HISTORY OF NEO-CLASSICAL ECONOMIC THOUGHT, CAPITALISM, SOCIALISM, AND KEYNESSIAN

HISTORY OF NEO-CLASSICAL ECONOMIC THOUGHT, CAPITALISM,

SOCIALISM, AND KEYNESSIAN

Daniel Alves

ECON 350 - Classical Economics

June, 2024

Introduction

Neo-classical economic thought emerged from the many weaknesses of radicalism and

conservatism. Radicalism feared the confiscation of private property, while conservatism

was considered contrary to democracy and modernization. Until the first half of the 19th

century, classical economics survived because poverty had not increased and economic

decline had not occurred. Neoclassical economics began to develop and replace classical

economics after classical political economists used the work of Karl Marx to oppose

capitalism and began socializing the thoughts of Adam Smith and David Ricardo. Changes

in the direction of economic thought also arose along with the emergence of a diverse

working class. In addition, the social problems that resulted from industrialization also

created demands for government intervention to improve education, security, public health,

and job security. The laissez-faire policy began to fall into disuse. In 1871, neoclassical

economic theory was developed by three economists namely Carl Menger (1840-1941) from

Austria, W. Stanley Jevons (1835-1882) from England and Leon Walras (1934-1910) from

Switzerland. The three of them developed classical economics that changed the focus of

political economy by no longer focusing on distribution and economic growth. The new

focus was on the behavior of individual consumers and the firms that participated in market

competition.

The capitalist economic system is an economic system that was born and developed in

Europe. This economic system is individualistic in the sense that it gives the widest possible

freedom of individual ownership. The capitalist economic system also seeks to separate

economic life from religious life. So that there is no role for religion in regulating human

economic life. In its course, the capitalist economic system creates a gap between the rich

and the poor. The rich who have a lot of capital become richer, while the poor are

increasingly helpless.

The socialist economic system emerged in the late 18th and early 19th centuries as a

reaction to the economic and social changes brought about by the industrial revolution. The

industrial revolution was indeed a blessing for factory owners at the time, but on the other

hand the workers were getting poorer. In the 1840s, the term communism began to appear to

refer to the militant left wing of socialism. This term is usually referred to the writings of

Etiene Cabet with his theories of public ownership. The term was later used by Karl Marx

and Friedrich Engel to describe movements that defended the class struggle and required the

Revolution to create a society of cooperation.

Keynesianism, or Keynesian economics or Keynes Theory, is an economic theory based on

the ideas of 20th century British economist John Maynard Keynes. It promotes a mixed

economy, in which both the state and the private sector play an important role. The rise of

Keynesianism marked the end of laissez-faire economics, an economic theory based on the

belief that markets and the private sector can run themselves without state intervention.

Theoretical review

The main principle of neo-classical economics is the law of supply and demand, which

states that market prices will reach an equilibrium point, but one of the criticisms of neo-

classical economics is that it tends to ignore the time factor in decision making. Despite its

criticisms, neo-classical economics remains one of the most influential economic theories in

the world. A capitalist economy is a system that emphasizes private ownership of the means

of production and distribution, with the aim of maximizing profits.

In a capitalist system, individuals and businesses are free to pursue their own economic

interests, and the role of government is limited.

The history of capitalism began in the 17th century and remains one of the most popular and

controversial economic systems today. A socialist economy is a system in which the

government controls the means of production and distribution, with the aim of achieving

greater equality and social welfare. In a socialist system, the government plays a central role

in planning and directing economic activity, and private ownership is restricted. Socialist

economics has been associated with various schools of economic thought, including Marxist

economics, neoclassical economics, and institutional economics.

Keynesian economics is a macroeconomic theory that emphasizes the role of government

intervention in stabilizing the economy. According to Keynesian theory, aggregate demand

(total spending in the economy) is not always equal to the productive capacity of the

economy, and it is influenced by a number of factors that sometimes behave erratically and

have an impact on production, employment, and inflation (Mubarok, 2023).

Keynesian economists generally argue that aggregate demand is volatile and unstable, and

that market economies often experience inefficient macroeconomic outcomes, including

recessions when demand is too low and inflation when demand is too high. Keynesian

economics has been redeveloped as New Keynesian economics, becoming part of the

contemporary new neoclassical synthesis, which forms mainstream macroeconomics today.

In short, these four economic theories offer different perspectives on how the economic

system works and how to improve it. Each theory has its strengths and weaknesses, and

economists continue to debate which approach is best suited to address the complex

economic challenges of the modern world (Mubarok & Abadi, 2020).

Research Methods

Using the literature research method with a brief summary of the approach used in

conducting literature research. includes collecting and analyzing papers relevant to the

research topic that has been determined. we search and review existing literature, such as

scientific journals, books, articles, and other sources related to the topic we are researching.

After that, we analyze and organize the information found to identify patterns, trends, or

findings relevant to the research objectives. General methods of literature research provide

an overview of the approaches used in literature research and can help in understanding the

focus and outcomes of our research.

Research Results And Discussion

Research Results

The results of the research conducted by the author are Neo-Classical, Capitalist, Socialist,

and Keynesian Economics are economic systems that have occurred in each period. these

economic systems have their own advantages and disadvantages.

Discussion

History of Neo-Classical Economic Thought

Neo-classical is a term used to define several schools of economic thought that try to

describe the formation of Prices, Production and Income distribution through the Supply

mechanism in a market.

This theory was developed by several economists such as Robert Sollow, Harrod-Domar,

Alfred Marshall and several other economists however, only Robert Sollow, Harrod-Domar

and Alfred Marshall will be discussed where they have their own assumptions such as:

➢

Robert Sollow

The assumption is more focused on the growth in output that will occur from the use of two

main input factors (capital and labor). Capital consists of equipment, buildings, machinery,

raw materials, computers and money. Meanwhile, the technology factor is assumed to be

constant.

➢

Harrod - Domar

The assumption is that additional capital will increase the ability to produce goods and

increase effective demand. According to Domar, investment spending has an influence on

demand and supply. The ability of the society to invest is strongly influenced by the

aggregate purchasing power demand of the society. The willingness to invest is also

determined by the ratio of the growth of one unit of capital input to the increase in

output.(Amin, 2011) Alfred Marshall

One of the famous figures in this Neoclassical economic theory is Alfred Marshal or known

as the "Father of Neoclassical Economics". Alfred Marshall is an economist who through his

book Principles Of Economy (1980), developed ideas about supply and demand, marginal

utility (marginal satisfaction) and production costs in a description that is organized and

related to each other.(Santosa, 2008).

Concepts and Contents of Neo-Classical Theory

This theory is based on marginal utility rather than production or labor costs. In addition,

demand and supply in neo-classical markets must be maximized. In this neo-classical theory

there is such a thing as property rights. Property rights are the right to own, use, control

power. There are two theories in property rights, namely:

 The Positivist theory is that property rights are political. So this property right can be

challenged.

 The theory of property rights is not static, i.e. property rights can change at any time

and evolve.

In this theory there is also externalization, namely third parties or outsiders who are not

involved in an economic process but they are affected by the process. So, the government

must be able to protect these third parties or externalization. Then in neo-classical theory

there are also market failures as in classical theory. The market failure in question is public

goods. That in neo-classics, the market sometimes cannot provide the goods needed so that

they become public goods. In neo-classics there are also terms monopoly and oligopoly.

Monopoly market is a market that has only one good or homogeneous and many people

need it, the producer or company is also only one so they are free to organize everything and

there are no competitors. Meanwhile, an oligopoly market is a market where the goods are

homogeneous, while in the market there are two or more companies selling them.(Hamzah,

2021)

The next school to emerge was the Neoclassical school, also known as "Human Relations

Theory". This theory arose due to dissatisfaction with the classical theory and the theory is a

refinement of the classical theory. This theory emphasizes the "importance of psychological

and social aspects of employees as individuals or work groups".

The more emerging school of thought is described as neoclassical, and simply as the human

relations theory or school. Neoclassical theory was developed on the basis of classical

theory. Neoclassical theory modifies, adds to, and in many ways extends classical theory.

Neoclassical theory emphasizes the importance of psychological and social aspects of

employees as individuals and as part of their work groups (Abadi, 2022).

The neoclassical school does not constitute or originate a pure theory as the classical school

did. Followers of the neoclassical school are those who discuss the weaknesses of the

classical model of organizational behavior, but do not oppose the entire classical theory.

Capitalism System of Economic Thought

Historically, the development of capitalism was part of the individualism movement. This

movement also had an impact in other fields. In the field of religion, this movement led to

reformation. In terms of reasoning, it gave birth to natural science. In public relations, it

gave rise to the social sciences. In the economic field, it gave birth to the capitalism system.

Therefore, the Capitalist civilization is legitimate. It implies that capitalism is a

comprehensive social system, more than just a particular type of economy. This system

developed in England in the 18th century and then spread widely to Northwest Europe and

North America (Ebenstein & Fogelman, 1994: 148).(Tâm et al., 2016)

The history of capitalism cannot be separated from Europe, where capitalism was born and

developed. The year 1648 (the year of the Treaty of Westphalia) is considered the birth of

the modern state system. The treaty ended the war.(Muslim, 2012)

The emergence of capitalism began with emperors and kings in Europe and Russia who used

religion as a tool to extort, persecute and suck the blood of the people. Religious leaders at

that time were used as shields to fulfill their desires. From such conditions, the following led

to a fierce upheaval, which then brought about an awakening for philosophers and

scholars.(Maulidina, 2019)

Until finally the opinion of the majority of philosophers and scholars is more likely to

choose the idea that separates religion from life, which then results in efforts to separate

religion from the state. It was also agreed not to question religion, in terms of whether it was

recognized or rejected, because the problem was that religion had to be separated from life

(An-Nabhani, 1953: 25).

The idea of separating religion from the state is considered a compromise between religious

leaders who want everything to be subject to them (in the name of religion) and philosophers

and scholars who deny the existence of religion and the dominance of religious

leaders.(Piliyanti, 2009).

On the basis of the above worldview, they argue that Human beings alone have the right to

make the rules of their lives. They also require the defense of human freedom, which

consists of freedom of religion, freedom of speech, individual (personal) freedom and

freedom of ownership (property rights). It is from the freedom of property rights that the

capitalist economic system is produced, which is the most prominent thing in this ideology.

Therefore, this ideology is called capitalism, a name taken from the most prominent aspect

of this Ideology (An-Nabhani, 1953: 24).(Tho'in, 2015)

As for the birth of capitalist economics itself, this cannot be separated from Adam Smith, a

prominent thinker in the 18th century who gave birth to economics through his monumental

work "Inquiry into the Nature and Causes of the Wealth of the Nations" in 1776 (Saefuddin,

1992: xvi).

Smith, with his market system, gave rise to unprecedented knowledge of economic behavior

which later became the material for analyzing the formation of an increasingly intact body of

knowledge. His views, thoughts, analysis and theories contained in detail in his book

underlie the birth of an economic system that is still in effect today, namely the capitalist

economic system. Smith's book is actually a picture, a peek and at the same time a

prediction of economic life in his day. With the sharpness and strength of reason, the wealth

of ideas and the confidence of a philosopher of his era, Smith saw behind the symptoms that

became the center of his attention, something that he later called the laws of the market

system. The basis of his analysis is solely objective underlying one's economic actions as he

wrote in his book (Saefuddin, 1992: xvi): "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 interests".

History of Socialism Economic Thought

The socialist economic system is an economic system that is fully regulated by the state. The

socialist economic system is also known as a centralized economic system, because

everything must be regulated by the state and also commanded from the center. The socialist

economic system is an economic system that wants the prosperity of its people and is carried

out evenly so that no more economic oppression occurs. The socialist economic system

developed by Karl Max requires the maximization of the role of the state. The state must

control all sectors of the economy to ensure justice to the people from production,

consumption to redistributing it to workers, so that they also enjoy the results of the

business. The market, in the socialist paradigm, must be guarded so that it does not fall into

the hands of greedy capital owners who monopolize and exploit labor power and then use it

to get the maximum profit. In socialist countries, where the government is generally

authoritarian, the poor cannot act as decisive subjects, but are merely objects for the

implementation of economic activities (Hidayat, 2014).

Socialism is an economic system that gives considerable freedom to everyone to carry out

economic activities but with government intervention. The government enters the economy

to organize the country's economic life and the types of economy that control the lives of

many people are controlled by the state such as water, electricity, telecommunications, and

so on. In a socialism or socialist economic system, the market mechanism in terms of supply

and demand for prices and quantities still applies. The government regulates various things

in the economy to ensure the welfare of the entire community. Socialist Economics is part of

Political Economy. Political Economy is included in the sciences of society. The problem

that is made a problem in a science is very important for scientific work, investigation,

teaching and learning. Socialism emerged in the late 18th and early 19th centuries as a

reaction to the economic and social changes brought about by the industrial revolution. The

industrial revolution was indeed a blessing for factory owners at the time, but on the other

hand the workers were getting poorer. As the idea of a capitalist industrial system spread, so

did the reaction in the form of socialist ideas. Although many previous thinkers had also

expressed ideas similar to socialism, the first thinker to do so was socialism.

Perhaps the most notable socialist was François Noël Babeuf whose thoughts emerged

during the French revolution. He strongly championed the doctrine of class struggle between

capital and labor which was later championed more vigorously by Marxism.

History of Keynesian Economic Thought

Keynesian economics is a macroeconomic theory of total spending in the economy and its

effects on output, employment, and inflation. It was developed by British economist John

Maynard Keynes in the 1930s in an attempt to understand the Great Depression. The central

belief of Keynesian economics is that government intervention can stabilize the economy.

Keynes' theory was the first to sharply separate the study of economic behavior and

individual incentives from the study of broad aggregate variables and constructs. Keynes is

known as a modern economist who raised the issue of investment by the state. As an

economist who based his theory on mercantilist theory, Keynes emphasized all forms of

efforts to stabilize the country's economy on government policies. Keynes stated that the

government, in order to avoid and deal with crises that can strike at any time, needs to make

a form of investment in the form of public facilities (Sajadi, 2019).

However, this is not always successful, because an increase in the value of investment that is

not followed by an increase in the ability to consume as fast as the production process will

also cause an economic crisis. So this needs to be balanced with the ongoing economic

strength in a certain period of time. The relationship between investment and consumption is

described by Keynes in a cyclical economic model where both are rooted in income. On the

other hand, Keynes also tried to explain the flow of government investment which then

moves towards savings. Saving can be referred to as investment when it is associated with

interest. So if savings are sufficient to make an investment, then interest will tend to fall and

can result in a new form of profitable investment. However, if savings cannot meet the

investment requirements, then interest will rise and tend to attract people to save their

money.

On the other hand, Keynes also argued about the importance of a country to be involved in

international economic and trade organizations, such as the International Monetary Fund

(IMF) and the World Bank. For Keynes, this is considered beneficial for the country because

the involvement of a country in these organizations can directly help the economy of the

country concerned if one day it experiences a crisis. Therefore, it is not surprising that

Keynes was also one of the economists who agreed to the establishment of a global

monetary system, the Bretton Woods System. This system then brought major changes to

the conditions and the world economic system.(Tentiyo Suharto et al., 2022)

In addition, Keynes also suggested income policies. This was then linked to the state's

efforts to achieve full employment. It is mentioned by Keynes that this can be done through

changing the status of private companies into a company on behalf of the state. Here it can

be seen that Keynes fully supports the authority of the state and government in regulating

the economy in his country. This change in status is intended so that the state can be more

free in regulating the policies issued by the company so that it can benefit the people as a

whole. It is through this that the state can create full employment. Just like other scientists,

Keynes also received criticism from other economic thinkers. This is related to Keynes'

opinion that inflation is not really a problem in the economic section, but inflation is more

likely to be a problem in the political sphere. Because of this view, Keynes did not really

highlight the issue of inflation as something that needed to be addressed through economic

efforts.

Conclusions

In the history of economic thought, there are several major approaches that have influenced

the development of the world economy. Neo-classical emerged as a continuation of classical

theory that emphasized the role of free markets and competition in regulating the economy.

Capitalism, which is based on neo-classical ideas, makes private ownership and free markets

the main pillars, which allows for significant economic growth, but also creates inequality,

while socialism, on the other hand, emphasizes collective ownership of resources and fairer

distribution. It aims to address the inequalities that arise in capitalism. Keynesianism

emerged as a reaction to the Great Depression and focused on the role of government in

regulating the economy through fiscal and monetary policies to achieve economic stability.

This theory provides the basis for government intervention in response to recessions and

addressing economic instability. In conclusion, neo-classical economic thought, capitalism,

socialism, and Keynesianism have had a significant impact on the development of the world

economic system. Understanding this diversity of views helps us to detail the different

approaches in organizing the economy and addressing the problems that arise. It is important

to continue to study and understand the role of each of these approaches in the context of

global economic development.(Faruq & Mulyanto, 2017)