics: the 
model of general equilibrium.
     From the perspective of the history of economic thought, the theory of general 
equilibrium was founded in the second half of the 19th century by the French economist 
Leon Walras. Walras' intention was to demonstrate the existence of a set of relative 
prices which assures the correspondence in all markets of the quantity demanded with 
the quantity offered, that is, the existence of a general equilibrium. To do so he 
elaborated a complicated model of simultaneous equations in which--as opposed to the 
classical Marshallian analysis of partial equilibrium--price was considered as the 
variable that adjusts to the changes and/ or disequilibria of the quantities, given that 
at root the dynamic of tatonnement (something like "probing towards the 
equilibrium") came to establish a unique and stable equilibrium in all the 
     Lamentably Walras had not confronted the problem in a rigorous and adequate fashion: 
the equality between the number of unknowns and number of equations of the model did not 
necessarily guarantee the existence of the equilibrium. Thus, it was as recently as 1930 
when a rigorous demonstration was given of the equilibrium on the basis of the 
contributions of Abraham Wald and John von Neumann. Later, during the Fifties, Wald's 
contribution was generalized by Kenneth Arrow and Gerard Debreu, which validated their
title to the model, that today is known as the "Arrow-Debreu model."
     This model starts from the assumption that the technology as well as 
preferences and endowments of the agents are given, that is to say, they are
exogenous to the model. Subsequently it describes a world in which all the agents 
optimize certain objective functions--utility for the consumers, profit for 
the firms--constrained by a series of restrictions of an economic and technological 
nature. The first problem that this formal representation presents is to establish 
whether a situation exists in which all the agents manage to optimize their objective 
function, given the restrictions on their decisional problem. Such a situation, if it 
exists, will be one of equilibrium given that in such circumstances not agent will 
wish to change their behavior since they already would be obtaining the maximum possible. 
In this way, in the case where the the system reaches an equilibrium, the famous 
fundamental theorem of welfare economics will be fulfilled, this is, that the 
mechanism of perfectly competitive prices will achieve an efficient economic allocation of
the resources. Why? Because if an economic general equilibrium exists this implies 
that the agents are maximizing their objective functions (given their restrictions) and 
that, therefore, we find ourselves in a situation of Pareto optimality.
     Now then, what properties does that equilibrium have? Principally two: uniqueness 
and stability.
     We begin with the first. In the general equilibrium model uniqueness means 
there exists a unique set of relative prices that causes the function of excess 
demand, that is, the difference between the quantity demanded and the quantity offered
at a given price, will be zero in all the markets. This property is important because 
wherever there is no uniqueness the problem arises of determining which position 
characterizes the real economy because there will be more than one equilibrium.
     We move now to stability. In the general equilibrium model stability is 
understood as a property held by equilibrium of attracting the system toward itself and 
away from disequilibrium positions. In this way, if the equilibrium is stable the 
trajectories of prices and of quantities out of equilibrium will automatically steer 
towards equilibrium, nullifying the function of excess demand.
     In essence, the famous model of general equilibrium is concerned with this. Yet 
before ending this section it is important to indicate one of the most useful functions of
this model for the orthodox paradigm: the function of "unifying" economic theory. In 
effect, because of its own level of abstraction and mathematical complexity, it is argued 
that this method has permitted studying under what conditions theses held by other 
economic schools can be introduced into the Neo-classical system of general equilibrium. 
Thus, for example, it has been possible to formulate "Keynesian" models incorporating 
(mathematically) situations with certain anomalies such as nominal or real rigidities in 
the prices, and Neo-Ricardian models assuming constant returns to scale. The consequence 
of that? That the majority of economists no longer discuss the validity of their 
approaches but rather instead the mode of formalizing them and incorporating them into 
this model. Thus, the model of general equilibrium functions as the nucleus of the 
orthodox paradigm and is used as a platform from which to approach any problem old or new 
and, therefore, to absorb whatever theory or paradigm is presented as a rival. A real 
"philosopher's stone"...

A castle in the clouds: the exaggerated abstractionism of the theory of general 

     The first thing that leaps into sight in the general equilibrium model is its 
exaggerated abstractionism. In effect, abstracted are social relations, the relative power
of agents, the institutions, asymmetries of information, risk, uncertainty, externalities,
technological changes, changes in preferences, the processes of wealth accumulation, 
etc., etc., etc. In this mode, the general equilibrium model does not properly represent, 
even in a simplified manner, a real economy but instead only considers a fraudulent
fiction - a logical, grandiose, elegant, and autonomous fiction, yet a fiction in 
the final analysis.
     In this sense, the affirmation of John R. Hicks--awarded the Nobel together with 
Kenneth Arrow in 1972 for his "contributions to the theory of general equilibrium and of 
welfare"--becomes absolutely disproportionate when, in his work Value and Capital 
(1939) he writes: This is a work of economic theory, considered as the logical analysis of
an economic system of private enterprise, with no reference whatsoever to institutional 
controls... For I consider that the pure logical analysis of capitalism is a job in 
itself, whereas the description of economic institutions is better realized by other 
methods, like those of the economic historian." No, Mr. Hicks, you have produced no "pure 
logical analysis of capitalism." A mathematical system comprised of an indefinite number 
of maximizing, completely informed agents, who only exchange goods in a perfectly flexible
world, without externalities, without taxes and without government, is--to put it 
gently-- only a mimickry of the pure logical analysis of capitalism it purports.
     And not only that. To say that one can perform a "pure logical analysis of 
capitalism" without considering the institutions--in order not to "take work away" from 
the economic historians--is to commit a gross fallacy of dissociation and, 
therefore, to perform a scientifically illegitimate abstraction. Capitalism functions 
always and necessarily within an institutional framework which 
underlies and constitutes it. Therefore, by abstracting "the economic 
institutions" in order to construct his "pure logical analysis of capitalism," what Hicks 
is doing in fact is abstracting capitalism itself!
     But it is not that Hicks is bad. He simply has no choice because, if he truly wants 
to be an economic theorist, he must necessarily adjust to the methodological canons
of the sacrosanct model of general equilibrium. So that once more Shackle's saying is 
realized that "when the moment came to invent economic theory, a certain number of well-
established modes and schemes of thought, exact and fully explored, were at hand that 
were imposed upon the minds of the inventors." 
     Thus, then, the general equilibrium model is nothing more than a (mathematical) 
castle constructed in the clouds. But given that the clouds cannot support anything, this 
castle will necessarily crash against the implacable ground of economic reality. 
And indeed, as Blaug well put it, "the Arrow-Debreu demonstration has more to do with 
mathematical logic than with the economy. It has become a perfect example of what 
Ronald Coase has called 'the slate economy,' a model that can focus on blackboards using 
economic terms like 'prices, quantities, factors of production,' and so on successively, 
and nevertheless--and in a clear and scandalous manner--it does not represent any 
recognizable economic system."

Impertinent commentaries: analyzing the pertinence of the assumptions of general 
equilibrium theory

     We have finished analyzing the question of the realism (or better, unrealism) of the 
model of general equilibrium. Now we shall pass to analyzing the pertinence of its 
     For that first we should understand that, as the distinguished MIT professor Lester 
Thurow said, "economics cannot avoid reverting to simplifying assumptions. But 
skillfulness lies in using the correct assumptions at the correct moment. And a good 
criterion should be provided from empirical analysis (including that used by the 
historians, sociologists and political scientists) of how the world is, and not how it 
should be according to our textbooks."
     In light of this can we say that the assumptions of the general equilibrium model are
pertinent. We believe definitely not. And especially because of the assumptions referring 
to technology, preferences and the endowments of the agents. Let us analyze each one of 
     - Technology: For the general equilibrium theory technology is maintained 
constant and is exogenous to the model. Its study belongs with the engineers and not with 
the economists. Furthermore, it is always available for all agents, that is, its 
knowledge and application are in the public domain. Therefore, there are not asymmetries 
of information.
     Evidently this involves an assumption not only unrealistic but above all 
inappropriate. In effect, as we have already seen in chapter 2, technology cannot be 
considered as something constant and exogenous because it is always constituted as a 
dynamic and endogenous process intrinsically united to economic development in 
every society.
     Regarding the hypothesis that technological knowledge is a given from beyond the 
economic system ("for the engineers") it must be called not only ingenuous, but also 
distorting because it loses sight of the set of social relations of production which 
internally condition the process of technological development, financing it,
directing it, coordinating it, and applying it.
     Finally, in what concerns the hypothesis that technological knowledge is at the 
disposal of all, the least that one can do is smile. Technology is not a free good.
Today more than ever it comprises one of the most powerful weapons and the 
principal key to economic success. Knowledge is power. Thus, technology 
must be possessed, nourished and activated. It should generate a "virtuous circle" between
investments, technological innovation, profits, and new investments. The consequence of 
that? That information will be ever more asymmetric and that the companies will have ever 
more market power, thus departing from the ideal of free and competitive markets which the
theory of general equilibrium sells us as a "touchstone."
     - Preferences: According to the theory of general equilibrium preferences are 
given. The study of their formation and changes corresponds to psychologists and 
sociologists, not to economists. Therefore, they do not have to be explained, only 
     Obviously this presents an absurd supposition. Preferences can never be considered 
as "given" because, as Marx truly said, "the number and extent of his so-called necessary 
wants, as also the modes of satisfying them, are themselves the product of 
historical development, and depend therefore to a great extent on the degree of 
civilization of a nation, more particularly on the conditions under which, and 
consequently on the habits and degree of comfort in which, the class of free labourers 
has been formed."
     Furthermore, as we have seen in the previous chapter in analyzing the postulate of 
"consumer sovereignty," tastes and preferences can never to considered as "exogenous" to 
the system. Or perhaps it is not evident that a large part of the economic problem of who 
produces and sells consists also of producing a preference--and on occasion even a 
necessity--for their product? If the preferences are purely exogenous, what then 
are the ubiquitous departments of marketing and market technique for, and why the millions
invested in publicity? Only to "inform us" about the properties of a new product which 
might coincide with our "exogenously given" preferences, or to direct the consumer 
to such a product?
     One cannot, then, deprecate the study of the formation and changes of preferences as 
mere work for "psychologists" and "sociologists" (the orthodox economists tend
--disgracefully--to utilize those terms dismissively). To say that these do not have to be
"explained" but instead only "optimized" is to fall anew into the sophism of the 
rational fools because, underlying this logic, any behavior, even the most absurd,
can be interpreted in the optics of orthodox economics as the result of a rational 
and optimal choice starting from certain preferences (given, yet unknown).
     - Endowments: The model of general equilibrium considers endowments, that is 
to say, the quantity of goods possessed by the different individuals before a particular 
market interaction commences, as a datum. The previous processes of accumulation and 
distribution, conditioned by the exchange system itself, are neither studied nor 
     Here the methodological fraud becomes the most evident. Who is primarily responsible 
for explaining how the economic resources are distributed among the agents? The 
psychologists? The sociologists? The engineers? Of course not! It falls principally
to the economists! Nonetheless they, like Pontius Pilate, wash their hands of the 
complicated and very messy problem of the primal inequality in wealth.
     Yet not only that. By assuming that endowments come given as "data," the general 
equilibrium model not only becomes inconvenient but also insubstantial. In effect, 
the orthodox economist can very well explain in her dynamic model how starting from the 
endowments at time t there will form by means of the market process the endowments 
at time t+1 and so on successively with the endowments at times t+2, t+3, 
t+4, etc. But it never will satisfactorily resolve the problem of the starting point, 
that is, of how the endowments at the initial time t are formed, because it would 
also have to append to a time t-1, t-2 and so on ad infinitum. In other 
words, and orthodox economist will never be able to resolve the problem of the original
     Nevertheless, indeed there was an economist of recognized erudition in historical and
sociological topics who managed to approach this problem in a serious and consistent 
fashion. We are referring to the already cited German economist Karl Marx, who in the 
famous chapter XXIV of the first volume of his work Capital, without 
circumlocutions and with great propriety, manifested that: "In actual history it is 
notorious that conquest, enslavement, robbery, murder, briefly force, play the great 
part. In the tender annals of Political Economy, the idyllic reigns from time
immemorial. Right and “labour” were from all time the sole means of enrichment, the 
present year of course always excepted. As a matter of fact, the methods of primitive 
accumulation are anything but idyllic." History allows no alternative on this point, the 
evidence being clear and compelling. From there Marx goes on, "Capital comes dripping 
from head to foot from every pore with blood and dirt," wishing with that to unravel a 
reality that only those who ignore history in their socio-politico-economic 
development might ignore.

The mirage of relative prices: the non-existence of general equilibrium

     As we had seen, the orthodox model of general equilibrium essentially consists of 
finding a set of relative prices that ensures the equalization of the quantity 
demanded with the quantity supplied in all the markets. In this mode, it can be said that
the question of the existence of a general equilibrium in all markets reduces to 
the question of the existence of the optimal set of relative prices.
     We see, then, that the prices calculated with the theory of general equilibrium are 
exclusively relative prices, that is, quantitative proportionality relations between the 
different prices of goods (as for example: an apple "costs" two oranges). To be able to 
sustain the possibility of calculating such relative prices, the general equilibrium 
theory assumes complete variability and flexibility of the prices, which is to say that 
those change immediately and automatically with the changes in supply or
demand of the goods in any of the markets. This assumption is essential because it allows 
reducing the economic problem to a problem of determination or relative prices and thereby
reduce economic choice to a problem of subjective preferences. Nevertheless, for 
this supposition to be fulfilled it is absolutely necessary to assume that wages 
too are completely flexible and variable. Yet that is evidently unrealistic and mindless 
because it implies assuming in turn that the human being has only preferences and 
not needs. But for a person to live and be able to work she needs to always have 
available a certain quantity of goods. Prior to her preferences are her 
necessities and prior to her tastes is her subsistence.
     In this fashion, having needs and existence being therefore imperious for a minimum 
of subsistence for every human being, the theory of general equilibrium becomes 
inconsistent and contradictory since now it is not possible to ensure a system of optimal 
equilibrium prices in all the markets if in fact wages have a positive lower limit, that 
is, if a minimum wage exists. Why? Because it might well happen that one of the 
prices of the alleged general equilibrium--determined in the final instance by the 
subjective preferences of the consumers--might be beneath the level necessary to cover the
minimum labor costs, which would evidently destroy the business incentives. But it would 
never happen that the firms decide to go broke so as to "obey" the general equilibrium 
since they would simply establish a mark up in their prices in order to a coherent 
gain thus disobeying the sacrosanct model.
     And there is still more. The exclusive consideration of relative prices and of the 
orientation of human action as a function of those prices such as the theory of general 
equilibrium proposes does not take into account the indispensable condition of 
ecological balance which is precisely what assures that human existence in the 
long term can satisfy its needs and preferences.
     In conclusion, the existence of the purported optimal relative equilibrium prices 
never becomes more than a fiction. Or better said a mirage, a mirage generated in 
the mind of the orthodox economists in the midst of their--often failed--search for the 
oasis of scientific validity. With that what John Kenneth Galbraith had said is perfectly 
fulfilled, that "A vivid image of what should exist acts as a surrogate for 
reality. Pursuit of the image then prevents pursuit of the reality.

An unprofitable theoretical transaction: the surplus costs of uniqueness

     The condition of equilibrium of uniqueness is extremely important for the 
orthodox theory of general equilibrium. Only if a unique equilibrium exists can we 
determine with exactitude in what position the real economy finds itself and, in the end,
perform a comparative static analysis, comparing an initial situation with another 
in which only one parameter or factor has varied.
     If this condition fulfilled in the general equilibrium model? Lamentably no, or at 
least not in a congruent manner. As Ackerman says: "There is no hope of proving uniqueness
in general given that it is possible to construct examples of economies with multiple 
equilibria... Some restrictions exist in the type of aggregate demand that ensures 
uniqueness, yet it is not possible to give them a realistic economic meaning."
     In this same line of critique is found Kehoe when he writes: "The only restrictions 
that can be interpreted in an economic manner, and which imply uniqueness, are that the 
demand side of the economy behaves like a single consumer or that the supply side be an 
input-output system."
     Nevertheless, the orthodox economists will not surrender before such an 
"insignificant" obstacle. The coherent economic meaning of the model can be left 
to one side. If it is necessary to introduce forced assumptions and mindless hypotheses, 
so be it. Thus, for example, it is assumed that there is gross substitutability, or
that is the substitution effects are greater than the income effects, to 
guarantee that excess global demand for an item diminishes when its price increases. 
However, that necessarily requires that the aggregate demand functions assume very 
specific forms and furthermore, that interdependence between markets is eliminated, that 
is, precisely what constitutes the merit of the model of general equilibrium!
     We see, then, that the "theoretical enterprise" of general equilibrium in its search 
for the desired uniqueness has not obtained zero benefits but instead losses for 
the costs that tend to be assumed in terms of realism and congruence are much higher than 
the degree of scientific validity achieved (if indeed any has been achieved)...and that is
not to mention the tremendous opportunity cost which occurred through employing the brains
of the greatest economic theorists of the age in the maintenance of an absurd mathematical
entelechy instead of much more realistic and relevant economic problems.

Destabilizing stability: the Sonnenschein-Mantel-Debreu theorem

     Throughout this chapter we have indicated various critiques of the orthodox model of 
general equilibrium. Yet we still have not approached the most destructive of all: the 
famous (well, in reality not so famous) Sonnenschein-Mantel-Debreu theorem.
     This theorem was initially proposed by the mathematical economist Hugo Sonnenschein 
in 1972 and 1973, and later generalized by Rolf Mantel in 1974, as well as by the same 
Gerard Debreu. The theorem affirms that, given a model of interdependent markets--in which
all the regularly introduced hypotheses are respected, regarding the behavior of the 
agents, the market and other forms--it is impossible to exclude instances of 
instability of the equilibrium.
     Specifically, the destructive result of the Sonnenschein-Mantel-Debreu theorem
is the following: starting from the usual maximizing behavior of individuals, and as a 
result of the assumptions required for demonstrating the existence of a general 
equilibrium of the Arrow-Debreu type, it demonstrates that functions of excess 
demand which satisfy Walras' law in an exchange economy can take practically any 
shape. This gravely damages the Neo-classical theory because one would have hoped that
excess demand functions would have always had a negative slope, which, in turn, guaranteed
the equilibrium's stability.
     In this way, even if we accept the form and assumptions of the general equilibrium 
model, it is in no way possible to count on automatic convergence towards equilibrium in 
the event the system yields disequilibrium and, thereby, the stability condition is 
     All these results constitute a true "nightmare" for the Neo-Walrasian orthodox 
economists since, in the first place, it implies that all comparative results are useless 
and, in the second place, that even if we assume perfect price flexibility, that now will 
not help to attain an equilibrium, much less an optimum.
     In that context, one might have hoped that the Sonnenschein-Mantel-Debreu theorem 
would put an end to research about the properties of net demand in the Arrow-Debreu 
general equilibrium model. However, the orthodox economists refuse to accept the defeat 
and, in order to preserve their precious theory, have pursued two strategies.
     The first consists in introducing a set of ad hoc hypotheses. Thus, subsequent
Neo-classical theories have incorporated the fiction of the famous "representative agent,"
which assumes that global offers and demand by agents take the form of a unique 
synthesizing agent. Models have also been broached where the Sonnenschein-Mantel-Debreu
theorem fails but in which it is necessary to assume that all the agents have the 
same preferences and income and, therefore, that the structure of consumption will not 
depend upon the income! Absurd by any lights.
     The second (and more effective) strategy was that of silence. In the academic world 
an unspoken critique is a non-existent critique. All the professors of microeconomics in 
the world teach their students the majestic model of general equilibrium...yet none (or 
nearly none) speak of the Sonnenschein-Mantel-Debreu theorem. The same silence is present 
in the textbooks, as much in the elementary as in the intermediate and advanced ones. 
Clearly fulfilled for economic orthodoxy, though with the sacrifice of intellectual 
honesty, is what was said by the famous epistemologist Paul Feyerabend that, before
so-called qualitative difficulties, "the usual procedure is to forget about the 
difficulties, not to speak of them and to proceed as if the theory were impeccable."

Stability and sterility: the absolute uselessness of general equilibrium

     Let us be compassionate. Let us imagine the Sonnenschein-Mantel-Debreu theorem does 
not exist, that we can assure the uniqueness of the equilibrium under realistic and 
coherent conditions, that a set of relative equilibrium prices indeed exists, that the 
model's assumptions are valid... Would those achieve scientific validity for the general 
equilibrium model? Unfortunately not. Why? Because to suppose that the agents handle 
perfect and complete information detracts from the very nature of the dynamic of economic 
choice, which is precisely that which we would like to explain. And indeed, as 
Hayek said, "any focus, like that of the greater part of mathematical economics with its 
simultaneous equations, which starts from the assumption that the people's 
knowledge coincides with the objective facts of the situation, 
systematically departs from explaining the main subject.
     The very same Tjalling Koopmans, "resuscitator" of the theory of general equilibrium 
in the decade of the Fifties and winner of the Nobel Prize for Economics in 1975 because 
of this, admitted this problem in the theory and confessed: "As far as I know, no formal 
model of the allocation of resources by means of competitive markets has been developed, 
that takes into account the agents' ignorance regarding their future actions, their 
preferences, or their technological knowledge as the principal cause of their uncertainty,
and which simultaneously recognizes the fact that futures markets, where one could put to 
the test and probe and adjust the expectations and intentions of those agents, do not 
exist in sufficient variety nor with sufficiently broad forecasts as to make the present 
theory on the efficiency of competitive markets applicable. If this judgment is 
correct, our economic knowledge has not yet advanced to a point where it could throw 
sufficient light on the central problem in the economic organization of society: the 
problem of how to confront and deal with uncertainty. The economic profession in 
particular is very far from being able to pronounce with scientific authority concerning 
the economic aspects of the polemic around the choice between individual or collective 
enterprise which divides humanity in our day."
     Later, when the stage of searching for the existence, uniqueness and stability of 
equilibrium ended, a second began that attempted to adopt more realistic assumptions 
introducing the problem of uncertainty. In general these models tried to explain the 
formation of future expectations beginning with extrapolations of data from the past 
(adaptive expectations).
     The research begins in 1959 with Theory of Value by Gérard Debreu, which 
did not yield much fruit. 12 years after the publication of the book by Debreu, Kenneth 
Arrow and Frank Hahn publish General Competitive Analysis (1971) where they feel 
obliged to admit on various occasions that they do not incorporate uncertainty in the 
alternative models that they analyze. Hahn himself declares: "The general equilibrium 
theory is an abstract reply to an abstract and important question: Can a decentralized 
economy be ordered that relies solely upon the price signals for its market information? 
The answer of the theory of general equilibrium is clear and definitive: an economy can 
be described with such properties. Yet this, of course, does not mean that one has 
described any real economy. It has responded to an important and interesting theoretical 
question and in the first instance that is all it has done. This is a considerable 
intellectual achievement, but it is obvious that for praxis much more argumentation is 
     In this manner, we see that the same general equilibrium theorists question the 
practical validity of their models, and if we remember that the purpose of all theory is 
to explain reality, then what is being questioned is the theoretical validity; in other 
words, the consistency and logical rigor of the model (which, in fact, we already put in 
question) do not imply theoretical validity.
     We close this section with the words of the reputable professor of the 
Collège of France François Perroux, who tells us that the general 
equilibrium theory continues to be the "main course" offered to the appetite of students 
called to become interpreters and transformers of the economy in their own societies, 
whether these be developed or underdeveloped: "The graduates, whether it be here (in 
France) or in those countries, despite them having at their disposal direct experience of 
the economic activity which the world offers them, engage in always reading it through 
the filter of economic theoretization...but the scheme is not valid either for 
description, nor for interpretation, nor for action. It constitutes a notable example 
of 'pre-fabrication': at attempts to resolve in advance, at the same time and statically, 
the questions of the existence, of the uniqueness, of the optimality, and of the stability
of the equilibrium... The theory general equilibrium in its mechanistic forms is repeated 
ad náuseum and translated into simple mathematics, which confers an aura of 
prestige in the eyes of the larger public. Thus sacralized, it becomes through force of
habit and of imitation, a piece of angle stone erroneously presented as unbreakable. When 
the premises and the content are put to the test, the system loses all its credibility; 
the edifice of such celebrated solidity exhibits multiple cracks. The ingenious 
construction annuls activity of the agent; she could be replaced by a robot registrar of 
prices that would adapt to using the quantities available to it." Before such a clear 
pronouncement, it suffices to simply quote him.

Is the DSGE model salvation? Confessions of an orthodox economist

     As we had seen at the beginning, the general equilibrium model constitutes, within 
the orthodox scheme, that which gives consistency and microeconomic grounding to 
macroeconomic theories. However, before the serious difficulties shown, standard 
macroeconomics has sought a more sophisticated version for a "life raft": the Dynamic
Stochastic General-Equilibrium model or DSGE.
     Basically the DSGE schema seeks to explain aspects of aggregate economic phenomena
such as growth, cycle and the effects of monetary and fiscal politics. Specifically, it 
starts from the interactions of the microeconomic decisions of the agents (families, 
enterprises, government, and central banks) in order to determine some of the principal 
macroeconomic variables such as consumption, savings, investment, and the supply and 
demand for labor, among others. As opposed to the standard Walrasian model of general 
equilibrium, which is static, it studies how the economy evolves over time (thus the 
dynamic character) considering that it can be affected by random shocks because of
technological change, fluctuations in oil prices or changes in the macroeconomic politics 
on the part of the government or Central Bank (thus the stochastic character).
     So then, it seems a promising path and, in fact, orthodox macroeconomics has advanced
thereby by means of the so-called Real Business Cycle Theory or RBC, which 
constructs a Neo-classical model of growth under the assumption of price flexibility to 
study how the real shocks cause the fluctuations in the economic cycle, this being the 
pioneering work of Kydland and Prescott. Nevertheless, this focus is not exempt either 
from serious criticisms and limitations.
     The key point here has been the crisis of 2008. And with this crisis not only the 
financial bubble deflated but also in large part the "bubble of hope" there had been with 
respect to this model (although, to tell the truth, there are numerous orthodox economists
who have not buried it nor wanted to bury it). Thus, for instance, we have Narayana 
Kocherlakota, President of the Minneapolis Federal Reserve, who recognizes that the model 
has not been very useful either for predicting nor for analyzing the crisis.
     In fact, the disturbance was such that it moved the U.S. Congress to convene 
prestigious economists to testify why the macroeconomic models had failed to predict the 
crisis. And could one guess who was one of the most critical economists there? No one more
nor less than Robert Solow, orthodox Nobel prize of 1987 economist and defender of the 
standard production function in the controversy of the two Cambridges. Specifically, Solow
centered his critique on the DSGE model. We cite his own words: "I do not believe that the
currently popular DSGE models pass the "smell test." They take as given that the economy 
as a whole can be thought of as if it were a single consistent person or a dynasty 
carrying out a long term rationally designed plan, occasionally troubled by unexpected 
shocks, but adapting to them in a rational and consistent manner... The protagonists of 
this idea make a claim to respectability affirming that that underlies that which we know 
about microeconomic behavior, yet I think that this affirmation is generally misleading. 
The partisans doubtless believe what they say, yet seem to have stopped breathing or to 
have completely lost their olfactory sense."
     One might think that such a declaration is explained by the "excitement of the 
moment" in a context of political and ideological effervescence due to the economic 
crisis. Yet the truth is that Solow had already previously expressed his very serious 
doubts regarding this focus. In 2003 he wrote: "The preferred model (the DSGE) has a sole
representative consumer optimizing over infinite time with perfect vision or rational 
expectations, in an environment where he recognizes the resulting plans more or less 
flawlessly through a market for goods and labor that is perfectly competitive, and 
perfectly flexible in prices and wages. How could anyone hope that a meaningful short 
and medium term macroeconomics could come from this sort of configuration...? I begin 
from the presupposition that we want macroeconomics to account for the occasional 
aggregate pathologies which affect the modern capitalism economies... A model that 
ignores the pathologies is by definition unlikely to be of assistance." And 
anticipating the objection of certain orthodox dogmatics, he adds: "It is always possible 
to claim that these 'pathologies' are illusions, and that the economy is merely adjusting 
in an optimal fashion to some exogenous shock. But why should a reasonable person 
accept this?"
     Perhaps some might think it is impertinent or arbitrary to give so much space here to
Solow. Yet the truth is that it is absolutely pertinent. It happens that Solow is not 
"any critic" in this respect but instead a key voice because the greatest part of the 
orthodox enhancements of the RBC line are based upon some version of Solow's growth 
     Thus, then, if some relevant advancement is to be made within this line of 
investigation the most probable is that it should incorporate into the model more of the 
aspects indicated by the heterodox economists (and not only the Neo-Keynesians but also 
the post-Keynesians, Schumpeterians, and institutionalists).


     The object of this chapter has been to critically examine the orthodox theory of 
general equilibrium. Basically we have seen that:
     1) The general equilibrium model falls under exaggerated abstractionism and 
does not even attain being a "pure logical analysis of capitalism" for it abstracts from 
characteristics cosubstantial with the phenomenon itself.
     2) The assumptions of the general equilibrium model are not only unrealistic (as is 
obvious) but also become impertinent with respect to the comprehension of reality for they
conceptualize technology as "given" when in reality it is constituted as an 
endogenously generated process, doing the same with preferences when it is clear
that these are in large part endogenously manipulated and directed, and considers 
endowments in the same fashion, thus concealing the serious problem of original 
     3) The idea of the determination of relative prices in a scheme of perfect 
flexibility is nothing more than a mirage for the workers who produce the goods not only 
have preferences but also needs which impose some level of minimum wage and, in 
consequence, there cannot be an absolutely free adjustment of prices since in practice the
businessmen apply the politics of "mark up." And this is not to mention the question of 
ecological balance.
     4) To procure the condition of uniqueness in the general equilibrium model one must 
impose such restrictions that practically eliminate all its coherent economic 
     5) The Sonnenschein-Mantel-Debreu theorem almost single-handedly constitutes 
the destruction of the general equilibrium theory for it demonstrates that excess demand 
curves can take practically any form and thus the condition of stability, which is 
absolutely necessary for the correct operationalization of the model, remains baseless.
     6) Beyond the foregoing, the general equilibrium model seems sterile in any event, 
since it bases itself on agents who handle perfect and complete information, spoiling 
the very nature of the dynamic of economic choice, which is precisely what it hopes to
     7) Nor does the Dynamic Stochastic General-Equilibrium model or DSGE comprise 
a sufficiently solid alternative to give a reasonable microeconomic foundation to the 
macroeconomic theories for it has not been very useful in predicting nor explaining the 
financial crisis and has received strong critiques with regard to its epistemological 
pertinence namely on the part of an orthodox economist like Robert Solow, who 
indicated that a model which leaves aside "pathologies" (macroeconomic anomalies) by 
definition will make it hard to comprehend them.
     All this constitutes a powerful cumulative case against the Neo-classical 
model of general equilibrium. So the orthodox general equilibrium theory is nothing more 
than a myth. May it rest in peace.

                        Chapter 8
                    "Were it not for the interference of government we would 
                         have no industrial fluctuation and no periods of depression."
                                            Friedrich von Hayek, Nobel prize 1974
The orthodox theory of non-intervention of the State

     In this chapter we will analyze the orthodox doctrine of non-intervention of the 
State. Various arguments are utilized by orthodox economists to justify this doctrine. We 
shall mention the most important.
     The first argument of the orthodox economists who oppose State intervention is that 
they consider it an essentially inefficient institution. Thus we have, for 
example, the famous liberal economist Jesús Huerta de Soto who without 
circumlocutions tells us that "it is a proven fact that the inefficiencies and distortions
extend themselves whenever the State invades spheres that should be reserved for private
initiative." In turn, in the same sense, von Mises writes: "The idea of government 
interference as a "solution" to economic problems leads, in every nation, to conditions 
which, at least, are quite unsatisfactory and, oftentimes, chaotic."
     Yet not only that. For the liberal economists the State is not only an essentially 
inefficient institution but also essentially corrupt. At least that is what 
Buchanan, Tollison, Tullock and all the other authors of the public choice school 
lead us to understand when they tell us that governments are nothing more than 
organizations whose members--following the homo economicus logic--are only 
interested in obtaining more gains (rent-seeking) without having any sort of consideration
for the general interest.
     In turn we find that another of the principal arguments of the orthodox economists to
oppose State intervention in the economy is that they consider that its interference 
destroys--or at least diminishes--the efficiency of the market. In this manner, 
"interventionism means that the government not only fails to protect the smooth 
functioning of the market economy, but that it also interferes in the different phenomena 
of the market; it interferes in the prices, in the wages, in the interest rates, in 
     In reality this is an idea that derives from Adam Smith and even from the 
Physiocrats. It conceives the market as a "natural order" which would function with 
greater efficiency the less the State intervenes in it. Consequently, the best politics 
would be that of not applying any policy. One must "let do and let pass" (the laissez-
faire, laissez passé attributed to Gournay).
     Nevertheless, as we had seen, the same Neo-classical paradigm--as opposed to the 
Austrian--accepts that the market has faults and that therefore there can be occasions 
when intervention of the State not only would be pertinent but also necessary. Thus, the 
State should, among its functions, regulate the monopolies and oligopolies (imperfect 
competition), establish policies to reduce contamination (externalities) and 
protect consumers so they will not be swindled (imperfect information).
     However, this argument was promptly answered by liberal economists, who judged that:
"Administrative measures also affect third parties. Just as there are 'market failures," 
so also are there "State failures" that are the consequence of 'external' or of 
'vicinity' effects. And if those effects are important in a market transaction, they can 
be equally so with the measures that the public sector takes to correct the 'market 
failure.'" Therefore, most probable is that it will not be expedient to regulate the 
defects of the market. The failures of State will always tend to be worse and, in 
consequence, the best that governments might do would be to lift the greatest quantity of 
restrictions possible so that the economic system more resembles the pure free market 
which is that, as is mathematically demonstrated, which leads to the greatest welfare.
     Following this line in the macroeconomic plane, the monetarist economists of the 
Chicago School, headed by Friedman, maintained that the policies of the government to 
stimulate economic growth--whether they be fiscal or monetary--were always inefficient 
since, by being discretionary, that is, accomodating at every moment to the 
circumstances, ended by destabilizing the economy. Therefore the solution consisted in 
totally eliminating fiscal policies and obliging the monetary authority to follow fixed
rules instead of discretionary policies. In this way, "setting a constant course and 
maintaining it, the monetary authority will be able to make an important contribution to 
the development of economic stability. Having this course consist of a constant, yet 
moderate, growth of the quantity of money, would make a fundamental contribution to 
avoiding inflation or deflation of the prices." Later came the new classical 
macroeconomics with the theory of rational expectations, developed principally by 
Robert Lucas and Thomas Sargent, according to which the agents systematically learn from 
their errors and manage to make accurate predictions (any error is "white noise") 
concerning the evolution of the economic variables, such that the government no longer can
"surprise us" with discretionary policies because of immediate adjustment to their 
activation and, thus, the economic policy will be rendered simply ineffective.
     Likewise, we find that another of the principal reasons why the orthodox liberal 
economists oppose State intervention is, curiously, a political reason. Specifically, it 
is considered that all State interference in the market is an attack on liberty because it
restricts and/ or conditions the individuals' field of choice. If an individual wants to 
buy cigarettes or alcoholic beverages she is entirely free to do so and the State has no 
cause to restrict it. Anyone who requests that would be someone who does not believe in 
freedom since, as Friedman would say, "at root almost all the objections against the free 
market are a loss of faith in freedom itself."
     Yet there is still more. From this liberal optics, the intervention of the State not 
only limits our freedom but also threatens to destroy it. As Hayek warned in his Road 
to Serfdom (1944) every step we take away from the market system is inevitably a trip 
that will bend in a totalitarian State with neither democracy nor liberty. That is to say:
we should not perform the most minimal regulation of capitalism because otherwise we shall
conclude by falling into the jaws of communism!

Good for nothing? The fallacy of the intrinsic inefficiency of the State

     The liberal economists have sold us ad náuseum the belief that markets 
are always and necessarily efficient and governments always and necessarily inefficient. 
However, such an extreme belief does not resist the least scrutiny. If indeed it is true 
that very many instances exist in various countries of inefficient States, no evidence 
exists that States are intrinsically inefficient. Even more: there exists varied 
and interesting evidence against that idea.
     We shall begin with the case of state enterprises. Perhaps people who live in 
underdeveloped nations with inefficient and corrupt governments will find it very 
difficult to believe but in Europe, principally in the so-called "Welfare States," state 
enterprises exist or have existed more efficient than the majority of private firms. 
Obviously that demonstrates the truism that the quality of an industry depends more on 
people who lead it than that it be a private or public enterprise. Nevertheless, even 
there the incessant propaganda against the state enterprises tends to deceive the 
population, a large part of whom would not share those prejudices if they were better 
informed. And indeed, as Joseph Stiglitz would say, "the argument...that the private 
sector is more effective than the refuted as much by ideology as by a rigorous
analysis but there exist a multitude of examples of public oil and mining companies that 
are efficient and examples of private companies which are not."
     Yet not only that. If we move from the theme of state enterprises to economic 
development in general the evidence that the State is not necessarily "good for nothing" 
is a striking truth. And if indeed one might appeal to the difficulties which are 
occurring in the "Welfare State" in Europe or to the corruption and inefficiency of the 
governments of Latin America or Africa, before the success of the countries of East Asia 
in rapidly achieving development there is not better option. While institutions like the 
IMF or the World Bank advocated a minimal role for the State in accord with their orthodox
models, the nations of East Asia relied intensively upon State intervention to generate 
development. In those nations the State developed strong industrial policies, limited the 
growth of inequality, applied commercial protectionism in certain sectors at the same time
they stimulated exports and invested heavily in education. In this manner, South Korea 
became a world leader in the production of steel, and Taiwan and Singapore did the same in
the electronics industry. And all of them started from extremely difficult and 
disadvantageous situations given that they were basically technologically backward primary
exporters. We have here, then, the "miracle" of the so-called "Asian Tigers."
     Therefore, together with Amartya Sen, it is necessary to warn to orthodox economists 
that it often happens that "we adopt biases and over-simplified generalizations...whose 
validity resides more in the use of selective information (and, on occasion, in the force 
of its pronouncement) than in a critical examination of the items," as is the case with 
"the contention, quite generalized, that the experiences of development have demonstrated 
the irrationality of state interventionism in contrast with the unquestionable virtues of 
a pure market economy, and that the indispensable requisite for development is the change 
from planning to the market. And if it indeed "is indubitable that observed experience in 
many nations has thrown into relief the extraordinary force of the market...the fact of 
recognizing the market's virtues should not induce us to ignore the possibilities, just 
like the achievements already attained, of the State, or on the contrary, to consider the 
market as a factor in success, independently of all governmental policies."
     Nevertheless, there still might remain some reader who thinks that he who has 
performed "biased and over-simplified generalizations" is us by only citing the case of 
the "Asian Tigers." In order to leave no doubt we shall view more cases.

Saved by the State: the industrialization of Germany, Russia, Japan, and China

     We all know that Germany, Russia, Japan, and China are very relevant industrialized 
economies in our world today. However, only one or two centuries ago they were backward 
economies with, seemingly, few hopes of attaining industrialization. Let us analyze, 
then, the path that each one of these economies followed in order to industrialize and we 
shall ask at every moment what would have happened if from the beginning they had 
left everything to the market, which is precisely what the Neo-liberal economists ask of 
the backward nations today in the context of "globalization."
     We begin with the case of Germany. Towards the end of the 18th century and the 
beginning of the 19th the great obstacle that Germany had in industrializing was that it 
did not possess a sufficiently broad market because of its excessive fragmentation, for it
had been divided into 350 states of the so-called Holy Roman-Germanic Empire. Such 
fragmentation could not be resolved by the market since it was that itself which was 
implicated in the question. A politico-administrative solution was required. Thus, on the 
1st of January in 1834 they created the Zollverein or Customs Union of the German 
states which eliminated all the duties on the member states (free trade) but did not 
impose it on the non-member states (protectionism). Nevertheless, there remained the 
problem of the still restrictive costs of transport, which was resolved by the effort to 
construct the railways. In this way, as the German economist Friedrich List said, "the 
Zollverein and the railroads acted like Siamese twins" and a national market was achieved 
there were it had been lacking.
     However, to confront a belated process of industrialization with the Second 
Industrial Revolution, Germany required a great deal of money to be able to finance 
large scale and capital intensive industry. It is there where the great banks and the 
government took the initiative offering strong links to the industrial firms to 
stimulate them. These links also implied a reciprocal relationship: the majority of the 
industrial firms were represented on the governing boards of the banks and the banks were 
represented on the governing boards of the firms. In this form, as Gerschenkron says, "a 
German bank accompanied an industrial enterprise from the crib to the tomb, from their 
establishment until their liquidation."
     We pass now to the case of Russia. At the end of the 19th century Russia as still 
clearly a backward economy. In fact, it lacked almost all the conditions that Rostow 
posited as necessary for industrialization taking as a paradigm the English case in his 
work The Stages of Economic Growth. Nevertheless, the Count Serguéi Witte, 
Minister of Finance in the regime of czar Alexander III, changed the fate of Russia and 
not exactly by leaving everything to the market. Faced with the tremendous lack of capital
and technology he incentivised the entry of foreign capital, which of course brought more 
advanced technology, by means of a system of fees and tariffs of the Russian government 
which secured the market for the investors. Likewise, he encouraged the construction of 
railroads and development banks were created for agriculture and industry. In this 
fashion, the Russian State had very important participation with intelligent substitutions
wherever the "key" conditions for industrialization were lacking, and with reason they 
called Count de Witte "the supreme chief of substitutions." Later, as we know, there were 
other historical contingencies that carried Russian industrialization in another 
direction (the "communist" revolution with the subsequent Stalinist degeneration) but it 
is clear that the initial part of the process was successful given that Russia's average 
growth beginning in 1890 was around eight percent annually, which implied a doubling of 
production every ten years!
     Let us view the case of Japan. The context in Japan was quite complicated because it 
possessed many of the characteristics of the backward economies of the periphery. It 
exported principally raw materials (raw silk, thread, tea, fish) and imported 
manufactures, and if it had been left to the sole dynamics of the market it very probably 
would have followed the fate of the other peripheral countries. However, Japan included an
important group of patriotic entrepreneurs with good academic credentials and, above all, 
a government obsessed with economic modernization like the one after the Meiji Restoration
of 1868. Thus, in addition to the creation of the material and institutional 
infrastructure necessary for the economy to function, the government dedicated a 
considerable effort to "industrial policy" constructing and nurturing factories in a broad
gamut of sectors, such as cotton textiles or naval construction. If in fact some of those 
attempts did not achieve success they later served as a basis so that, once the 
enterprises are privatized, the private sector can build upon the foundations laid by the 
State unlikely to be there if all was left to the natural dynamic of the market. 
Similarly, the Japanese government paid to employ foreign technicians in the manufacturing
sector at the same time financing scholarships abroad for Japanese students so that in 
the near future they might replace those technicians. Additionally, upon recovering 
autonomy, it increased the tariffs on the importation of many industrial products in order
to incentivize national industry given that "these efforts yielded fruit especially in 
cotton textiles, where Japan established in 1914 a first order industry capable of 
displacing British exports not only to the Japanese markets, but also to the markets of 
their Asian neighbors."
     Finally, we consider the last case in this respect: China. This case is especially 
interesting because China has stopped being a semi-feudal and backward country at the 
beginning of the 20th century to have become today a world economic power of such 
magnitude that it threatens to dethrone the United States itself, if it has not already 
done so. So then, as Rodrik reports: "The feat that the Chinese economy achieved would 
have been difficult to imagine had it not happened before our eyes. Since 1978, the per 
capital incomes in China have grown an average of 8.3 percent annually, a rate which 
implies that incomes have doubled every nine years. Thanks to this rapid economic growth, 
five hundred million persons were lifted out of extreme poverty. During the same period, 
China passed from being almost an autarchy to being almost the most feared competitor in 
the international markets. That this should happen in a nation with a total lack of 
private property rights (until recently) and governed by the Communist Party, only 
magnifies the mystery."
     In continuation, some of the key principles of the Chinese success that permit 
untangling the "mystery": 1) A social politics of satisfying the basic necessities of its 
population through state action (generally when one speaks of the low wages of the Chinese
workers they do take into account that many of the basic needs have been resolved through 
the State); 2) one of the best political distributions of income in the world (although 
today many Chines multi-millionaires have appeared, the starting point has been clearly 
egalitarian); 3) great importance of the state sector and national industry in production 
(not everything is foreign private enterprise as in the majority of Latin American 
nations); 4) struggle against corruption as a national priority (for the most serious 
cases even capital punishment is applied and there is implacable prosecution of those 
state functionaries who commit crimes); and 5) application of state planning at all levels
of society, increasingly incorporating the private sector (we have here the politico-
organizational essence of what has been called "market socialism").
     All this has contribution in determining fashion China's current status in the
international economy and, as Rodrik concludes: "this was not the result of certain 
natural processes guided by the market, but instead of the decided influence of the 
Chinese government. Undoubtedly, the low labor costs helped China to export, but they 
were not all."

What is corrupt in the corruption argument: critique of Friedman and the public choice 

     As we had seen, the orthodox economists--and especially those of the public choice 
school--conceptualize the State as an institution not only inefficient but also corrupt. 
The argument is principally based upon the identification of homo economicus with 
homo politicus: the politicians will always and necessarily be corrupt because, 
acting as rational (that is, egoistical) agents, they will seek above all to
maximize their individual profit instead of worrying about the social welfare - or in any 
event, they will worry about that only to the degree that not doing so might affect their 
individual welfare.
     Perhaps the best and most persuasive defense of this line of argumentation was 
realized by the famous liberal economist Milton Friedman. When in an interview, after 
having discussed inequality, greed and the concentration of power, Friedman is told that 
the actual capitalist system "seems to reward not virtue but instead the ability to 
manipulate the system," he responds: "And who rewards virtue? Do you think the communist 
commisars reward virtue? Do you think that Hitler rewarded virtue? Do you think, pardon 
me, that the president of the United States rewards virtue? Choose their delegates 
according to their virtue or according to their personal interest? Is it really true that 
personal political interest is more noble than personal economic interest? I think they 
are taking many things for granted. Simply tell me where you find those 'angels' who 
organize society for our benefit. I do not even trust you to do that."
     Obviously Friedman's reply contains much truth. The great majority of politicians 
base their success more on corruption than on virtue, and concern themselves more with 
personal interest than with social well-being. Nevertheless, like a Trojan horse, along 
with that truth this argument sells us an entire series of tendentious fallacies.
     In the first place, it sells us a fallacy of accident for it proposes as 
essential something which in reality is accidental. In effect, politics has 
to do primarily with the administration of power, not with corruption. And if indeed it is
impossible to conceive of politics without the administration of power, to conceive of a 
non-corrupt administration of power is not. Therefore, corruption is not essential.
It is extremely important to keep this in mind for only thus can we have incentives to 
fight against corruption. Otherwise, it would not make sense to do so: if corruption is 
inevitable, it would be useless (and inefficient) to try to avoid it. We 
have here the great danger in Friedman's argument and that of the economists of the public
choice school: destroying the moral basis--as much of the public functionaries in 
particular as of the civil society in general--to fight against corruption. Thus Bresser 
Pereira says that those economists who "thought they were defending public morality by 
denouncing rent-seeking by the adopting the postulates of the 
Neo-classical and public choice economic theory" in reality ended in reducing moral 
patterns. "During the heyday of the Neo-classical economic theory, one spoke of 
transparency in politics and criticized corruption like never before (the World Bank, for 
instance, became a sort of anti-corruption agency) yet never was the moral standard of 
the economists and functionaries so low.
     In the second place, it sells us the fallacy that two errors create a truth. 
Given that the State is bad, the market is good. Since "those 'angels' who organize 
society for our benefit" do not exist we should confide, as Friedman himself later says, 
in the "invisible hand of the market" to transform our egoistic search for individual 
well-being into social welfare and that, therefore, "there is no alternative path...
to improve the life of ordinary people productive activities in a free 
system." Or that is, given the defects of government, everything must be left to 
laissez faire capitalism. Obviously we deal with a fallacy since from the fact 
that there are no "angels" it does not follow that the market is a "god" as we saw 
     Finally, and here is where we should be most on our guard against the neoliberal 
strategy of criticizing the State in order to later propose a system founded exclusively 
on the free market, it sells us a fallacy of dissociation for it abstractly causes 
us to believe that political corruption and economic (entrepreneurial) corruption are 
separate phenomena when in reality they almost always interact synergistically.
Therefore, paraphrasing him, we can reply to Friedman: "And who corrupts the politicians?
Do you believe that businessmen finance their campaigns solely out of charity? Do you 
think that they do it for amusement? That the businessmen finance the politicians only out
of virtue or in accordance with their personal interest? Is personal political interest 
not indissolubly united with personal economic interest? We think he is taking many things
for granted. Simply tell us where that 'invisible hand' is found which converts our 
personal greed into social well-being. We do not think you will be able to find it."
     However, if he is consistent in his line of thought, Friedman will not be mute before
such a critique. He will accept without a problem that economic corruption is united with 
political corruption and very detachedly will tell us: "As someone who believes in the 
search for self-interest in the competitive capitalist system, you cannot blame a 
businessman who goes to Washington and tries to obtain special privileges for his 
company. He has been hired by the investors to make them as much money as possible 
within the rules of the game; and if these are that one must go to Washington to seek 
privileges, I do not blame them for doing so." As against this "argument," the only 
refutation that suffices is indignation.
     Now, referring more directly to the approaches of public choice theorists like 
Buchanan, Tollison and Tullock, we discover that great deficiencies are also found in 
them. Thus, for example, the theory of public choice has serious problems in explaining 
why people bother to vote in contexts where that is voluntary considering this a non-
rational conduct, a product of mere habit.
     Yet not only that. In fact, there are approaches of the public choice school which 
lack logical consistency. In effect, the theorists with this focus speak of the 
existence of a "political cycle" in the sense that the politicians in power carry out 
expansive fiscal politics around the elections period in order to artificially inflate the
economy and win votes; yet at the same time defend a concept of rationality for the agents
which includes rational expectations. We deal with a logical inconsistency because 
one cannot have both things at once. If the voters have rational expectations they will 
soon notice what the politicians are doing and punish them with fewer votes. The 
politicians, for their part, having rational expectations, will note that and cease 
committing the error. In consequence, whether the public choice theorists like it or not, 
one cannot have the cake of rational expectations and eat it at the same time so that the 
theory of the political cycle will operate.
     Therefore, we can agree with Steven Pressman that, "at root, the problem is that the 
theory of public choice begins with an ideological aversion to government and a religious 
cult of the market" which prevents them seeing "the self-refuting and self-contradictory 
nature of their arguments." Given this, we conclude along with Lars Udehn that: "The 
theory of public choice fails or is severely limited...because a politician can be much 
more than merely egotistical; she can be socialized to attend to her interest group and to
the public interest as well." Nobody denies the obvious that in general politicians act 
egoistically. But to think that that is their only mode of acting and that they 
necessarily do so in a mechanical fashion is the great error of the school 
of public choice.

More assistance to those who cooperate? The role of the State in the promotion of 
economic efficiency

     When the orthodox economists speak of State "intervention" or "interference" they 
always do so in negative terms: they consider it as something undesirable for the economy 
and the market. Markets are naturally efficient and, consequently, all State 
intervention would disturb such efficiency.
     Yet, can it be true that the only thing the State can do to promote economic 
efficiency is to not disturb the efficiency of the market? We do not think so.
     First, because the markets are not intrinsically efficient. Nothing assures us
that such a thing as an "invisible hand" or the "spontaneous order" of markets exists. In 
fact, there are certain moments when the markets become incredibly inefficient and de-
coordinate instead of coordinating, establishing disorder in place of order; we are 
referring to the crisis. And what better example of that than the current financial 
crisis. In this crisis it was clearly proved that, at Paul Samuelson himself said, 
"unregulated market systems sooner or later commit suicide" and "what then is it 
that, since 2007, has caused Wall Street capitalism's own suicide? At the bottom of this 
worst financial mess in a century is this: Milton Friedman-Friedrich Hayek libertarian 
laissez-faire capitalism, permitted to run wild without regulation. This is the root 
source of today's travails. Both of these men are dead, but their poisoned legacies live 
     Second, because to counterpoise the State and the market as if treating of water and 
oil is to fall into a false dilemma fallacy. The State as well as the market 
participate in the economic dynamic and thus are jointly responsible for the global 
efficiency of the economy. And indeed without the State or without a market the system 
loses constitutive elements inherent to its regulatory and innovative functions. The role 
of the market without a State or of the State without the market is, in the end, 
unintelligible. Even more, as Gurrierri puts it well, in the vast majority of experiences 
of development "the public and private sectors have intermixed in a strict fashion...and 
the instances of greatest success...have been based upon a relatively stable combination 
and mutual growth."
     Third, because the State can contribute to increasing the efficiency of the markets. 
We take for example the phenomenon of "cumulative causality" noticed by the Swedish 
economist Gunnar Myrdal. According to Myrdal economic efficiency is above all a product of
interaction of spheres of influence, in which one observes that an ascendant movement or 
an improvement in sector or factor "A" drives an ascendant movement in sector or factor 
"B," that in turn propagates towards the other sectors or factors, with a positive effect 
through absorption on the original factor "A." So then, we have here an important area 
where the State can intervene so as to increase the global efficiency of the markets: 
fomenting "productive articulation" among the different sectors in order to utilize in the
best manner the synergistic effects that might be generated. This objective 
obviously "presupposes recognizing all the different sectoral specificities," that "all 
sectors have complementary and different roles" and that "industry has a crucial role to 
be the carrier and diffuser of technical progress"; something that orthodox economics 
cannot do because it "starts from the assumption of inter-sectoral neutrality: that is, is
indifferent towards what the productive activity is which drives it."
     Fourth, because the State can intervene in areas that the market cannot reach or in 
which it lacks interest to do so yet that affect (positively or negatively) social well-
being. To illustrate this point we can look as reference to the famous problem of 
social equilibrium. As Galbraith explains, this problem consists in that "our 
societies are opulent in goods produced for the private sector and poor in public 
services." Thus, for example, if in fact it is evident that an increase in acquisition of 
automobiles requires a corresponding increase in roadways, signage and parking spaces, it 
is also true that every time the greater utilization of these has already overwhelmed the 
public services involved bringing as a result extraordinary vital congestion, great annual
mortality through accidents and chronic colitis in cities through environmental 
contamination. In this context the most pertinent solution would be that the State re-
establish the balance between goods produced by the private sector and services produced 
by the public sector, taxing the former to provide for the latter such as to cause private
goods to be more expensive, and their inherent public services to be more abundant, and 
thereby, if indeed by one perspective we have automobiles with higher prices, nevertheless
this would finance that we could have more highways and streets upon which to circulate, 
better health services and more uncontaminated green areas.
     We have seen, then, four good reasons to reject the orthodox theory that the best 
State is the minimal State and that the best politics is not to apply any policy. However,
there still remains one escape for the orthodox economists: to say that even if the State 
can intervene in the economy to provide economic efficiency and even repair market
failures, such an intervention will end by generating "State failures" and, in 
consequence, will be largely inefficient; therefore, the intervention of the State should 
not be permitted.
     To this argument we must start by conceding that, in reality, "State failures" do 
exist. Yet that in no way implies that one must a priori reject all State 
intervention. There is no evidence that the "State failures" would be always and 
necessarily greater than the "market failures." Therefore, instead of eliminating the 
State plane, the most coherent would be to apply criteria of pertinence and reasonableness
to evaluate its interventions, comparing the costs with the benefits in order to determine
the net efficiency from a social point of view.
     It is thus that Gerald Meier, after analyzing different theories and perspectives on 
development, concludes that: "If the future of development economics is dominated by some 
theme, it will be, as in the past, about the respective functions of the State and the 
market in reducing poverty. But there will be new perspectives concerning the role of the 
State. The issue will not be the failure of the market or of the State, as was viewed from
the Neo-classical perspective. In place of that, the future analysis will have to 
recognize new market failures, tackle the cost-benefit analysis of the policies of the 
government and determine how public action can support the institutions and deepen the 
market. The future probably will include a reaction to the minimalist State which was 
proposed by the second generation. Certainly, the State should not be over-extended. And 
it is true that the government cannot do better what the private sector does in the 
direct production of goods for the producer or for the consumer or in inducing innovation 
and change. But government will even have extensive functions in dealing with the new 
market failures (imperfect information, imperfect or incomplete markets, dynamic 
externalities, increasing yields to scale, multiple equilibria, and patterns of 
dependence) purveying public goods, satisfying worthy desires such as education and 
health, reducing poverty and improving income distribution, furnishing the physical and 
social infrastructure, and protecting the natural environment. The goal will be to have 
governments who do what they best know how to do. The challenge will be to obtain the 
benefits of government action at the least cost."
     And effectively, today in some countries new and more sophisticated forms of 
government intervention are being developed that have come to be called "State capitalism 
2.0" and which exhibit the following three new characteristics: 1) greater resilience and 
capacity to respond against the crisis of 2008; 2) an important focus of the public 
enterprises not only on social or political goals but also on cost effectiveness for 
sustainability and competitiveness; and 3) that in general the government participate as 
a minority investor in the main industries instead of being the manager or owner directly 
such that avoids the principal problems of agency associated with public property and at 
the same time obtains important information and a significant revenue flow. Similarly, 
learning from the experience of the Soviet Union, which failed because its public firms 
could not emulate the rhythm of productivity and innovation in the West, "State capitalism
2.0" is now more interested in innovation. To take only one example, we know that the 
Chinese bullet train, outside of its problems with safety, implies a clear technological 
improvement with respect to the German and French train. This occurs because a structure 
has been configured where the Chinese bureaucrats have strong incentives to show results, 
since their careers are not limited to the public enterprises, but instead extend to 
within the Communist Party.
     Therefore, for us to surrender before the idea that "the State will always be 
corrupt and inefficient and thus everything should be left to the market" is simply 
intellectual laziness. Intelligent ways of generating incentives for efficiency and 
transparency exist. It is only a question of striving to think of them for them to be 
implemented and then to improve them once implemented.

Seeking "the optimum" is not always optimal: the Lipsey-Lancaster theorem

     In the previous section we have seen some practical references to how it is not 
necessarily true that the best which the State can do to promote economic efficiency is 
simply to "stay out of the way" in order to give space to the pure free market. 
Notwithstanding, there is a much deeper theoretical reason: the Lipsey-Lancaster
     This theorem, also known as the theory of the second best, was proposed in 
1956 by the economists Richard Lipsey and Keven Lancaster and its implications for the 
orthodox theoretical scheme are as devastating as Robinson's critique of the production 
function and the Sonnenschein-Mantel-Debreu theorem. Subsequently we shall see why.
     As we know, the Neo-classical paradigm takes the model of a perfect free market as 
the omnipresent epistemological ideal for it is only starting from it that one 
understands and analyzes further sophistications (imperfect markets, regulations, market 
failures, et cetera). Similarly, it takes it as a valuational ideal with respect to 
welfare since this will yield "the best of all possible worlds," that is to say, Pareto 
optimality. Therefore--the orthodox economists reason--given that we can never have a 
perfectly free market world, the best that we can do to increase welfare is to cause the 
real world to resemble that ideal world by as much as possible by lifting the greater 
part of restrictions and regulations.
     Now then, the essence of the Lipsey-Lancaster theorem is that is formally 
demonstrates that the previous idea ("touchstone" of practically the entire Neo-classical
scheme) is false and dangerous. In effect, what this theorem proposes is 
that if, for some reason, some of the conditions to obtain the Pareto optimum are lacking 
(that is, what always occurs in our real world), procuring the remaining conditions
of the pure free market will not necessarily cause welfare to increase and to 
impose them might even cause welfare to diminish. In this manner, if we are not in 
a full free market world, to approach it more will not necessarily be best. And the 
inverse also follows, namely, nothing assures us a priori that to impose more 
regulations and restrictions will cause our welfare to increase.
     Thus, what this theorem accomplishes is to do away with a simplistic vision of 
political economy for it demonstrates that the supposedly universal "recipes" of  
always "more free market" or always "more State intervention" are destined for failure. 
The political economists should always keep in mind the specific conditions of the 
place in question and decide a posteriori, after careful study, the type of 
intervention and participation that the market and the State will have in them. This is 
not a trivial question but instead is of absolute practical importance since not 
understanding it may lead us to compromise the well-being of millions of persons. 
That is no exaggeration. In the decade of the Nineties, upon an orthodox theoretical 
scheme, the IMF attempted to apply a single recipe known as the "Washington Consensus" 
which consisted basically in "liberalizing, privatizing and de-regulating." These 
policies were applied in various nations of Latin America, Asia, Africa, the ex-communist
eastern Europe, and Russia itself, and the results were disastrous in terms of welfare, 
as has been amply documented.
     Likewise, another fundamental implication of the Lipsey-Lancaster theorem is that it 
ends the absurd State versus market debate. Indeed if we cannot know a priori which
of the two is better, the relevant question now is not that of "less or more" 
intervention but instead what type of intervention. In this regard the approaches 
of the regulationist school gain importance. In accord with this focus, initiated 
by a group of French economists in the Seventies decade, economic analysis should treat 
"the transformation of social relations, which creates new forms--as much economic as non-
economic--organized into structures and which reproduce a determinate structure." In this 
mode, two fundamental concepts are distinguished: a regime and model of reproduction and 
accumulation. The accumulation regime refers to the configuration of relations that
permit capitalism to "reproduce itself in a stable manner" as a "continuous system." 
Meanwhile, the mode of regulation is defined as the set of institutions, types of 
States, rules of politics, et cetera, that provide the context for the functioning of the 
accumulation regime. Then, the crises in production will be produced, as well as by 
exogenous factors, by maladjustments between the regime of accumulation and the mode of 
regulation. Then, it will be essential to consider the different modes of regulation 
possible, with emphasis on the diverse forms of State participation in the economy.
     Thus then, as the Lipsey-Lancaster theorem has demonstrated, there is not a single 
infallible recipe and consequently, in a mixed economy one must be open to different forms
of intervention to increase welfare, including indicative planning. This, 
evidently, undermines the very basis of the deterministic orthodox scheme and it is not 
strange, as also happened with Robinson's critique and the Sonnenschein-Mantel-Debreu 
theorem, that the politics of silence are applied to it. Yet one really must speak
about this.

In defense of political economy: critique of monetarism and the theory of rational 

     It is a known fact that the vision held by orthodox economists concerning the 
macroeconomic policies of the State are generally based upon what we could call the 
"perversity thesis," according to which any constructive action to improve a certain 
characteristic of the political, social or economic order serves only to exacerbate the 
condition it tries to remedy. Thus, when dealing with the macroeconomy, the government can
never improve matters, only make them worse. "We do not have problems with the State, the 
State is the problem" should be the slogan adopted by the neoliberals following president 
     As we saw at the beginning, this posture was principally defended on the academic 
plane by Milton Friedman and the other monetarists of the Chicago school. According to 
them the policies that seek to stimulate growth or employment, by being discretionary, 
always end by destabilizing the economy and consequently will ultimately be inefficient.
Best then would be to remove all discretionary action capability from the fiscal and 
monetary authorities, establishing that the latter will be limited solely to having the 
monetary mass grow in a fixed and moderate amount which does not stimulate inflation, that
is, the constant and sustained growth in the price level. In summary, the solution will 
consist of establishing fixed rules to impede every action of the fiscal or 
monetary authorities that attempts to respond discretionarily to the economy's 
     It is true that a manager of the political economy who acts discretionarily can end 
by destabilizing the economy given that when she observes a certain perturbation: 1) she 
does not know if it necessarily will require an intervention (delayed recognition); 
2) she may delay deciding what type of policy to apply (delayed decision); 3) once
determined the policy will be delayed in application (delayed action); 4) altering 
the policy will alter the expectations of the private agents (problem of 
expectations); and 5) she will have no certainty regarding the magnitude of the effect
(uncertainty about the multiplier) which her policy will have on the different 
macroeconomic variables (growth, inflation, employment, et cetera). However, we find no
sense in the monetarist thesis that monetary and fiscal policies should not be actively 
used against important perturbations. If indeed the previous considerations show us 
important difficulties and inefficiencies of macroeconomic policies, there still are 
clearly defined circumstances wherein there can be no doubt it is necessary to apply a 
     Perhaps the best example of the above was provided us by the well-known phenomenon of
the Great Depression in the decade of the Thirties. The situation was truly terrible, 
above all in terms of unemployment: 14 million persons in the United States, six million 
in Germany, three million in the United Kingdom. In Australia the unemployment rate was 
even greater than in the United States and the United Kingdom combined. Nevertheless, in 
the midst of this so difficult situation, the orthodox economists preached that one had to
have patience and trust that the god of the "invisible hand" of self-regulated markets 
would extract us from the "desert" of a Depression in the long run. But time passed and 
the god of the "invisible hand" was in truth invisible and did not arrive to save her 
people. Then John Maynard Keynes appeared and, like the good heretic he was, made fun of 
the preachings of the orthodox economists and answered them that "in the long run we are 
all dead." Because of that, it was necessary to act. The proposal of Keynes was the 
following: to stimulate aggregate demand in the economy by means of government 
expenditures. Thus, by virtue of the multiplier effect upon investment and private 
consumption the economy would re-activate and, finally, could exit the crisis.
     However, Friedman would argue that "the Great Depression in the United States, far 
from being a sign of the inherent instability of the private enterprise system, is a 
testament to the great damage that the errors of a few men can cause, when they possess 
broad powers over the monetary system of a nation" and that Keynesian policies are in 
large part ineffective because their alleged multiplier effect is not seen in 
consumption since the agents deciding their consumption mold their consumption behavior to
their permanent or long-term consumption opportunities, and not to level of their current 
or short-term rent which affects the Keynesian policies. We have here the essence (and 
also the political and ideological background) of Friedman's theory of permanent 
     To this reply by Friedman one can respond as much on the theoretic plane as upon the 
empirical. Thus we know that since the post-Keynesian focus it has been 
consistently demonstrated that the monetary offer is not a variable exogenously 
determined by the Central Bank as Friedman thinks but a variable endogenously 
determined by the dynamic of bank credit expansion given that the monetary authority
adjusts to it afterwards. Pursuing this model, the reputed heterodox economist 
Steve Keen has refuted the monetarist interpretation of the Great Depression through a 
detailed statistical-comparative analysis of unemployment dynamics, monetary aggregates 
and the acceleration of the debt, concluding that "it is evident that the argument 'the 
Federal Reserve caused it' is upon shaky ground with respect to the Great Depression."
     Elsewhere, with regard to the permanent rent hypothesis we know that various of the 
tests which have been done arrive at the conclusion that consumption is exceedingly 
sensitive to variations in current expenses, which is precisely the contrary of that 
propounded by Friedman. Furthermore, there also exists the important phenomenon of 
restrictions on liquidity, that is present when persons have no savings from which 
to draw nor access to credit to finance their consumption and, therefore, must base it 
principally on their current revenue, being no more, so to speak, than the amount of money
in their pocket. This phenomenon is common above all in the underdeveloped nations, where 
the great majority of the population must survive on only what they get that 
day. The fact that Friedman wishes to ignore it does not imply that we too have to do 
     We pass now to analyzing the other approach en contra to political economy: 
the theory of rational expectations. As we have seen, according to this theory the agents 
perform correct calculations following the course of economic variables 
systematically learning from their errors, such that the government can no longer 
"surprise them" with discretionary policies and, therefore, the economic policy becomes 
     The theory of rational expectations can be confronted in various ways. In the first 
place we know that it is an absolutely heroic assumption to think that all the agents can 
make accurate predictions of the course of the economic variables or to do so "on the 
average" as Lucas assumes. And this applies even to the "sophisticated" versions of that 
focus where they claim it is not necessary for the whole population to have rational 
expectations but only certain "relevant agents" who make decisions, such as union leaders,
lenders and investors who constantly read the economic news in the press and even reports 
and specialized papers. Now, if Hayek's critique, according to which those who control 
economic policies fall necessarily into a "fatal arrogance" of "pretension to knowledge" 
in wanting to shape a reality so complex it exceeds comprehension, has some pertinence,
in this case it is very much more pertinent. Even more, what do the agents do (even
if we refer only to the "relevant agents") to always find the "correct" macroeconomic 
model in which to place the parameters of the respective predictions if not even the 
greatest and most educated macroeconomists in the world have been able to do so?
     Yet it not only concerns the (enormous) difficulty of always finding the "correct" 
model in which to box the parameters but that these future parameters do not even 
exist in the present! Yet the calculation should be made in the present and, there 
always being uncertainty about the future, exact predictions cannot be made. To 
think otherwise is to ignore the nature of real time (the future does not 
exist in the present) and to ignore the implications of uncertainty in the processes 
of economic decision. In fact, as the Keynesian economists have argued, given the 
intrinsically uncertain character of the future, we are all affected in some measure by 
temporal myopia, meaning we focus more on present variables than on future. If that
is so (and there is very good evidence in this regard) the rational expectations theory 
begins to seriously fail.
     Lastly, we must also question the idea that the agents learn systematically 
from their errors. And indeed, as behavioral economics have fully demonstrated, it is more
that on many occasions we commit errors systematically. Thus, contrary to the 
rational expectations theory which sees us as "rational predictors," the reputed 
behavioral theorist Dan Ariely argues that we more likely are predictably 
irrational and he supports this with ample empirical evidence in an entire book.
Therefore, if the partisans of the new classical macroeconomics want to keep 
systematically commiting the error of believing that we do not commit errors 
systematically, this is now their problem...

Against the sword and the wall: totalitarianism of the State or totalitarianism of 
the market

     We now arrive at the political argument of the orthodox economists to oppose State 
intervention in the economy, namely: that all interference of the State is an assault 
against individual liberty and will lead us inevitably towards totalitarianism. Therefore,
one must choose: we either accept the pure free market or we submit to State 
totalitarianism. There are no more options. "The idea that a third system exists...
is pure absurdity," writes von Mises, given that "when one speaks of 'planning' they are 
speaking, of course, of centralized planning, that is to say a plan created by 
the government...which prohibits all planning performed by anyone who is not the 
government." In turn, Mises' most prominent disciple, Friedrich von Hayek, tells us that 
the sole fact of seeking "social justice" in the market "must necessarily 
conduce to a totalitarian system."
       To all this one must respond that, by asserting that no intermediate option exists 
between the pure free market and totalitarian central planning by the State, they are 
clearly falling into an all or nothing fallacy. Not all planning has to be 
totalitarian and centralized as Hayek claimed in his Road to Serfdom (1944). And if
it may be true that many countries that introduced some degree of economic planning had 
bad experiences in terms of efficiency (think of the Soviet Union) the general prediction 
that planning leads inevitably to totalitarianism has not been seen to be confirmed by 
the facts. In this respect, the distinguished economist George Stigler has observed the 
following: "Today I believe much less in the central thesis of Road to Serfdom... 
The reason is that if its principal prediction turns out to be true, it shall be so in an 
indeterminate future. According to my reading of Road to Serfdom, this work 
maintains that 40 more years of the march toward socialism will result in important 
losses of political and economic freedom for the individual. However, in those 40 years we
have seen a continual expansion of the State in Sweden and England, even in Canada and the
United States, without such horrendous consequences for personal freedom as Hayek 
predicted... Hayek thought that the unsystematic regulation of hundreds of different 
industries and occupations could not survive. The conflicts and inconsistencies would 
require the adoption of a single, systematic and centralized plan - and that plan would 
not allow much leeway for individual choice. Yet that multitude of inconsistent partial 
interventions on the part of the State in economic life is precisely that which we have. 
Hayek's orderly mind could not comprehend the survival of our disordered world."
     And not only that. Economic planning has no reason to always be bad or inefficient. 
For example, the Dutch have been practicing it since they lost their colonies, and 
Leontief as well as Galbraith recommended it for overcoming stagflation, namely, that 
situation in which stagnation and inflation co-exist. Thus, the dilemma is not between 
freedom versus planning but instead between authoritarian planning and 
democratic planning, between rigid, tyrannical and bureaucratic planning, on one 
hand; and participative, flexible and decentralized planning, on the other.

Liberal hypocrisy: liberalism, dictatorship and other demons

     Perhaps the most well-known episode in the origins of neoliberalism--the political 
ideology of orthodox economics--would be the formation, in 1947, under the leadership of
Friedrich von Hayek, of the Mont Pelerin Society, a group of liberal intellectuals--among
who were also found Karl Popper, Ludwig von Mises and Milton Friedman--who were committed
to the diffusion of the ideas of liberalism throughout the world with the goal of 
combatting the advance of socialism.
     These intellectual presented themselves above all as defender of the "freedom" and 
the "democracy" of the market as against the "oppression" and the "totalitarianism" of 
the State. In this fashion, whoever opposed themself to them, that is, who opposed the 
pure free market calling in some measure for the intervention of the State, were 
immediately characterized as "enemies of freedom" who do not want that to happen and who 
attempt to subject society to the State. And indeed, in accordance with this vision, it is
either capitalist democracy or socialist dictatorship. There is no middle 
ground given that "planning leads to dictatorship" and, furthermore, "when the 
government interferes in the market it is more and more carried towards socialism.
     Yet have those liberal economists remained always true to their ideals of "freedom" 
and "democracy"? The truth is they have not. Whenever those ideals entered into conflict 
with their sacrosanct "market," they were immediately shredded. It is a known fact that 
the economists of the Austrian school decidedly supported the genocidal rightist regimes 
in South and Central America. Thus, for example, in an interview granted to the El 
Mercurio newspaper on the 12th of April in 1981, the brilliant founder of the Mont 
Pelerin Society, Friedrich von Hayek, commented: "Sometimes it is necessary for a nation 
to have, for a time, a form of dictatorial power. And I prefer a liberal dictator to a 
democratic government lacking in  liberalism. Pinochet's dictatorship in Chile also 
was supported by members of the Chicago school (the so-called "Chicago Boys") and 
particularly by its founder, Milton Friedman. A tremendous example of liberal 
hypocrisy: they say (and act) one way, yet do another.
     But the truth is it could not be otherwise. The successful maintenance of a regime of
free laissez faire competition would necessarily require a dictatorial and 
authoritarian government ready to suppress everything which might limit or disturb 
economic liberty, such as what the unions, the nationalist parties and cooperative 
movements propose. All of them will have to be persecuted and eliminated if one desires 
the survival, now not of the market, but instead of the absolute free market. The 
distinguished economist and founder of CEPAL, Raúl Prebish, was not groundless when
he said that: "The Neo-classical principles can only be applied under a regime of force." 
Consequently, the anti-statist approach of the neoliberals keeps being statist on the 
principal point: that of the coercive power of the State as against the society.
     "I think that the dictator, Juan Perón here in Argentina, had a good approach 
when he was forced into exile in 1955. We hope that other dictators, in other nations, 
offer a similar response," said von Mises in one of his famous conferences in Buenos 
Aires. It was easy for him to say in reference to a populist government of pro-syndicalist
tendencies like that of Perón. Yet would he have said the same of Pinochet? We cannot
know... The liberal dictatorship of Pinochet began in 1973, the year that Mises died. But 
what we do know is that Hayek, the principal disciple of Mises, supported that 


     The object of this chapter has been to critically examine the orthodox theory 
concerning State intervention. Basically we have seen that:
     1) The idea that State intervention is intrinsically inefficient is refuted by the 
sole fact that there are some public enterprises more efficient than some private and, 
above all, by the "miraculous" case of the Asian Tigers who achieved development
precisely thanks to State intervention.
     2) State intervention was fundamental for the processes of industrialization 
in nations as relevant as German, Russia, Japan, and China, given that, if everything had 
been left to the market alone, they would have been unlikely to achieve the same during 
the period that has elapsed.
     3) To conceptualize the State as an intrinsically corrupt institution, such as the 
public choice school does, implies falling into a set of fallacies (of accident, of
"two errors yielding a truth" and of dissociation) and even incurring clear internal 
inconsistencies such as positing (in a critical manner) the existence of the 
"political cycle" and at the same time assuming rational expectations.
     4) To see the State as necessarily a disturbance to the market constitutes a false 
dilemma because, in fact, the State can improve market efficiency by means of 
certain interventions in aspects such as "production articulation" or the problem of 
"social disequilibrium."
     5) The Lipsey-Lancaster theorem formally demonstrates that if we do not have 
all the conditions of the pure free market, to procure the others will not necessarily 
cause welfare to increase. Therefore, each situation should be analyzed separately and the
neoliberal "recipe" that less State and more market is always better (which is precisely 
what the Washington Consensus proposed) remains baseless.
     6) The monetarist idea that political economy should be limited to only having the 
monetary mass grow moderately is unreasonably restrictive for in clear contexts of crisis 
it can be necessary to apply expansive fiscal policies of the Keynesian type. 
Meanwhile, the rational expectations theory, which posits the inefficacy of economic 
policy, is seen as purely utopian since it implies an exaggerated "pretension to 
knowledge" when in reality we suffer from temporal myopia, as the Keynesians say, 
and even commit systematic errors, as the behavioral researchers propose.
     7) To propose, like Mises and Hayek, that ultimately the only possible form of 
planning is centralized planning and that, therefore, any adjustment or regulation of the 
pure free market can only lead us to totalitarianism, is clearly an all or nothing 
fallacy since decentralized planning is also possible and, furthermore, in the 
European welfare States an important degree of government intervention has been observed 
without that having implied limiting political freedoms (indeed the contrary has 
     8) Paradoxically, the orthodox position terminates, in practice, being entirely 
statist on the most crucial point of all: that of the coercive power of the State over 
society. And indeed, if we wished to maintain an absolutely free market regime, it 
would be necessary to prohibit, suppress and persecute everything that could disturb it, 
such as unions, nationalist parties and cooperative movements.
     All this comprises a powerful cumulative case against the orthodox postulate 
of non-intervention of the State. Therefore, the orthodox theory regarding the State is no
more than a myth. May it rest in peace.

                        Chapter 9
                        THE MYTH OF FREE TRADE
                        "Free and open commerce permits every country to expand 
                             its level of production and consumption, that is, to elevate 
                             the world standard of living."
                                                Paul Samuelson, Nobel prize 1970
The orthodox theory of free trade

     We now pass to studying one of the orthodox theories that has assumed more importance
because of the current context of economic globalization in which we find ourselves: the 
theory of free trade.
     As we know, the orthodox approach to free trade among nations commences with the 
famous theory of comparative advantage which David Ricardo presents at the 
beginnings of the 19th century during the British debate about the advisability of 
opening the market of that country to the production of wheat from other countries. 
Ricardo maintained that the English economy would substantially increase its welfare by 
the mere fact of commercial opening. His argument was very convincing. He began by 
imagining an artificial situation where Portugal was more productive than England not 
only in wine, something that was obvious, but instead even in cloth, which was absurd. He 
proceeded to show that even thus it was convenient for England to open herself to free 
trade with Portugal and vice versa. Why? Because if we suppose that Portugal is much more 
efficient in wine production than in cloth it might well happen that she should dedicate 
all her productive resources to the production of wine and let England be 
dedicated to cloth production. Thus, England would export its relatively cheaper 
cloth to Portugal and would import the absolutely cheaper  wine from that nation, 
that occurring as the result of the two nations' mutual benefit and, ultimately, the 
increase of welfare in each of them.
     Upon that hangs, then, the celebrated principle of comparative advantage 
according to which every country can obtain the benefits of free trade by 
specializing in the production of those goods which they can produce at a relatively lower
cost and by importing those goods it produces at a relatively higher cost.
     Such is the importance of this principle for the orthodox theory that Paul Samuelson 
has come to say that "it provides the immutable basis of international commerce." 
However, David Ricardo's theory of comparative advantage had one great limitation: by 
assuming that factors could move freely from one industry to another, he did not analyze 
how free trade affected income distribution in the countries. In order to remedy this 
deficiency of the classical theory the Neo-classical economists introduced the famous 
Hecksher-Ohlin model, so named in honor of the two Swedish economists who 
formulated it.
     The theoretical assumptions on which this model is based are the following:
1) liberty of commerce; 2) production and consumption occur in conditions of perfect 
competition; 3) transport costs do not exist; 4) the dynamics of trade lead us to complete
specialization; 5) the nations are identical in tastes and preferences and, ultimately, 
have identical demand conditions; 6) the countries are endowed with homogeneous factors of
production in limited quantities; 7) those factors of production are now fully employed; 
8) there is perfect factor mobility to the nations' interior, but not internationally;
9) the nations do not differ in their technology; and 10) production exists under 
conditions of constant returns to scale.
     To develop their approach Hecksher and Ohlin start from two basic concepts: 
factor intensity and abundance. By factor intensity they understand the intensity 
with which the productive factors are required or utilized in each productive activity, 
given the state of the technology; and by factor abundance they understand the 
quantity of the factor that each economy possesses. In this manner: 1) the goods are 
differentiated within themselves by the greater or lesser quantity of factors which its 
production requires, and 2) the countries are differentiated in their factor endowments 
(capital or labor).
     We come to see that each nation will tend to produce in a relatively more efficient 
way those goods which require a more intensive utilization of their abundant factor. Thus,
applying the principle of comparative advantage, those countries will have a relative 
advantage in the production of those goods that utilize their relatively more abundant 
factors of production in an intensive form and, ultimately, export these and import those 
in which it is disadvantaged. If every country does this they will obtain the gains of 
free trade.
     Later, at the end of the Forties, Samuelson demonstrated that, under some additional 
assumptions and by application of the Hecksher-Ohlin model, the absolute and relative
prices of the factors of production will equalize in the nations that trade. In other 
words, he was affirming that free trade among nations promoted not only efficiency but 
also equality! Here we have the famous Hecksher-Ohlin-Samuelson theorem.
     We see, then, that as much for the classical conception as the Neo-classical 
international trade is always efficient, mutually beneficial and positive for the 
entire world. It follows that the orthodox economists are so decidedly in favor of 
free exchange and so against protectionism: all commercial opening increases the 
welfare of nations and all restriction diminishes it.
     Yet beyond all that, and even before the classical and Neo-classical school, there 
was formulated what economist Dani Rodrik calls "the best argument for free trade ever 
known." In effect, in 1701, in a work titled Considerations Upon the East-India 
Trade published anonymously, the English lawyer Henry Martyn developed his argument
making an analogy between technological progress and free trade. "Martyn offered examples 
of technologies that had been familiar to the readers of his time. For instance the 
sawmill...allows two persons to do the work which, without it, 30 persons could not have 
done. If we decline to use the sawmill, we might employ those 30 people, but would not 
that be 28 more than those really necessary and, therefore, a waste of the nation's 
resources...? We would be fools to abandon technological innovations such as the sawmill 
or the barge. Following the same logic, Martyn offered an irrefutable argument. Would it 
not be a similar waste to employ workers in England if the textile products that they make
can be obtained in India putting fewer people to work?" Thus, if we do not oppose 
technological progress even when it destroys jobs, as in the case of the sawmill, it is 
absurd for us to do so with respect to free trade.

Welfare for all? The critique by Singer and Prebisch of the comparative advantage 

     As we just saw, one of the principal predictions of David Ricardo's theory of 
comparative advantage was that, if one specialized in the production of those goods which 
were relatively more efficient, all the nations could obtain the benefits of free 
trade independently of their level of development or absolute productivity.
     But it was too pretty to be true. Then in 1950, H. Singer and R. Prebisch, two 
economists of the U.N. interested in problems of underdevelopment, questioned the 
Ricardian thesis about the benefits of free trade.
     Basing themselves upon a study conducted by the U.N. on the evolution of relative 
prices of primary with respect to industrial prices during the period 1870-1948, Singer 
and Prebisch found that the evolution of the terms of exchange in international 
commerce were decreasing, which signified that the price of industrial products increased 
more than that of primary products. Therefore, free trade was becoming unfavorable for 
the poor nations (specialized in primary materials) and favorable for the industrialized
(specialized in industrial products).
     Starting from there they elaborated a center-periphery schema to explain 
international relations, proposing that the division of the benefits of trade between the 
industrialized nations (center) and the underdeveloped peripheral nations 
is asymmetric since it favored the first group more in stimulating their economic growth 
to a higher degree than the second.
     This thesis was supported by various arguments:
     1) The technological advantage of the industrialized nations permits them, on the 
one hand, to reduce the utilization of primary materials and, on the other, to substitute 
traditional primary products with industrial products.
     2) The increases in productivity derived from technical progress affect the sectors 
in different ways: in the case of industrial products that translates into greater 
aggregate value and, ultimately, in greater benefits and wages; while in the case of 
primary products it translates into price reductions, with the subsequent drop in incomes.
     3) Primary products have a low income elasticity of demand and industrial 
products a high income elasticity of demand, which tends to diminish the price of 
the former and increase that of the latter.
     4) The price elasticity of demand of primary products is also low, which means
that the increase in demand induced by the diminution of the price does not compensate, in
monetary terms, for the fall in incomes due to the foregoing.
     5) A large part of the specialization of underdeveloped nations in the export of 
primary products has been financed by foreign investment, so most of the benefits go 
     On that basis the proposal of the Cepalian structuralist school (this focus 
was institutionally associated with CEPAL, the Economic Commission for Latin America and 
the Caribbean) consists in that underdeveloped nations achieve industrialization 
through import substitution (IIS) importing capital goods from the developed nations 
in exchange for consumer goods. Additionally, they recommend that inter-regional commerce 
between them be encouraged and pressure the industrialized nations to eliminate their 
barriers to the importation of primary products. One can be an optimist or pessimist with 
regard to the efficacy of this proposal, but what is wholly certain is that David 
Ricardo's comparative advantage model, in which all the nations benefited from free trade 
independently of their level of productivity or industrialization, simply has failed. In 
this mode, as Gian Flavio Gerbolini would say, "the model is mistaken not because liberal 
but because ultra-liberal. Or that is, it aspires to free trade, which is indispensable, 
but putting national production versus world production at a disadvantage."

Porter's critique: competitive advantages and comparative advantages
     Yet this is not only Prebisch and Singer's critique. During the decade of the 
Nineties the comparative advantage theory of David Ricardo was criticized by the renowned 
United States economist Michael Porter on the basis of a notion of competitive 
advantages. According to Porter the success of nations in trade does not lie in 
comparative costs nor in the relative factor endowments but more in their strategic 
selection of sectors to develop and, above all, in the capacity of their industries to 
improve and innovate. In other words, the key to the wealth of nations through commerce 
lies in the competitive advantages, not in the comparative.
     Yet how exactly are competitive advantages differentiated from comparative 
advantages? Simple, in that comparative advantages come given whereas, competitive
advantages develop, or to put it more graphically, competitive advantages are not 
born, they are made.
     In effect: while the comparative advantage theory tells us that the 
prosperity of nations emerges from their natural resources or an abundant workforce, such 
that one must specialize in the sectors where one is relatively more efficient; the 
competitive advantage theory tells us that the prosperity of nations is based upon 
the capacity of their industries to improve, compete and innovate, given that one should 
promote the development of these capacities in those sectors which are more 
profitable or strategic to the national interest (even beyond that if one accounts or not 
with a comparative advantage in that sector at the beginning).
     As an example of the above we take the case of Korea's steel industry. At the moment 
recently when that sector was going into operation, Korea had an important comparative 
advantage in rice cultivation. Nevertheless, even if the Korean farmers had converted into
the most efficient rice growers in the world, their incomes would continue to be low. 
Therefore, they had to seek another alternative. The Korean government was conscious that 
to achieve success in development its economy had to move from a basis in agriculture to a
basis in industry. Thus, it promoted the development of competitive advantages in 
this last sector and obtained a rousing success. Today industry--and especially steel--
represents an important percentage of their national income.
     An important question that one can ask at this point is why the notion of 
competitive advantages is currently assuming much more importance than that of comparative
advantages. The answer obviously has to do with globalization. And indeed in the current 
global scenario of interconnected markets, commercial competition more than being a 
competition among nations is a competition between multinational firms. As 
the Peruvian economist Oswaldo de Rivera has correctly stated we are experiencing a 
"decline of the nation-State" in which, because of "the action of the transnational 
companies, the State-Nations have been losing sovereignty over economic and cultural 
decisions." In this mode, the "new world aristocracy" are no longer the great powers but 
instead the great multinationals. The implication of this? That, given that international 
trade is almost a byproduct of the investments, alliances and agreements among trans-
national enterprises, the enterprise's competitive advantages will have more importance
than the comparative advantages of the nations.

Why do factor prices not equalize? Critique of the Heckscher-Ohlin model

     As we had seen, according to the Hecksher-Ohlin-Samuelson theorem free trade 
will not only provide efficiency but also equality since if each nation specializes in 
the production of those good that apply their relatively abundant production factors in an
intensive fashion, eventually the absolute and relative prices of the factors of 
production will equalize.
     But lamentably, although it concerns a lovely and simple focus, there exists a 
"small" (almost "insignificant") problem with said theorem: that in the real world
factor prices do not equalize! Thus, for example, there exists an extremely wide range of 
wages (price of the labor factor) between countries and although some of these differences
can reflect differences in the categories of labor, they are too big to be explained 
solely on that basis.
     Why does Samuelson's theorem fail? The diligent reader will already have taken note 
of the reply: because of the extreme unrealism of the assumptions upon which model is 
based. It is not a problem per se that the assumptions of any theoretical model are
in large part unrealistic, yet if they are extremely unrealistic very probably 
they will cease being pertinent. We shall analyze, then, the pertinence of the assumed 
principles of the Hecksher-Ohlin model.
     - Conditions of perfect competition: With respect to the awkwardness of 
supposing conditions of perfect competition in order to explain some phenomenon of 
economic reality we have already spoken considerably in chapter 5. Here we limit ourselves
to citing Lazonick: "The myth of the market economy is not appropriate even for the 
most successful capitalist economies. It has not been appropriate for almost a full 
century in terms of internal organization of the most advanced capitalist nations, and 
never has been convenient for their international relations; this because of its systems 
of national power. Therefore, no reason whatsoever exists for believing that the theory
of the market economy and its postulates of laissez-faire should be applied to a national 
economy which is trying to initiate a process of economic development."
     - Equality of preferences between the countries: This assumption is not only 
unrealistic but also absurd for one of the principal reasons why commerce between nations 
occurs is precisely because they do not have the same preferences! Furthermore, if we 
analyze the dynamic of preferences correctly, we immediately notice that to suppose a 
constant flux of commerce between rich and poor nations, which is what the Hecksher-
Ohlin model does, is simply and wholly absurd, since what occurs in reality is that the 
rich countries prefer relatively more goods in which they have a relative production 
advantage. In other words, in the rich nations they prefer to consume goods produced by 
other rich nations... Or perhaps in the United States one would prefer to say her clothes 
were produced in Haiti instead of in France?
     - Technology is identical for every country: This assumption is the height of 
unrealism and of impertinence (in the sense of "lack of pertinence," clearly). If there 
exists a central factor that explains the development levels of nations it is 
technology. And obviously that affects trade. Only consider Posner's model of 
technology gap. In turn, it affects the supposed equalization of factor prices. Indeed
if nations have different production technologies, it is almost certain that a nation with
superior technology will have higher wages and revenues than one with inferior technology.
     - Constant returns to scale: With respect to this assumption and that of 
perfect competition the renowned orthodox academic and 2008 Nobel prizewinner Paul Krugman
felt obliged to accept that "the markets are often not perfectly competitive" and that 
"the returns to scale sometimes are not constant." Note well the significance and the 
implications of the euphemisms used by Krugman. In effect, he evidently uses a euphemism 
when for instance he says that Neo-classical perfect competition "often" does not occur: 
it is obvious that it never occurs, since it is nothing more than a theoretical 
abstraction without any place in reality! Do we need 200 years perhaps for this to be 
recognized? It is, likewise, a euphemism to say one has noted that returns to scale 
"sometimes" are not constant when the truth is that very seldom are they constant.
But it is not only a euphemism yet also an ambiguity because, if the returns to scale are 
not always constant, that implies they can be increasing or decreasing, yet Krugman tells 
us nothing about which of the two alternatives will predominate.
     But the Hecksher-Ohlin model not only is based on inconvenient and unrealistic 
assumptions but the empirical evidence as well is adverse to it. In particular, the most 
empirical evidence against Hecksher and Ohlin's approach was provided by the Russian 
economist Wassily Leontief in a work published in 1953. In his study, he shows how the 
United States with a high capital/ labor ratio in comparison with the rest of the world 
surprisingly exported products with a lower capital/ labor ratio than that of its imports,
a tendency maintained during the 25 years following the Second World War. This phenomenon,
that obviously contradicts the predictions of the Hecksher-Ohlin model, was baptized as 
the Leontief paradox.

Liberal hypocrisy once again: the kick down the stairs

     "The only recorded cases in history in which the masses escaped a situation of 
poverty...are those which possessed capitalism and free trade in large measure.  If you 
want to know where the masses are worse it is exactly in the classes of society distant 
from this, such that the historical record is absolutely crystalline that there is no 
alternative path," said Milton Friedman.
     As we see, the entire force of Friedman's affirmation that "there is no 
alternative path" than capitalism to attain development rests upon the premise that 
"the historical record is absolutely crystalline" that there exists a necessary and direct
relation between development and free trade (like that between underdevelopment and 
protectionism). Yet can it be true that the only nations who managed to attain the desired
development are only those who possessed "capitalism and free trade in large measure"? No,
Mr. Friedman, the truth is almost the contrary: the historical record is absolutely 
crystalline that the great majority of nations which achieved development did so because 
they practiced protectionism and knew how to largely administer their commercial barriers.
     Thus, for example, Ha-Joon Chang, is his very famous work "Kicking Away the Ladder: 
development strategy in historical perspective," tells us: "Part of the conviction of the 
advisability of free trade by the partisans of globalization derives from the belief that 
economic theory has irrefutably established the superiority of free trade. Or well, 
almost...since there are some formal models which show that free trade might not be the 
best (yet even those who have conceived those models, like Paul Krugman, will argue that 
liberalization of trade is the best policy because it is almost certain that the 
interventionist commercial policies will suffer abuses on the part of the politicians). 
However, even more powerful is their belief that history is on their side, so to speak. 
In the final analysis, the partisans of free trade will ask, was it not through free 
commerce that all the developed nations became rich? What are developing nations thinking
--they ask--who refuse to adopt this demonstrated and proven recipe for economic 
development? A more careful examination of the history of capitalism reveals however a 
very different history... When they were developing nations, practically none of 
today's developed nations practiced free trade (nor an industrial policy of 
liberalization as the domestic counterpart) yet instead promoted their national industries
through duties, customs rates, subsidies, and other measures. The biggest gap between 
'real' history and 'imaginary' history of the commercial policies is that which refers to 
Great Britain and the U.S. which are considered nations that reached the top of the world 
economic hierarchy by adopting free trade policies" when in reality "in their 
initial stages of development those two nations were in fact the pioneers and, often, the 
most ardent practitioners of interventionist commercial measures and industrial 
     We have here, then, the great liberal hypocrisy: the developed nations, on the one 
hand, tell--within a context of international economic globalization--the underdeveloped 
countries to eliminate their barriers to be able to achieve development; and on the other,
they themselves have become developed by means of protectionist policies and restrictions 
on trade (intelligently administered, of course). The say one thing and do (and have done)
another. In other words, they rose to the desired development by means of the ladder of 
protectionism and restrictions on commerce and later, under the pretext of 
"globalization," they raised it so that nobody else could rise on it.
     Yet not all nations have been so ingenuous as to pay attention to the free trade 
United States preaching. Thus, for example, Japan, after its defeat in the Second World 
War, practiced protectionist policies establishing a systematic regime of quotas and 
duties that made foreign consumer goods prohibitively expensive and, at the same time,
permitted the development and organization of large sectors of its economy to conquer the
export markets. In this manner, "despite all asseverations to the contrary, Japan believes 
in administered trade."

The development of underdevelopment: the problem of circular causality with cumulative 

     According to the free trade preachings of the orthodox economists, free trade will 
invariably promote the development of countries and, what is more, will foment in the 
long run a convergence  between developed and underdeveloped nations.
     Unfortunately for orthodoxy there exist good arguments to think that that is not so. 
The main one of them was developed by the Swedish economist Gunnar Myrdal, who states that
the residual effects of trade can lead to sub-development. This author maintains that free
trade tends to accentuate the differences in incomes between countries principally by what
he denominates a causal cumulative process.
     We quote his own words: "The theory of international trade that we have inherited 
was never expected to explain the reality of underdevelopment and the need for 
development in the poor countries... The facts are that--contrary to the official 
economic theory--unrestricted international trade and movements of capital tend, in 
general, to engender inequalities and will do so with greater intensity when starting from
great inequalities already established. It is what I call circular causality with 
cumulative effects. A nation that already has much superior productivity will tend to 
be even more pre-eminent, while a nation finding itself at a lower level will tend to 
remain at that level, or even ultimately to deteriorate, when things are left to the free 
unwinding of the market forces."
     As Myrdal claims, the principal reason for this is that with the free flow of 
capital and due to external economies, industrial investments will go to the areas where 
investments have already been made, leading to the financial impoverishment of the others.
Meanwhile, the economically active population will migrate to the regions of expansion, 
while the stagnant regions will become dispossessed not only of their workforce as of 
their potential businessmen. In consequence, the problems of regional imbalance worsen, 
and the predictions of the orthodox classical and Neo-classical models remains with no 
effect whatsoever.

The law of the jungle and globalization: international Darwinism

     As we know, during the greater part of the 20th century the world was geo-politically
structured in a bipolar fashion, the United States and the Soviet Union being the two 
great powers that disputed world hegemony. Capitalism vs. Communism, East vs. West: that 
was the so-called "Cold War." However, at the end of the Eighties the Soviet Union 
experienced a great social, political and economic crisis that it could not resolve and 
which led to it definitive dissolution on the 21st of December in 1991. Communism had 
fallen; therefore, capitalism had "triumphed." It was time, then, to construct a "New 
World Order." How? By globalizing capitalism, that is to say, interconnecting the 
markets of all the nations of the world by means of free trade. We have here the essence 
of so-called "globalization."
     However, this New World Order has nothing to do with "spontaneous order." 
Globalization is above all the result of a very concrete geopolitical and 
historical process, and not a natural and inexorable phenomenon, as the neo-
liberals pretend. It concerns a new form of organization of the world economy 
behind which exists a very definite set of organizers: the great powers and 
capitalist multinationals who organize the world as a function of their interests.
     In what, then, does the New World Order consist? Very simple: in the application of 
the law of the jungle (and of the pyramid) to the economic relations among nations. Only 
the strong prevails, the most competitive (the wide road for him and narrow for the rest).
We are present at what the Peruvian economist Oswaldo de Rivero astutely called 
international Darwinism," that is, a global system in which the "mechanism of 
natural selection" of free competition determines which nations and firms will achieve 
growth and development (evolution),  the "most apt," destined for survival, being the 
industrialized nations and the great multinational enterprises, and the "least apt" being 
the poor nations and the small national enterprises, destined for extinction.
     In this way, an asymmetric situation is created in which there exist face to 
face, on one side, the developed nations whose great multinational firms operate in an 
environment of administered capitalism where the State models its external trade 
policy as a function of the commercial interests of its productive system, and, on the 
other, the underdeveloped nations whose incipient enterprises find themselves suddenly 
imprisoned within a laissez-faire capitalism model where the State fashions its 
external trade policy as a function of the needs of the "international system," which is, 
as a function of the interests of the other nations.
     Thus, following Gian Flavio Gerbolini we can say that "what exists in the developed 
countries is a capitalism which utilizes the market to the degree that it wants; a liberal
capitalism tempered by a realist trade policy with a high level of capitalization/ 
productivity, defended by concentrated institutional structures" and, alternatively, "in 
the unprepared nations under development," as a result of the very process of neoliberal
globalization, that which exists is "an unchained capitalism of atomistic institutional 
structures, and without trade policies suited to their reality.
     And not only that. In the midst of this context of international Darwinism we 
are also in the presence of an historic rift between production, national space 
and consumption that is altering the basis of the political system in the representative 
democracy of the States-Nation type. When production is dissociated from the national 
space and the citizen cedes her place to the consumer in this abstract world of 
globalization, it blurs one of the fundamental referents of the last 150 years of history:
the idea of social responsibility. The new globalized forms of production and consumption 
seek to break that idea imposing social Darwinism, a vision where poverty appears 
as an immanent and irremediable phenomenon that, far from harming it, favors the selection
of species and global efficiency.
     Then what we have in truth with the fall of communism and the disappearance of the 
East-West bipolarity is not world reunification. The world continues to be divided in 
two, only that now the division is between North and South, rich nations and poor 
countries. Therefore, Thomas Friedman was completely mistaken when, in his book The 
World Is Flat: a brief history of the 21st century (2005) he said that globalization 
had "flattened" the world creating a leveled playing field where the developed and under-
developed nations can compete in equal opportunity. No, lamentably the world is not flat. 
In reality it has two floors and, as we already said, those who already are on the second 
floor have "kicked the ladder"...
The great fraud: United States and the Free Trade Treaties

     It is impossible to perform a good analysis of the situation of "free" trade in the 
world without saying one or two words about the famous "Free Trade Treaties" (FTAs). In 
essence what these propose is the elimination of trade barriers--especially the tariffs--
between the countries subscribing to them. Yet the truth is that they are nothing more 
than another example of what we have called "liberal hypocrisy" given that, in reality, 
they are based upon the following logic: "Trade will be free...always and when 
you fulfill the following conditions..."
     A very good example of the above is seen in the famous FTA between the United States 
and Mexico signed in 1992. One of the main arguments in favor of this Treaty was that it 
would contribute to alleviating the existing abyss between the income levels of Mexico and
the United States, thus diminishing the illegal migratory pressure of the inhabitants of 
the first nation towards the second. Nevertheless, as Stiglitz reports, "the income 
disparity between both countries in reality increased during the first decade of the FTA's
functioning" and even "one could say it contributed to Mexico's poverty." Why? Principally
because, for variety, the conditions of the accord were asymmetric. And if it eliminated 
duties, it allowed non-tariff barriers that benefited the United States to exist. 
Thus, for example, when Mexican exports of tomatoes began to increase around 1996, the 
United States farmers began to pressure Congress and the Clinton Administration to take 
measures. What was done? Simple, they accused Mexico of "dumping," that is, of selling her
tomatoes at a below cost price in order to eliminate the competition. But Mexico was not 
doing such a thing, for its tomatoes were simply cheaper than from the United States. 
However, the prices of the tomatoes were measured in a biased manner, and since Mexico did
not wish to risk going to a judge against someone more powerful and solvent, she simply 
acceded to raising the price and, in consequence, lost participation in the large United 
States market.
     Another very suggestive example we can find in the negotiations for the trade 
agreement between the United States and Morocco in 2004. Here what the United States was 
doing was to plead the interests of the large pharmaceutical companies seeking to put 
restrictions on generic medications which, being much less expensive, were more accessible
to persons of limited resources who had serious illnesses such as AIDS. The argument from 
United States pharmaceuticals was truly cynical: they argued that is the circulation of 
generic medications were allowed their profits would fall and, therefore, faced with a 
lack of incentives, research would cease, which would prejudice everyone in the long run. 
What perversion, them giving greater importance to short-term profits than to life itself!
     Thus, we can say with Stiglitz that, in general, "the politicians and economists who 
promise that trade liberalization will cause all to improve their situation are not 
sincere" for "historical experience indicates the contrary." You cannot coherently analyze
the relations between nations (and trade is definitely part of that) without entering into
analysis of geopolitics and power relations. Yet for the orthodox economist
these are merely "exogenous" variables...

Refuting Henry Martyn: fallacies of the analogy of free trade and technological 

     We close the chapter analyzing "the best argument for free trade." Basically the 
idea proposed by Henry Martyn, as we saw at the beginning, is that if we do not oppose 
ourselves to technological progress even when it can destroy labor positions (for example,
when the automobile spread, many of those dedicated to carriages lost their job) it is 
inconsistent that we oppose free trade which is in reality a more efficient way of 
allocating our resources and productive forces at the world level. Therefore, if we are 
all in favor of technological progress, we should also be in favor of free trade.
     Very well, in the first place it seems that Martyn commits a false premise 
fallacy for he already assumes that we are unreservedly in favor of technological 
advance. Yet that is not necessarily certain. Many have doubts and reticence with respect 
to the technological advances in the area of cloning, transgenic foods and nuclear 
technology, to cite only some examples. Likewise, in areas related to health, safety, 
telecommunications, transport, and nutrition the products generated by technological 
advance have to pass rigorous approval processes subject to a whole set of legal 
requirements. Therefore, it suffices to invert Martyn's argument to refute it: "If we are 
not even unreservedly in favor of technological advance, for we are conscious that, left 
to its own dynamic, it can affect other aspects important to our welfare or security, nor 
do we have to be unreservedly in favor of pure free commerce."
     And that is not all. Martyn's argument also fails because it centers exclusively upon
unemployment when in reality there is a much broader gamut of social and economic effects,
not necessarily desirable, that can be associated with rapid commercial liberalization. A 
very good example of this is the case of Chile where, during the dictatorship of Pinochet,
a very accelerated and indiscriminate opening policy was imposed, moving from an average 
tariff level of 94 percent in 1973 to a universal one of ten percent in 1979. With that 
they demolished not only inefficient enterprises but also enterprises potentially viable 
for industrialization through import substitution. And all that, together with other 
factors, ended by unleashing a tremendous crisis providing evidence of how unmeasured the 
opening policies had been since, by the sole fact of temporarily increasing duties to 20 
percent and 35 percent in 1984, they managed to "revive" some of the firms that had 
     In another aspect, one also must consider the differences between technological 
progress and free trade. For instance, technological progress has practically no limit but
free trade does have one: even if operationally possible, nevertheless there is no sense 
in reducing tariffs below zero percent. Thus, if indeed technological progress can 
ultimately benefit all in the long term (even those temporarily unemployed), pure free 
trade can ultimately affect the same persons time and again. A small farmer or artisan 
with a low academic level and slight economic mobility can find himself negatively 
affected by free trade almost all his life.
     Therefore, we can concur with Dani Rodrik that: "As powerful and elegant as it may 
be, the reasoning presented by Henry Martyn, David Ricardo and others, is not the whole
story. The life of the expert economist in international trade would be quite boring 
were it so. Granted, it may not be as amusing as being Mick Jagger, but I can certify that
dedicating oneself to international economics as a livelihood implies much more than re-
affirming the marvels of comparative advantage day after day. All those who pursue higher 
studies of commerce learn that this is a subject that allows for all kinds of 
subtleties and variants. It is necessary to establish a long list of pre-
requisites to reasonably convince ourselves that free trade improves the global 
welfare of a society. On occasion, less trade can be better than more trade. The 
analogy with technical progress can be misleading in several ways."
     In consequence, it is not that we are pleading for an absolute protectionism, since 
that would be absurd and counterproductive. Rather we advocate intelligent 
management of trade and believe that free-tradism, considered as a dogma, is not 
helpful to this.


     The object of this chapter has been to critically examine the orthodox theory 
concerning free trade. Basically we have seen that:
     1) David Ricardo's idea that free trade would benefit all the nations by virtue of 
comparative advantage does not abide with the fact that, for example, in the trade 
relations of the countries of Latin America (specialized in primary materials) with 
respect to the industrialized nations (specialized in industrial products) a clear 
degeneration of the terms of exchange can be observed, as Singer and Prebish have
shown, because of which they have proposed the IIS model.
     2) As Michael Porter shows, more than in comparative advantages, the key to success 
in trade lies in competitive advantages, which are not given as "endowments" of 
nations but instead have to be developed in those sectors that are most strategic.
     3) The Hecksher-Ohlin model which, united with Samuelson's theorem, predicts that 
free trade will equalize the price of productive factors, not only has unreasonable 
assumptions (such as that nations have the same technology and preferences) yet also is 
contradicted by the empirical evidence such as seen in the so-called Leontief 
     4) As the economist Ha-Joon Chang has demonstrated, the developed nations that so 
often prescribe free trade for the underdeveloped nations got to be developed by applying 
protectionist policies, that is, the opposite of what they preach.
     5) In accord with economist Gunnar Myrdal's hypothesis of circular causality with 
cumulative effects, an unregulated trade relationship between two economically unequal
nations can tend to systematically accentuate the disparities between them.
     6) The globalization process directed from above, instead of creating a single world,
continues to generate two worlds in terms now not of the East-West polarity between
communists and capitalists, but instead of the North-South polarity between rich nations 
with great multinationals and powerful governments, on one hand, and poor nations with 
precarious firms and weak institutionality, on the other.
     7) In practice the purported Free Trade Treaties are a huge swindle for in 
them the most powerful nations ultimately impose the conditions that most suit them. 
However, for orthodox economics questions of geopolitics and power relations are merely
     8) The "best argument for free trade," formulated by the English lawyer Henry Martyn,
is fallacious for it starts from the false premise that we all are unreservedly in 
favor of technological advancement, not considering the relevant social and economic 
consequences which rapid liberalization can bring beyond the concern for unemployment,
and ignores important differences between free trade and technological progress 
with respect to the possibilities of long-term benefits.
     All this constitutes a powerful cumulative case against the orthodox 
postulate of free-tradism. Thus, the orthodox theory of free trade is no more than a myth.
May it rest in peace.

                         Chapter 10
                         THE MYTH OF DEVELOPMENT
                         "Productivity isn't everything, but, in the long 
                               run, it is almost everything."
                                                 Paul Krugman, Nobel prize in 2008
The orthodox theory of development

     In this last chapter we shall analyze the conception held by orthodox economics 
regarding development. This theme is exceedingly important because of all the ideas 
maintained by orthodox economics this is that which has most profoundly influenced
--and still influences--our criteria of political and social choice.
     Without further preambles, we initiate our exposition. The first thing that must be 
said about the orthodox conception of development is that, as much in theory as in 
practice, it ultimately identifies growth with development. In effect, as the 
distinguished economist Jürgen Schuldt says, "the majority of economists still keep 
disseminating the naive belief in the existence of a positive mechanical correlation 
between economic growth and well-being, which should be a truism for all times and 
     The reason the orthodox economists give to justify this positive correlation between 
growth and development is that economic growth always implies an increment in production 
and consumption so therefore, given that utility is a function of the person's 
consumption level, it will cause her welfare to increase. The truth is that that deals 
with a belief that emerged at the end of the 18th century with Bentham's utilitarianism, 
yet has extended to the economists of our day, be it in an explicit or implicit way. Thus,
for example, Richard Easterlin recently has affirmed: I adopt the concepts of welfare,
utility, happiness, life-satisfaction, and well-being as interchangeable."
     In that context the reader will have already noticed which statistical datum is most 
reverenced by the orthodox economists: yes, the famous economic growth index. This 
represents no exaggeration. And indeed, even when one accepts that it has many 
limitations, the majority of economists still believe (though it may be in an implicit 
fashion) that "the rate of increase in income...remains the all but exclusive measure of 
social achievement. This is the modern morality. St. Peter is assumed to ask applicants 
only what they have done to increase the GNP." And in effect: the principal, and often 
only, parameter that is used to evaluate a government's success is how much it has 
grown the Gross National Product. It is secondary whether they have arbitrarily invaded 
other nations or have openly legalized pernicious or immoral things, as long as they have 
caused the GNP to grow.
     In fact, such is the importance given to growth by the orthodox economists that they 
ask all other social objectives and aspirations to be subordinated to it. Even more: only 
by seeking economic growth is it possible to construct a "decent society" for, as Hayek 
said, if it "seems fine to say 'The devil with economics, let's re-make a lovely world!' 
that is, in fact, pure irresponsibility. With our world such as it is, everyone convinced 
that the material conditions should be improved everywhere, our only possibility of 
constructing a lovely world is the power to continue improving the general level of 
     Finally, the last belief associated with the orthodox conception of economic 
development is that of the inevitability of development in all countries. The orthodox 
theorists and technocrats can debate about the different methods and roads toward the 
development of nations yet never doubt its possibility. In that optic the problem of 
underdevelopment is simply a problem of of degree and not of type.
     Even more, it is conceived as a mere situation of "temporal delay" of the 
underdeveloped nations with respect to the developed. "The country that is more developed 
industrially only shows, to the less developed, the image of its own future," even Marx 
would say.
     The clearest illustration of this last point we can find in the different names that 
have been used over the last two centuries to refer to the poor nations. First they were 
called "backward nations," later "underdeveloped nations, then "nations 
on development paths and, finally, "developing nations." In this manner, 
development is conceived as a linear and inevitable process for societies, like a sort of 
racetrack where those now called "developed nations" are those which have passed the sign 
reading "development" (paying the "toll" for economic liberalization, of course) and the 
"underdeveloped nations" are those which still have not passed it yet later or 
sooner--if they stay on the same track--they will come to pass it.

What can be measured and what cannot be measured: the fetishism of the GNP

     In its most general definition of fetish is an object to which extraordinary 
qualities are attributed that in reality it does not have. Now then, that would seem to be
the actual situation of the famous indicator of the Gross National Product (GNP) given 
that, on the one hand economists, politicians and journalists sell it as the exclusive 
measure of social achievement, welfare, happiness, and progress, while on the other, if we
analyze it exhaustively, we shall find that it has various limitations and deficiencies.
     Let us begin with its definition. From the viewpoint of value added the GNP 
can be defined as the total value of the final goods and services produced within a 
country during a year. Already one can find various deficiencies here. In the first place 
we note it only speaks of quantities and not of qualities. In this mode, if 
in an economy many more goods are produced yet of low quality, the GNP will increase at 
the same time that social welfare diminishes!
     Also, it does not take qualities into account, namely, the nature of the 
goods and services produced; given that one can increase the GNP by producing more arms, 
drugs, pornography, and other superfluous goods! (And this without mentioning the 
opportunity cost that that will mean for the production of textbooks, basic 
medicines at low cost, services for healthy amusement, and other necessary goods.)
     Even less does it take into account the value of leisure. Yet it well may 
happen that a society decides to work less in order to enjoy more free time resulting in 
this way in a lesser GNP without that necessarily implying a diminution of its welfare.
     And not only that. By considering solely the production within a nation the 
GNP does not take into account the flow of factors and receipts with the exterior, since 
if a group of United States companies establish themselves in an African nation and 
commence to exploit the African workers to fill the pockets of their United
States investors the GNP of the African nation would increase instead of diminishing!
     We now pass to considering the GNP from the expenditure side. In accord with this 
focus the GNP is constituted as the sum of expenditures for personal consumption of goods 
and services (C), gross private internal investment (I), government expenditures (G), and 
net exports of goods and services, that is, exports minus imports (X - N). Several 
limitations and deficiencies are found here too. For example, it does not discriminate 
between different types of expenditures. People do not eat machines (investment) nor gold 
(exports) and it could well occur that the greatest part of the GNP increase in a certain 
year is due to the expansion of exports and/ or private investment without the level of 
private consumption to have varied, which is what is found most directly related to the 
well-being of the people.
     We also shall examine the GNP from the side of incomes or costs. According to 
this perspective the GNP is comprised of the total revenue that are the costs (salaries, 
benefits, interest, rents) of producing the consumption goods. The first great deficiency 
we find is that the problem of distribution is not taken into account. It cannot be said 
that the GNP represents a good measure of social welfare is 20 percent of the population 
concentrate 80 percent of the wealth and the other 80 percent only have the remaining 20 
     Yet this is not the only important omission. The GNP on the costs side does not 
account for the environment costs of production. But production almost always implies 
environmental costs! So then, whoever said the GNP meant "Gross National Pollution" was 
not so farfetched.
     And it also omits the phenomenon of self-consumption, which is very relevant not 
only in rural economies. As Reinart says: "If the world is a scenario where everyone 
should play her part, we are all--in an economic sense--playing two different roles: that 
of producer and that of consumer... What counts as GNP is limited to the production 
where those two roles are 'separated,' where the producer is not the consumer. The 
economics profession has abdicated the study of the situations where the roles of consumer
and of producer are played by the same person. These cases of domestic economy have been 
left to anthropological economics."
     We see, then, that the "GNP god" does not have all the marvelous blessings attributed
to it by the priests of economic orthodoxy. And indeed, as Dornbusch and Fischer said, 
despite that "the economists and politicians speak as if an increment in real GNP would 
mean that the people live better" we should be conscious that "the GNP data are far from 
being perfect measures, of production as well as of welfare." Therefore, the famous
GNP is no more than a fetish, an idol with feet of clay, with no reason to keep adoring 

The obsession with development: the error of the absence of choice

     It is not difficult to understand why we speak here of an "obsession with 
development." In effect: our societies have become addicts of growth. To put in 
doubt that 5 percent growth is better than one of 3 percent is something which 
border on blasphemy. It would be like doubting that 5 is greater than 3! Therefore,
the panacea must be defended with a fervor and devotion that annuls all doubt because, 
what other alternative can be conceived to that of economic development? We have here the 
proclamation of orthodox faith.
     But do not believe that this concerns a purely theoretical point. Few orthodox ideas 
are so present in the social imagination. We live constantly hypnotized by the slogans of 
growth, efficiency and productivity, which are always the order of the day 
in the communication media and political discourse. It is not strange, then, that we hear 
the politicians tell us in their end of year speeches that we have done things well, that 
we have grown, and later, in their speeches at the start of the next year, that we 
have to work more than ever to grow to a higher level if we want to fulfill "our role in 
the world" and not be left behind by the other nations since development is a path of 
"blood, sweat and tears" (Winston Churchill) and we should pursue it if we hope someday to
arrive in the "Promised Land of Welfare."
     Nevertheless, as the distinguished English economist E. J. Mishan has well noted in 
his work The Costs of Economic Development, "this is circular reasoning that seems 
to open few alternatives for choice. It is as if we were trapped in gears, having to force
ourselves ever more if we wish 'not to lag in the race,' or even simply subsist. Yet, to 
tell the truth, no economic justification exists for such beliefs. In any event, 
we should be ashamed that our patriots have hypnotized us for so many years with their 
inexorable mentality."
     It is clear, then, that the great problem of the "developmentalist" mentality of 
orthodox economics is that it leaves us few alternative choices. We are not "free to 
choose" as Friedman professed. Economic growth has become the new categorical 
imperative of global civilization and there is no alternative to it.
     Yet...can it be true that we have no alternative? We think not. We can grow less in 
order to enjoy more. We can give priority to aesthetic goals instead of to economic. We 
can have fewer private goods and more public goods. We can produce fewer superfluous 
goods so as to enjoy more free time. We can produce fewer industrial goods and conserve 
our forests. We can reduce the competitive struggle and opt for an easier and more 
restful life.
     Alternatives like these, and also many more others, could perfectly well be put 
into practice and even increase our welfare were it not that the fascination with the 
indices of growth keep our attention diverted from those broader goals of policy. 
Accustomed to value things in terms of wealth and not of well-being, we do not contemplate
the alternatives open to us and, what is worse, we keep nourishing an economic model which
seeks growth per se without concern for the goals it pursues. In this mode, we are 
in the situation of the idiot who dares to drive her car at night without turning on the 
headlights nor looking in the direction she is going. Thus, it is not strange that a 
disaster is going to happen.

I'm rich! Yet why am I not more happy? The "paradox of happiness"

     As we have seen, the main argument of the orthodox economists for establishing a 
mechanical and positive correlation between growth and development is that, given the 
utility principle, every increase in the levels of production, consumption and 
wealth of the societies will invariably provide an increase in the level of the 
individuals' welfare which is assumed to be like happiness.
     However, heretics who question this sacrosanct belief have not been lacking. Thus we 
have, for example, the British economist Richard Layard who performed a statistical 
comparison between the GNP per inhabitant and the average happiness in the United States 
during the period 1946-1991, arriving at the curious result that despite the tripling of 
income, the self-perceived welfare index remained practically motionless, even 
falling from 2.35 to 2.2.
     Likewise, in 2014 an infographical document was published on the "happiness index" 
throughout the world. Beyond there being some degree of arbitrariness in this index (as 
necessarily occurs due to the subjective factor) a very clear and significant 
referential pattern is found: the richest countries are not necessarily the happiest. 
In fact, the three happiest nations in the world, according to this index, are: Costa 
Rica, Vietnam and Colombia (in that order). Evidently it does not need great economic 
powers. What happens with the economically most powerful nations? The United States 
appears at number 105 for happiness, China at the 60th position and Germany at number 46.
     Yet what is the reason for such a strange paradox? Is it perhaps not true there is 
greater happiness at greater levels of consumption and wealth? Curiously it is the same 
economics which offers some interesting arguments for elucidating this "paradox." Let us 
see the main ones:
     1) The hypothesis of relative income: This theory more or less proposes that, 
if such a choice were possible, an individual would prefer, let us say, a 50 percent 
increase in her income without anyone else getting a 100 percent increase among the 
persons around including her. Obviously this concerns an hypothesis and not a universal
law, yet it has high explicative power for the conduct of individuals and, under certain 
restrictions, is very difficult to oppose. And indeed, as the North American economist 
Thorstein Veblen has studied in detail in his Theory of the Leisure Class (1899) 
in analyzing the concepts of "pecuniary emulation" and "conspicuous consumption," the 
welfare that consumption goods give up depends not only upon the individual utility which 
they provide us but also (and often, principally) on the image or social prestige 
that they offer with respect to the other persons in our surrounding. The implication of 
this is that the level of welfare for individuals will not increase as much as awaited 
because, upon the average level of life rising, it will result that the initial 
individual welfare increase in their absolute income will be counteracted by 
considerations of relative income. For instance, if our boss doubles our salary 
but, leaving the office, we learn that he has quintupled the salary of all our companions,
will our level of welfare remain unaltered?
     2) The thesis of "hedonic adaptation": According to this thesis, when 
individuals attain higher levels of consumption and wealth they rapidly adapt to their 
circumstances, returning to their initial state of satisfaction (or dissatisfaction?) 
Think for example of an individual who wins the lottery. He goes crazy, leaps, calls all 
his friends, holds a super-party. What before he only dreamt of now is made reality: 
houses, autos, trips, restaurants, hotels... Yet with time he becomes accustomed to it. 
Little by little everything returns to normal and nothing special now, such 
that that lifestyle fascinates him ever less even coming to seem heavy and boring. Think 
also of the offspring of this "fortunate" man who, given his new level of wealth, he can 
afford the luxury of satisfying all their whims. His little son continually asks him for 
the toy of the day he has seen on television and his adolescent daughter, brand name 
clothing...yet for the New Year now he pays them no attention. This is "hedonic 
adaptation": we rapidly adapt to new situations.
     3)  The theory of the "satisfaction threshold": According to this proposal 
once an individual reaches a certain level of income or consumption, her satisfaction no 
longer increases. In economic terms, to the extent that her income and consumption attain 
the so-called "comfort point," the marginal utility obtained from them tends towards zero.
One could say it is a particular application of the "paradox of value" discussed by Adam 
Smith, given that the marginal utility of consuming another good in a situation of 
opulence is almost nil. And indeed to the degree that our income increases we tend to 
consume ever more superfluous goods that we really do not need and, by accustoming us to 
that lifestyle, obtaining them finds us almost indifferent. To illustrate this with a 
simple example: imagine the value of finding a dollar experienced by an indigent who has 
not eaten for two days and that it would have for a multi-millionaire. The first would 
obtain a great increase in his utility level, the second perhaps not even bending over to 
recover the bill.
     4) The phenomenon of the "expansion of necessities": Following this argument, 
to the extent that levels of individuals' income and consumption increase, their needs 
will also increase when, paradoxically, their unsatisfied needs tend to grow instead of
diminishing. In this manner, following what Plato said that "poverty does not arise 
through the diminishment of wealth, but instead through the multiplication of desires," we
find that economic growth, at least that arising in "developed" nations, will tend to 
increase poverty instead of reducing it! And in effect, as much in the United States 
as in Europe--especially in the so-called "Welfare States"--the population is experiencing
ever more "misery of wealth." People seek to be happy consuming ever more and more goods 
and for that reason tend to create more necessities and, in consequence, to feel more 
dissatisfied. To illustrate it with an analogy we might say the situation exists of the 
thirsty man who seeks to relieve his thirst drinking salt water. The more that he drinks, 
the more thirst he will have! And the same occurs with technological products: we seek to 
be happy getting the most sophisticated mobile telephone, dedicated a large part of our 
income to do so and, when we achieve it, the next month or week another more sophisticated
appears and we return to being dissatisfied until we can possess it. And thus the 
vicious circle continues of buying for satisfaction, returning to being 
dissatisfied, buying anew to do away with that dissatisfaction...and so on successively: 
the chain between the man and the consumption expands towards infinity or, to be more 
precise, "until mortality separates them."
     5)  The argument from relational goods: According to this argument to be 
richer will not necessarily make us happier because to the extent that our income 
increases, or precisely because we endeavor to always have more, our consumption is 
reduced of the so-called "relational goods," that is to say, the relationships with the 
persons in our environment, especially our spouse, children and friends. Yet the most 
tragic is that this reduction in the consumption of "relational goods" not only occurs as 
a consequence of our ambition but also because of "inevitable" technological development. 
And indeed every step towards technical progress transforms our dependence upon other 
human beings into dependence on the machines. "The devaluation of the human world grows in
direct relation to the valorization of the world of things," Marx had consistently said. 
And in effect: what better demonstration of that than the time we spend with the computer,
the television and the cellular in place of a direct and personal relation 
to our family and friends.

Persons or merchandise? The personalist critique of the orthodox theory of 

     As the alert reader will already have noticed, the orthodox theory has a wholly 
materialist conception of development. It does not see it as a question of people but 
instead above all of merchandise and, if it does consider persons, only does so as 
producers or consumers of merchandise (here we have the implicit anthropology of the 
utility principle). In this line of thought one is considered as a means and not
as an end.
     Perhaps no one has expressed it with greater eloquence than Saint Simon in his famous
"parable of the drones." According to this, if someday France were to lose 3,000 of its 
most distinguished men of science and agricultural, manufacturing and commercial industry,
it would be transformed into a soulless body and would find itself immediately surpassed 
by other nations. If, on the contrary, it were to keep them but simultaneously lose 30,000 
of its men considered the most important: public functionaries, men of law, priests, 
philosophers, et cetera, that would not constitute any damage for the nation since even so
it would preserve its position among the civilized nations. Therefore, each person is 
valued only according to their productivity ("what you produce, what you are worth") and 
man is nothing more than raw material which must be introduced into the economic machine 
with the goal of augmenting the National Product and, someday, arriving at the desired 
     Against this type of mentality the personalist conception of development 
raises its voice. According to this focus development deals above all with a question 
of persons, not of merchandise; man must always be in the center and can never be 
treated as a means but instead is more constituted as the ultimate goal and principle of 
development, not only as a consumer but instead in every personal dimension: economic, 
political, ethical, cultural, and spiritual. It follows that in this conception education 
has a central role. Yet not a technocratic education destined only for 
accumulation of "human capital" as orthodox economics advocates in the current 
context of globalization, but instead more a humanistic education destined to 
construct that "whole man" of whom the great economist Ernst Schumacher spoke.
     Yet maybe the most important representative of what we have called the "personalist 
conception of development" is Amartya Sen, the Indian economist and winner of the Nobel 
prize in 1998 for his work on world hunger. According to Sen, development is constituted 
primarily "as a process of expansion of the real freedoms that individuals enjoy." In that
context, "the growth of the GNP or of personal incomes can be, of course, a very important
means for expanding the freedoms which the members of society enjoy. But--Sen 
continues--the freedoms depend also on other determinants, such as the social and economic
institutions (for example, educational and medical care services), as well as on 
political and human rights (among them, the freedom to participate in debates and public 
     Therefore, these factors should not be treated as "exogenous" components of 
development but instead more as its constitutive components, and their importance 
should be evaluated as a function of their capacity to augment people's freedom and not 
only in terms of their contribution to the GNP. So then Sen says that: "There is a great 
difference between means and ends. The recognition of the role which human qualities play 
as a motor of economic growth does not tell us the reason for that. If, in the last 
analysis, the goal were to propagate human freedom to live a worthy existence, then the 
role of economic growth would consist in providing greater opportunities in that direction
and should include a more basic comprehension of the development process."
     In consequence, the first thing we should ask ourselve when we speak of promoting 
development is whether we have in mind persons or merchandise. And in the event they are 
persons, what persons? Where do they live? How do they live? What do they need? What do 
they think? What capabilities do they have? For what do they hope? When we view 
development as it truly is, as a question of people, there necessarily arise numerous 
questions like those proposed. However, the functionaries at institutions such as the IMF 
and the World Bank are almost not interested in asking those questions and simply proceed 
with their predetermined theories and their econometric models. Yet such is the 
complexity of the real world and we must confront it. Therefore, to shield oneself 
behind abstract mathematical models that take the population into account only as a mere 
quantity to be used as a denominator after the numerator, the amount of available 
merchandise, has been determined (think of the famous growth models of Solow or Ramsey)
is simply and plainly epistemological blindness.

Is the road to heaven paved with bad intentions? Concerning the good, the beautiful, 
the dirty, and the useful

     In the year 1930, in the midst of the worldwide economic Great Depression, one of 
the most influential economists of the past century, John Maynard Keynes took the liberty 
of writing an article about "the economic chances of our grandchildren," in which he came 
to the tremendously optimistic conclusion that the day we would all be rich was not far 
away. Once there, he said, "we shall once more value ends above means and prefer the good 
to the useful... But beware!--he continued--the time for all this is not yet. For at least 
another hundred years we must pretend to ourselves and to every one that fair is foul and 
foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be
our gods for a little longer still. For only they can lead us out of the tunnel of 
economic necessity into daylight."
     Hayek would think the same (he might be the author who most differs from Keynes, yet 
at least they coincide in their "cult of growth"). For Hayek for whom saying "The devil 
with economics"--that is, our current economic model--to seek the good or the beautiful 
is "pure irresponsibility" given that "our only possibility of constructing a lovely world 
is the power to continue improving the general level of wealth." And how to do that? Well 
easy, with the help of "our gods": avarice, usury and hedging. They and they alone will 
take us from the inferno of poverty and carry us to the paradise of wealth and welfare. 
And once there we shall have time to worry about the good and the beautiful.
     Yet, can it be true that the road to wealth is the road to peace as Keynes and Hayek 
claim? Obviously not. And indeed the actual model of economic growth, at least as we 
experience and conceptualize it, tends by the same dynamic to undermine the necessary 
moral and spiritual conditions for mankind to attain peace and happiness, for how 
could a system based upon excessive ambition, envy and egoism create of society of "good 
and happy men"? How could a "development" model that systematically cultivates and 
justifies all the vices as "rational" constitute the road towards peace? To assume so 
would be like believing the best way to expel demons is to summon Beelzebub, the prince of
     Ernst Schumacher was right, then, when in his very famous (and very 
recommendable) book Small is Beautiful (1973) he wrote that "the hope that the
search for goodness and virtue can be postponed until we have reached universal prosperity 
and that with the individual pursuit of wealth, without troubling our brains about moral 
and spiritual questions, we shall be able to establish peace on earth, is an unreal, 
anti-scientific and irrational hope."
     Does this means that we are against economic development? By no means. It makes no 
sense to oppose economic development per se because it can also comprise a powerful
weapon to liberate mankind from its material and moral poverty, but what yet must be 
opposed is the model of economic progress such as is being carried out in reality 
principally in the nations of the West for it is destroying the essence of man himself. 
It is time to understand that progress for progress' sake, abandonment to the pure dynamic
of economic efficiency, will never bring man peace and prosperity which can only be 
achieved if it is grounded. And this grounding must come from within only
through a profound ethical and social consciousness.
     Therefore, instead of listening to Keynes and to Hayek perhaps we should reflect 
somewhat upon these papal words: "It is not wrong to want to live better; what is wrong 
is a style of life which is presumed to be better when it is directed towards 'having' 
rather than being,' and which wants to have more, not in order to be more but in order 
to spend life in enjoyment as an end in itself. It is therefore necessary to create 
lifestyles in which the quest for truth, beauty, goodness and communion with others for 
the sake of common growth are the factors which determine consumer choices, savings and 

Development for all? The fallacy of universal prosperity

     Just as we had seen at the beginning of the chapter, one of the main orthodox 
beliefs associated with the idea of economic development if that of the 
inevitability of development. In effect: it is thought that all the underdeveloped 
nations are no more than developed nations in potencia and that it is only a matter
of time for them to actualize such potential. Therefore, if they follow the same path
--remember that they are "nations on paths to development"--late or soon the moment
will arrive when all are rich and the Kingdom of Heaven will become real here on earth: we
shall have attained universal prosperity.
     Yet, is this hope justified? Lamentably no. In the first place because there is not 
enough to satisfy the ambitions we have. As Mahatma Gandhi said we have sufficient to 
satisfy the necessities of all mankind but not enough to satisfy each man's 
avarice. We all know of poor nations that do not have enough to survive, yet where 
is the rich nation which says: "Ok enough! We have sufficient"? The reason for this is 
that, as Galbraith observed, "to the extent that a society becomes ever more opulent, 
ever more necessities are being created by the same process which satisfies them." In 
this mode, our growth model by being based upon the dynamic of production of 
necessities has no internal criterion of self-limitation, and therefore is absolutely 
incapable of determing how much is sufficient.
     And this takes us to the second great problem that frustrates the hope for universal 
prosperity: the ecological problem. As Meadows had correctly noted--and what the 
orthodox development economists so often forget--growth has ecological limits. In 
effect: there cannot be infinite growth in a finite world. If we continue with our 
same patterns of production and consumption we shall inevitably end by preying on the 
planet. Even more, it seems significant that the World Wide Fund for Nature has projected 
that by the year 2030 we will need two planets to cover our demand for resources! It is 
evident, then, that our production and consumption patterns are ecologically 
     If there still remains some skeptic we propose that they perform a simple mental 
exercise. Think for a moment that all the nations achieve development, that all are rich. 
Now think that all the Africans begin to consume as much as in the United States 
(one billion Africans versus 300 million in the United States), that all Indians begin to 
use as much electricity as the Norwegians (1.2 billion Indians versus five million 
Norwegians), that all South Americans begin to consume as much fuel as the English 
(300 million South Americans versus 55 million English)... Could the planet Earth 
support all that? Obviously not.
     Ricardo Paredes Vassallo expresses it in rough terms: "Now open your eyes and 
think. Think only of what would happen to the world when a third of the population became 
rich, not as rich as you, but medium rich like the Japanese or Norwegians. Well, they 
consume in a month (according to the painful world statistics) more nutrients than the 
entire population of the African continent consumes in a year (120 million Japanese versus
900 million Africans). Now so happens that this wealth put into the mind 
(illusorily) or on the scales, would be neither shocking nor critical; on the contrary 
serious, as always, the object of magnetism and desire for all (is there anyone who does 
not want to be rich?) Yet, put into play and in the hands of those men themselves, this
wealth will constitute the complete massacre of the planet. That is the point.

Only a question of time? "Schumpeterian underdevelopment" and dependency theory

     Let us continue with our critical analysis of the orthodox idea that "it is only a 
question of time" for all nations to become developed. One of the most common arguments 
given to justify this is that of technological progress: technology will cause the 
productive capacity of all the nations to grow and, at length, all will come to be highly 
productive, thus attaining the desired development.
     The problem with such an affirmation is that it starts from the assumption that 
technological progress is an orderly process whose effects are diffused in a symmetrical 
and generalized fashion. Behind this is, evidently, one of the most basic notions of 
orthodox economics: the production possibilities frontier. However, technological 
progress does not behave like a pretty expanding concave curve but instead like a 
disordered diagram of dispersion which is diffused in an asymmetric and oblique mode. 
There are certain sectors and activities where technology is much developed, and others 
developed little or practically not at all. And this is what results in what Erick Reinert 
has called Schumpeterian underdevelopment, which is, when international economic 
structuring yields poor nations specializing in those forms of production where slight
technological development has arrived, so perpetuating their backward position.
     We find a very good example of this in the case of Haiti. According to Reinert's 
reference, Haiti dominates the world market in one manufactured product: baseball balls, 
produced principally for the United States market. It represents an instance of 
"Schumpeterian underdevelopment." It so happens that high technology, which is applied to 
the production of golf balls, has not yet reached the production of baseballs, that have 
to be sewn by hand even if fabricated in the United States. The consequence? The 
following: "The most efficient producers of golf balls in the world are localized in 
industrialized nations and experience a normal wage of nine dollars per hour. The most 
efficient producers of baseballs in the world are in Haiti and work ten hours a day for
a wage of 30 U.S. cents per hour. The wage ratio between these two groups of workers, both
in the same industry and both the most efficient in the world, is practically 30 to 
one... When Haiti sells baseballs to the United States and buys golf balls at the 
same time, an hour of labor in the United States is exchanged for 30 hours in Haiti. 
This is so despite the sewers of United States baseballs not being more efficient than the
Haitians. These are effects of "unequal exchange" with "Schumpeterian 
     Yet there is also another theoretic framework to comprehend this, and it is offered 
to us as the theory of dependency. According to this focus, initiated by Latin 
American economists from the most radical line emerging from Cepalian structuralism, 
relations between nations should be conceptualized in terms of domination, in a 
schema where the rich nations are the dominant and the poor nations are the 
dominated. We undoubtedly deal with a somewhat simplistic vision, yet it should in 
no way be disdained for it signals some very important things that the other schemes 
simply do not see. Whether in a correct or mistaken way, this focus approaches power
relations in a direct fashion and the way that they structure the world economy. And 
indeed for the great supranational economic interests the idea cannot be very 
attractive that all the nations will become prosperous "Welfare States" with broad 
social rights and solid institutionality because, if it were so, where would a cheap 
workforce and raw materials be obtained? It is necessary, then, to ensure that 
nations exists which remain poor.
     One of the most interesting testimonies in this regard is that of John Perkins, 
author of the book Confessions of an Economic Hit Man, where he ways that: "The 
economic gangsters (EHM) are generously paid professionals who swindle billions of 
dollars in countries around the world. They channel money from the World Bank, from 
the Agency for International Development (USAID) and from other international "aid" 
organizations toward the treasuries of the great corporations and the pockets of a 
handful of rich families who control the natural resources of the planet. Among their 
instruments figure fraudulent financial statements, sham elections, bribes, sexual traps, 
and assassination. The game is as old as empire, yet it acquires new and terrifying 
dimensions in our era of globalization. I know that well, because I have been 
an economic gangster." The fundamental labor of an "economic hit man" is, therefore, "to 
promote the indebtedness of the poor nations in order to tie them to the global empire." 
This does not seem very consistent with the "happy world of development for all" that the 
neoliberals promise us...

Predestined enemies: orthodox theory and underdeveloped nations

     Now, to close our critique of orthodox economics with a gold clasp we shall examine 
its relation to the underdeveloped nations. Already from the first analysis it becomes 
clear that this relationship is not benevolent in any way.
     Let us begin with an innocent question (well, in reality not so innocent): where does
the orthodox economic theory come from: from the developed nations or from the under-
developed nations? The answer is obvious. It suffices to ascertain the nationalities of 
the main orthodox economists: Adam Smith (Scottish); David Ricardo, John Stuart Mill and 
Alfred Marshall (English); León Walras (French); Milton Friedman, Paul Samuelson and
Gary Becker (United States)... It is not strange, then, that around 80 percent of the 
Nobel prizes in Economics are awarded to United States or English economists, and this 
without considering that a large part of those who comprise the remaining 20 percent are 
associated with universities in those nations.
     But what is the problem with that? A big problem to tell the truth. It is that, as 
the developed nations evolve, orthodox economic theory does not take into account many of 
the conditions that not only are peculiar to the underveloped nations but also are 
principally responsible for their underdevelopment and for the difficulties which they 
encounter by attempting to develop. For example, it abstracts from the level of 
technological development (which is tremendously high in the developed nations and 
terribly low in the underdeveloped), the size of the population (which in the 
developed nations tends to be low, while the majority of the underdeveloped nations tend 
to be overpopulated) and the institutional conditions (which in the developed 
nations are very good, for they initiated their capitalism already having had consolidated
their Nation-States, while in the underdeveloped nations these are precarious and 
incipient, since the majority of them have recently obtained their political independence 
from the developed nations themselves and, no small matter, they were impelled into 
capitalism before they could constitute coherently as more than de facto 
     Are we saying with that that the orthodox economists are not interested in the 
situation of the underdeveloped nations? No, we do not go that far. Yet what we do say, 
and we say it very clearly, is that the orthodox theory simply does not take the  
situation of the underdeveloped nations sufficiently into account. And not only that. 
When it is applied to them as a panacea to achieve development, most of the time it ends 
by obstructing and even impeding it. And indeed the orthodox theory has not even served
for development of the now so-called "developed nations." Does one perhaps think that 
the United States has developed with atomistic enterprises that freely compete among 
themselves, with zero State intervention and pure free trade? Completely to the contrary! 
That developed (assuming we can designate that as development) by means of 
oligopolistic and monopolistic market structures, important State 
intervention and constant administration of trade. Nothing do do with that 
which economists say in their textboks, textbooks used to educate the economists of the
underdeveloped nations.
     Therefore, it becomes evident that orthodox theory and underdeveloped nations are 
"natural enemies." In consequence, the first step for their material 
liberation is their mental liberation. It is in that direction that we have 
sought to realize our contribution.


     The object of this chapter has been to critically examine the orthodox theory of 
development. Basically we have seen that:
     1) To focus so much upon GNP as a measure of development is to fall into an absurd
fetishism for there are many highly relevant aspects that do not consider this 
indicator, as are the relationships of quality and quantity to goods, and leisure, equity,
the environment, and unpaid consumption.
     2) The obsession with development leads us to the error of the absence of 
choice when in reality, as the economist E. J. Mishan has indicated, many alternatives
open for us which most of the time are not even contemplated if unilaterally centered upon
the goal of growth.
     3) Clear evidence exists that greater wealth does not necessarily lead to greater 
happiness, which is explained by the relative income hypothesis, the hedonic 
adaptation thesis, the theory of satisficing, the phenomenon of the 
expansion of necessities, and the argument from relational goods.
     4) The orthodox conception of development is centered almost exclusively upon 
commodities and even considers the individual not as a person but instead only as a 
consumer ("level of utility") or producer ("human capital"). Thus, a personalist 
conception of development like that proposed by Amartya Sen with his development 
theory as the "expansion of freedoms" becomes much more pertinent.
     5) To propose that to achieve development we should continue resorting to a system 
based on greed and egotism, and only later concern ourselves with the beautiful and the 
good, is an openly irrational idea because "development" constructed on this model 
will end by destroying the moral and spiritual bases from which an authentically decent 
and human society could be constructed.
      6) The idea of "universal prosperity" is a great fallacy for if indeed nations are 
found in the world without enough not one can be found that says it already has enough, 
and that presents us with the ecological limits of growth.
     7) Technological progress does not in itself mean development for every nation for 
by the same dynamic it also generates Schumpeterian underdevelopment where the poor
nations are "assigned" the technologically backward productive activities. Furthermore, 
dependency theory shows us that the power relations of globalization itself require
the existence of underdeveloped nations.
     8) Orthodox theory and underdeveloped nations are practically natural enemies 
since the orthodox theory is generated out of the developed nations in a manner that 
excludes or does not take sufficiently into account those crucial factors that affect the 
economy of the poor nations.
     All this constitutes a powerful cumulative case against the Neo-classical 
focus for economic development. Therefore, the orthodox theory of development is no more 
than a myth. May it rest in peace.

                                         "What is to be done?"
                                   Toward a new economic theory

     And now what shall we do? This is the pressing question that comes to mind after 
having read so many critiques. And also it is the open mode of positing the question 
which, so formulated, creates space for analysis, discussion and reflection. Elsewhere, 
that obfuscated orthodoxy whose "sacrosanct" doctrine this "heretic" is attacking, which
represents its precious "intellectual capital," will broach the question in the closed 
mode: "and what do you propose?" they will say. Translating, this means: "If right 
now you do not have a completely structured and formalized theory with which to replace 
the Neo-classical theory, I do not have to consider your criticisms for they are purely 
destructive and do not propose anything constructive. If you are not going to give us a
solution, better to remain silent and leave us alone with the theories that we have."
     Well, to such a type of "questioning" various replies can be given. In the first 
place, to indicate that it does not even reach being a questioning. Even if the author of 
a series of criticisms of a certain theory is an absolute incompetent who makes no 
proposal nor approach, that does not at all diminish the validity and force of the 
posited critique. The questionings are there and one must interact with them. To seek 
facile exits in order not to have to confront all that is another demonstration more of 
fanaticism and/ or emotional addiction with respect to the orthodoxy ("I have spent years 
studying and working with this!") than of rational compromise in the search for truth.
     Similarly, one would have to tell her that to refuse to examine a set of problems 
simply because one has no "solution" in advance is an absolutely irrational attitude since
it is precisely because we need solutions that we first should pose the problems! In fact,
as great scientists such as Einstein or Henri Poincaré have repeatedly said, a 
large part of the solution lies precisely in the correct approach to the problems. 
Thus, the sole fact of contributing the correct delineation already is in itself a very 
important approach with respect to solutions and to attempt to minimize this could perhaps
be due to one not wanting to see the problems. And, possibly, it is for that that 
one does "better to remain silent."
     In the 2d place, to immediately demand "a completely structured and formalized 
theory to replace the Neo-classical theory" is a demonstration that the basic problem has 
not been understood. The economy is a very complex phenomenon and cannot nor should 
not be enclosed by predetermined "recipes." Were this book to posit that sort of 
deterministic recipes it would be falling into the same vice as orthodox economics. And, 
in fact, there already was a heterodoxy which fell into that formerly: Marxism. 
Effectively, though indeed it was a critique of capitalism and the dominant economic 
theory of his time, Marx encapsulated all the unfolding of the economy, and even all of 
history, in his schema of dialectical materialism and ended being refuted by the facts. 
This book, therefore, does not come to give "recipes" but instead critical elements for 
reflection. In this sense, the requirement that one sole mind give all the solutions 
becomes totally impertinent. It is more as a group and with with approach of many minds 
that the solutions will be constructed. Solutions which, in turn, will have to be 
constantly questioned and renovated so as not to be refuted by the facts. By frontally 
challenging the dominion of orthodoxy a space for precisely that is opening.
     Yet, is it true that absolutely the whole book is only "destructive" and does not 
give the most minimal element of input? The reader who thinks that has a very serious 
problem of reading comprehension. If indeed the emphasis of the book is the critique 
of the orthodox theory, this critique is not performed with a "destructive irrationality" 
as if one were throwing a rock upon the orthodox theory is the clearest cave-dweller 
style. No. The questionings have been performed from a specific intellectual and 
epistemological perspective and, therefore, in their development various elements may be 
found starting from which the alternative and solutions could be constructed. More than 
that: throughout the work we have mentioned and briefly explicated the approaches of 
practically all the heterodox paradigms that comprise important alternatives confronting 
the Neo-classical orthodoxy on various topics. Keynesianism, Neo-Keynesianism, Post-
Keynesianism, Marxism, Institutionalism, Austrian School, Structuralism, Focus on 
Dependency, Regulationism, Behavioral Economics, Neuro-economics, Experimental Economics,
Ecological Focus, Neo-Schumpeterian Economics, etc. We have named more than ten consistent
alternative paradigms, yet even so almost all the space in the teaching of the "pure and 
hard" theory is given to orthodox economics and the little space left is given, in large 
part, only to "alternative" paradigms consistent with the neoliberal agenda such as 
Monetarism, New Classical Macroeconomics and Neo-institutionalism. Yet, as we have shown, 
this is completely deficient and therefore does not justify the epistemological quasi-
monopoly which it flaunts.
     But there is not only the question of the need to incorporate more actively and 
decidedly the approaches of other paradigms and research programs, but also the question 
of the necessity for a multi-disciplinary approach to the economy. And indeed there exists
no such thing as "chemically pure" economic phenomena but instead they are always and
necessarily involved in the broad framework of "social phenomena" and, in 
consequence, to understand the economy well one must do so also from the 
perspective of other human and social disciplines like Sociology, Anthropology, 
Psychology, History, Law, Political science, etc. Orthodox economics, on the other hand, 
excuses the economist from this indispensable intellectual task saying from the same 
methodological starting point that all those are "exogenous" factors (which is to say 
in practice, "exogenous" factors to which the economist, "as such," need not assign 
     Still more: it is not enough to attribute those items to the multi-paradigmatic, 
multi-disciplinary character of the study of the economy but instead it becomes imperative
to re-think the transdisciplinary  question, that is, the philosophic fundamentals 
themselves which have been developing economic theory. The ontological materialism, the 
instrumentalist epistemology, the utilitarian ethics, the individualistic anthropology, 
the subjectivist axiology: all this has to be profoundly questioned and re-evaluated. 
Perhaps the economics students (and professors) are not conscious of all these 
aspects since most of the time these are implicit and not explicit, which causes one not 
even to notice their prejudicial effect.
     In sum, we have to move towards a new economic theory. We have to broadly 
incorporate the approaches of other paradigms, interact constantly with other social 
sciences and profoundly evaluate our philosophic presuppositions. Which is a very 
difficult task? Well yes, but there is no reason for continual construction of a truly 
scientific vision (and not only a mathematicized substitute for it) to be an easy task. 
The road to knowledge is a very arduous road, even more so when it deals with such a 
complex phenomenon as the economy.
     However, surely there will be some enchanted with the orthodox theory who, like the 
Grand Inquisitor to Jesus in Dostoevsky's work, will say "Why, then, art Thou come to 
hinder us?" Yet it is necessary for this "heretic" to importune orthodox theory because 
this theory, when attempted to be put in practice, ends by "importuning" and even directly
injuring that which should matter most to every economist: flesh and blood persons 
with their dreams, expectations, opportunities, frustrations, and difficulties. We need to
construct a new theory with a broader and deeper humanist vision, a new economic theory 
which helps us cement a better economic reality, especially so that the poorest can have 
a better situation and greater opportunities. In this regard, the great Spanish heterodox 
economist José Luis Sampedro would say: "There are only two classes of economists:
those who work to make the rich richer and those who work to make the poor less poor." One
selects which sort of economist they wish to be. In any event, this book starts from a
decision and also seeks to incentivize action in that sense. And indeed, as we had 
already said at its beginning, there is no struggle more important than the struggle 
for a better world.
     In that context, I make my own what my father (who came to be Technical Adviser to 
the High Command of the Ministry of Labor and Employment Promotion in my country  
reporting to the branch minister in the National Council for Competitiveness, that of 
Labor and the Interministerial Commission on Social Affairs, the fight against poverty) 
pertinently told me, in the sense that to sacrifice our own necessities in favor of 
development from which future generations can profit lacks any existential incentive or 
justification for our condition as rational beings if that enjoyment reduces simply to 
individual material well-being: "What is special about others for me to sacrifice my own 
to propitiate theirs," he said. And he concluded proclaiming that "it would be different 
if the welfare had social implications such as the common good, justice, solidarity, 
commitment, and a true and really inclusive education which, surpassing mere instruction-
capacitation, places knowledge and human development in its real ontological context; all 
these aspects being genuinely transcendent, lasting and sustainable that do contribute to 
a better world and to authentic happiness.
     Meanwhile, with respect to the creators, defenders, actors, and receivers (including 
uncritical docents and alumni of Economics and all related) of the still prevailing 
economic theory and with the commitment on my part of giving, through Facebook and 
YouTube, an adequate response to all comments, it suffices to ask oneself what is the true
espistemological and empirical basis of the assumptions in which they happily persist to 
maintain their theory. Likewise, in that context there emerge many questions regarding the
outcome of this book: will blind, comfortable and regresssive orthodoxy apply its familiar
policy of eluding or ignoring in every sense that which is difficult or impossible for 
them to refute? Will they seek to marginalize me as an author acceding to ad 
hominem fallacies such as that I am "young" (read inexpert) and/ or "idealistic" (read
deluded)? Will they gaseously say that I only offer "more of the same" and that the 
objectionable was just the result of such and such a "paper" or study which they only 
affirmed without demonstrating that effectively it had been so? Will they generate complex
and diffuse "solutions" in order to refute that that is questioned? Will they discreetly 
re-fabricate their orthodoxy introducing the minimum changes necessary in order to 
maintain it in force yet insisting upon their unsubstantiated assumptions. We shall soon 
     However, what should remain clear as noon is that the "god of Growth," such as he is 
conceived, is only a "clay idol" whose high priests (the ideologues and orthodox academics
who have created, feed and disseminate their "faith") and disciples (the consultants, 
executives, functionaries, and leaders who carry it or pretend to carry it out in practice
through in reality they do not) remain blindly and even self-interestedly in 
adoring it over and above the principle of the primacy of reality (now 
clearly evidenced).
     Because of all that I invoke the readers of this book, above all the students and 
instructors of Economics and all related, to reflect on its content and not to be simply 
"actors of a role" overwhelmed by those priests and disciples but instead, on the 
contrary, to begin and persist in direct questioning until obtaining, not privately but 
publicly (classes, conferences, ad hoc events) consistent answers concerning what 
is challenged here and not the evasions of "this subject is not in question" or "it is 
exogenous to my concerns" or the gassy "read such and such a paper, book or study about 
it." Only thus can a genuine and profound intellectual change be propitiated which, 
subsequently and without further violence, can make attainment viable for the laudable
and transcendent goals previously mentioned.
     And indeed another world is not only possible but instead also 
necessary, since the prevailing economic model we have is not ecologically 
sustainable nor socially viable nor morally acceptable. In fact, its excluding character 
is resulting in still passive and controllable growing social violence in the developed 
nations (think of movements like the "Indignados," "Anonymous," "Occupy Wall Street" or 
"99 percent against the one percent") yet active and now overflowing in the 
relegated and dispossessed underdeveloped countries (the ever greater delinquency among
their lower social strata and even measures that, specializing in forms or extortion and 
pressure, are affecting even the pro-orthodoxy leaders). The governments and especially 
the businessmen (those who in reality are underpinning the power) should reflect 
deeply about this. And indeed in our current difficult civilizational situation, 
construct a more just, equitable and sustainable world not merely have an "idealistic 
dream": it is the only realistic alternative.