In an attempt to critique mainstream economics, Adler’s short book focuses on two key pillars of today’s dominant economic theory: 1. Pareto’s efficiency theorem; and 2. The theory of wages. The central question to bear in mind is the implicit assumption that what is good for the rich is also good for the rest of us. How did we get to this point? Was this always the case? What led to this situation? The author does not attempt to provide a complete overview of current economics but rather show that two of its essential principles are not supported by current policies and the historical evidence.
Efficiency and happiness
To critique Pareto’s efficiency theorem and its policy and social implications, Adler uses Bentham’s utilitarian theory. This theory says that happiness in any society is the sum of the happiness of every one of its members – happiness being measured in “utils” (which by the way we do not know how to measure!). In this setup, increasing the happiness of the poor will rise overall happiness, so the redistribution of resources is feasible -and probably required given the way capitalism works.
Instead, Pareto argued that, once maximum efficiency is achieved, it is not possible to increase someone’s happiness without making everybody else less happy. The critical assumption here is that rich and poor people are fundamentally different and thus have dissimilar “utility functions.” The rich therefore enjoy money much more than the poor. The redistribution of say one dollar will thus generate a more significant decrease in their happiness relative to its corresponding increase for that of the poor. What if the rich enjoy the poverty of the poor? Here, the concept of efficiency takes center stage, ignoring many other potential social considerations such as inequality, social exclusion, and overall poverty, among others.
The book provides examples of how Pareto’s theorem has been used to attack food subsidies, health care, rent control schemes, clean air policies, taxation, monopolies, and the provision of overall private and public goods. However, Pareto’s principle has little to say when it comes to policy recommendations since any change in the status quo will inevitably lead to a decrease in overall happiness. But how did we get to this point? No answer to this question can be provided by this theorem.
Wages and employment
The neo-classical theory of wages is criticized using the Classical theory of wages developed in the XVIII/XIX centuries by Smith and Ricardo (no mention of Marx in this book). They mainly showed that wages were determined by the bargaining power that workers have (or have not) vis-a-vis capitalists and that higher salaries did not lead to increase unemployment but instead promoted overall social well being..
But the classical political economists also open the door for neoclassical economists and the development of an alternative theory of wages. Ricardo’s theory of rent introduced the concept of the value of the marginal product (VMP) which, he argued, was not applicable to industry or workers wages. This approach, however, was used by J.B. Clark at the end of the XIX century to develop the theory of the marginal productivity of labor. This theory argues that each worker is paid what she or he produces, a claim that runs against current historical evidence if we look at CEO compensation, service sector salaries or the so-called Big Mac wage index. In the same vein, VMP says that wages above the actual minimum wage will lead to unemployment as firms will fire workers. And this idea has been used to explain the crash of 1929, for example.
Keynes challenge this idea by showing that employment is a function of investment, and thus it does not directly depend on the level of wages. Indeed, falling wages in a recession can actually lead to further declines in investment which in turn will increase unemployment. Keynes suggested that the free market economy does not self-correct on its own (so government intervention is required) and that wages do not depend on VMP as workers do not get what “they are worth” (pg. 169).
To counter Keynes, the theory of sticky wages was developed first by both Friedman and J. Stiglitz. Friedman argued that unemployment is voluntary as workers refuse to work for lower wages. And, in times of crisis, they quit their jobs seeking higher wages in other industries. Workers are thus misinformed and act accordingly. Stiglitz saw workers are “shirkers” by default. To counter this, companies must pay an efficiency wage higher than average so shirkers will have something to lose if fired. But what if all corporations pay the same efficiency wage? In that case, high wage companies must hire fewer workers thus creating unemployment.
In any case, Adler says, the evidence supporting these claims is weak. CEO compensation is an excellent example of how these wage theory does not explain real phenomena.
Adler concludes that “the damage from the teaching of the economist’s theory of wages is far greater than the damage from the teaching of creationism. Yet, the theory of wages is part of economics education in any and all schools, and it continues to without any notice of opposition” (pg. 192).
But how do we address these issues? Adler calls for the replacement of the rule of power with the rule of law, demanding the issuance of new legislation that directly confronts the current status quo where inequality continues to gain steam by the minute.
Adler, Moshe. 2010. Economics for the Rest of us. New York: The New Press. ISBN: 978-1-59558-101-3 (hardcover edition).