“Capitalism” makes a comeback
As Democratic presidential hopefuls find themselves responding to the questions “are you a socialist?” and “are you a capitalist?,” it is useful to remember that for most of the post-War era, the word capitalism was taboo in economics, the discipline whose very role is to provide rigorous analysis of … capitalism. Robert Heilbroner described economics as capitalism’s “explanation system,” but the profession will barely speak the word. Harvard Professor Gregory Mankiw’s textbook, Economics, one of the most popular in universities today, mentions the word “capitalism” just once in its 837 pages, and this in a quote from Eric Schmidt, the CEO of Google/Alphabet.
Despite a post-War “golden age” of capitalism from 1945-1973, and despite a historic triumph over communism in 1989-1991, “capitalism” appeared to be dangerously associated with the 19th century factory system: efficient for sure, but also dirty and exploitative. But today, the word capitalism is not just in use, it is becoming part of everyday parlance. Beyond the questioning of presidential candidates, a number of recent books by major publishers include the word in the title, and the most recent Michael Moore film is sarcastically titled “Capitalism: A Love Story.” Even a multi-billionaire hedge fund manager and philanthropist challenges his community in finance and decries publicly “Why and how capitalism needs to be reformed.”
“Capitalism” has reappeared in our lexicon now, ten years after the financial crisis because capitalism is in trouble, being questioned by the public. The re-emergence of “capitalism” has come, paradoxically perhaps, at a moment of deep concern about the relevance of economics and its ability to explain recent history.
The current global wave of populism is a lagged response to the financial and economic collapse of the late 2000’s. Economists largely missed the warning signs of the crisis and the significance of its aftermath; a prolonged stagnation of average incomes, a historic increase in income inequality and a decline of health and well-being. It took research by Ann Case and Angus Deaton — two economists whose work has often been dismissed as overly sociological — to bring serious attention to the alarming hollowing out of large parts of the US since 2000, with increased drug addiction, suicide, obesity, diabetes and heart disease, all leading to a rise in the rate of mortality and decline in life expectancy among middle-aged white men.
Economists failed to recognize the economic and social problems in the lead-up to and aftermath of the 2008 crisis, and the politics of populism have mostly been the opposite of what economists have recommended for decades, with its wave of trade protection, xenophobic response to immigration, procyclical cutting of taxes, attacks on individual civil liberties and freedom of expression, and efforts to reduce the independence of the judicial and monetary systems.
Why did economists miss capitalism’s return?
Economists missed the return of the use of the word capitalism because they failed to predict the financial crisis and to appreciate the depth and persistence of its broadly-felt negative economic consequences. This occurred for several reasons, including an excessive degree of specialization that blinded the profession to general system-wide forces, and an embrace of mathematical eloquence that limited economists’ capacity to appreciate the broader social and political world. But math and narrowness are not the only ways to understand the problem and to see how economics might overcome these limitations. We need to dig deeper into the philosophy of social science and the history of economic thought.
Economics’ protective belt
Neoclassical economics has been the dominant paradigm in economics since the late 19th century and even more dominant since the emergence of mathematical general equilibrium theory in the 1950s and 1960s. Philosopher Thomas Kuhn noted that it is the formation of a dominant paradigm that allows for the progress of “normal science,” the “technical and puzzle-solving” aspect (to use Roger Backhouse’s phrase) which involves the use of widely accepted norms and beliefs in research. Normal science need not explain everything, Kuhn notes. “Anomalies” often arise, and as long as they are minor or side issues, they can be ignored and normal science can continue. The persistence of the dominant paradigm was explained by philosopher of science Imre Lakatos, who proposed that scientific research programs often have a “protective belt,” whereby anomalies can be ignored for long periods of time if the theoretical core of the paradigm continues to generate useful findings.
An example of the functioning of the protective belt was research in international trade in the post-World War II era. The neoclassical theory — rooted in the standard rational choice framework — predicted that advanced countries would export capital intensive goods and import labor intensive products. But the empirical evidence did not support this, a finding that was considered a “paradox” and led not to a rethinking of the theory, but to a long series of empirical tests to explain away the “paradoxical” result. Philosopher Alex Rosenberg referred to the protective belt as providing “Lakatosian consolation,” implying that explaining away anomalies was a practice, common in economics, that protected the mainstream model rather than pushing practitioners to explore a shift to a new paradigm.
The protective belt of the post-War era in economics promoted the hyper-mathematization that became normal economics and this was associated with an insularity from broader social and institutional forces. For Paul Krugman, “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”
One might have expected financial collapse in 2008 to trigger a shift in economic theory. There were some efforts to bring the analysis of finance more closely into the picture, and there was homage paid to the Keynesian economist Hyman Minsky who had, twenty years prior, elaborated a theory of “financial fragility” that seemed to accurately theorize the system-wide and endogenous nature of the risks. But most of the economics profession has not yet recognized that the anomalies of our era strike at the very heart of our understanding of capitalism. There has not been an effort to reformulate economics the way there was in the in 1930s. Keynes’s General Theory of Employment, Interest and Money, published in 1936, challenged the dominant paradigm of the day at its core. It was not individual choice or individual frugality (saving) that created full employment, but their opposites: spending by business, households and governments created employment and these were to driven in part by the “animal spirits” of businesses operating in a fundamentally uncertain world, where the future is not knowable.
Of equal importance today is that the teaching of economics has not changed with the financial crisis and the Great Recession, largely because there was too much at stake in overturning the status quo: Too many well-rehearsed ideas within the economics mainstream, not to mention too many well-marketed textbooks and too many well-crafted course syllabi. Even Minsky’s financial fragility thesis was never integrated into the canonical thinking and certainly did not filter down into the undergraduate economics textbooks.
Liberal economics, illiberal politics
While philosophy of science helps explain why economists largely missed the recent developments in capitalism, why did the profession not respond with more concern once the problems became clear? Recall that it took a group of young protestors in a makeshift park in lower Manhattan to invent the category “the 1%” in 2011 and draw national attention to the rise in income inequality.
It turns out that one culprit was an esoteric piece of liberal social theory named after a 19th century social scientist named Wilfred Pareto and made famous by British and American theoretical economists in the 1930s. According to the Pareto social welfare criterion, situation B is preferred to situation A if no one is worse off in B compared to A, and at least one person is better off. This is the ultimate classical liberal criterion, since it places value on the well-being of any one individual (“no one is worse off”) above the well-being of any mass of people.
The economists took Pareto even one step further. To rank situation B above A required not actual “Pareto superiority,” but only the potential for it. That is to say, if the winners in the move from situation A to B could potentially compensate the losers so that the losers were no worse off in B than in A, and nonetheless the winners could, after the compensation, still be better off in B than in A, then B is considered a potential Pareto improvement.
The potential Pareto criterion has been criticized on two counts. The first is that it ignores the distribution of income and wealth. An initial distribution of wealth could be extremely unequal and nonetheless be “Pareto optimal” if there is no Pareto improvement possible. Moreover, even if an economic change further enriches the rich while leaving the poor unaffected then, according to the Pareto criterion, the change constitutes an improvement. Economists were, as a result, often blind to concerns about inequality.
Second, according to the potential Pareto criterion, a well-being improvement is said to occur even if no compensation of loser by winners takes place in practice . Economists rarely made the case for compensation in their advocacy of policy. Where were the economists touting the need for compensation required when trade was liberalized and imports hurt jobs and wages? Where were the estimations of the gains from trade and technical change that would allow a calculation of the compensation that could be made to losers — in terms of income transfers, tax concessions, job training — and still leave the winners better off? The rarified classic liberalism of economics had brought an indifference to economic suffering and injustice.
In fact, there were very few studies of Trade Adjustment Assistance in the US and even fewer calls by mainstream economists to ramp up TAA to levels of support that would make a significant difference. Paul Samuelson called the profession out for its ethical “shell game” in the failure to advocate for the compensation of losers that would make a potential welfare gain an actual one:
Should non-economists accept this as cogent rebuttal [of opposition to trade liberalization] if there is no evidence that compensating fiscal transfers have been made or will be made?… The economists’ literature of the 1930s — Hicks, Lerner, Kaldor, Scitovsky and others, to say nothing of earlier writings by J.S. Mill, Edgeworth, Pareto and Viner — perpetrates something of a shell game in ethical debates about the conflict between efficiency and greater inequality.
And Alan Blinder registered similar frustration with the shell game, noting that “trade liberalization is not, repeat not, a Pareto improvement unless the losers are actually, not theoretically, compensated — which they never are.
Economics is deeply rooted in the enlightenment and liberal traditions, dating to its founding in the late 18th century Scottish enlightenment. Economics emerged as a response to the corrupt, inefficient and illiberal mercantile order — that oligarchic system of trade and empire that was slowly losing hold, as scientific, liberal, individualistic and more recognizably capitalist thinking and practices emerged. Adam Smith’s Wealth of Nations, best known for its portrayal of an invisible hand of market forces that created social good out of individual pursuit of self-interest, was just as importantly an eloquent treatise against the protectionism, favoritism, and state-ism of the day.
To this day, economics retains a 19th century utilitarian conception — the liberal ideal — of individual autonomy, exogenously driven in tastes and rational, maximizing in behavior.
The irony today is that the economics profession, embedded in the deeply liberal traditions of Smith, Bentham and Pareto, has ignored the limits of its liberal lens and in the process blinded itself to the economic trends and social forces that have brought an illiberal turn in politics. Economist Dani Rodrik sees economists themselves as partly responsible for the illiberal turn today, commenting in a recent interview that “there was a curious disjunction between what economists know and the way they represented the discipline to the rest of the world…[E]conomists, who thought that freer trade was a direction that was worth moving in and were happy, by and large, to act as cheerleaders for the kind of globalization that we have experienced. Economists lent their expertise and their prestige to particular interest groups [financial interests and exporters], who used economists to advance their case.” Economists Jerry Epstein and Jessica Hagenbarth found that economists’ published research on the financial crisis often did not divulge their connections to financial institutions.
It would be easy to dismiss the problem as one of ideology or even corruption, with economists captured by the financial industry, for example. Critics of neoclassical economics have referred to it variously as “bourgeois economics” or “vulgar economics,” to signal its role in legitimating the status quo. But that is not the real issue today. The real point is that the “operating manual” of capitalism — economics — failed to deliver socially desirable results.
Economics has turned inward, has stopped seeing capitalism as a system, and was not open to other ways of seeing the economy. As Krugman wrote in 2009 about the financial collapse: “Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy… There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year .”
The Crisis of Vision: Risks and Opportunities
There are risks for society in the current constellation of science and politics. Populist politics have involved a questioning of expertise, in the natural sciences but also in economics. Joan Robinson, the Cambridge economist, noted in the early 1970s that periods of economic turmoil lead to a questioning of expertise and an increased reliance on “cranks” for policy advice:
A sure sign of crisis is the prevalence of cranks. It is characteristic of a crisis in theory that cranks get a hearing from the public which orthodoxy is failing to satisfy…The cranks are to be preferred to the orthodox because they see that there is a problem…The cranks and critics flourish because the orthodox economists have neglected the great problems that everyone else feels to be urgent and menacing.
One look at the Trump administration’s economic team and its recent recommendations for the Federal Reserve show how this has occurred in our time and in the U.S..
The reappearance of “capitalism” reflects a gross anomaly in economic science that can no longer be ignored. Economic orthodoxy promoted a narrow research program that was unable to see the big picture. “Capitalism” was invisible. Blindness to the dynamics of financial collapse, income stagnation, social decline and historic increases in inequality signaled a deeper failure of economic thought.
What emerged in the face of the “anomaly” of failing to account for fundamental market dynamic and outcomes has been a doubling down. Instead of adopting a realism and a serious treatment of institutions, power and politics, there was an insistence on models of “dynamic stochastic general equilibrium,” more general in a mathematical sense than its predecessor, but also more insular. This at a time when it was precisely insularity that seemed to lie behind the difficulty in recognizing important economic and social trends.
This scientific move has also maintained the closedness of the profession — to women, minorities, African Americans and LGBTQ economists. A recent survey by the American Economics Association found “deep evidence of gender and racial discrimination in the field.”
At the same time, there are promising signs, both within the orthodoxy and in an array of creative and varied heterodox approaches. From within the mainstream, Thomas Piketty’s Capital alerted a broad audience to the long-term upward trend in inequality. David Autor, the late Alan Krueger and others have done detailed empirical work on the labor market effects of trade, technological change and minimum wage policy, showing that the American labor market does not work the way the economics textbooks explain.
Heterodox approaches to the economy have flourished, but remain outside the discussion. Minsky’s financial fragility thesis has been updated and integrated into macroeconomic models. The question of corporate governance and its influence on profits, innovation, wages and stock prices has been studied in a barrage of compelling case studies showing the persistence of oligopoly and oligopsony. Economic stratification by race and gender have become distinct areas of research, showing the multiple dimensions of power related to white privilege and patriarchy may be as important as the traditional economic analysis of power seen strictly as market (i.e. monopoly) power. Post Keynesian economists have made great advances in understanding the impact of the distribution of income between wages and profits on the rate of economic growth, showing that distribution can determine the level of aggregate demand. Ecological economists have instilled the models with a criterion of sustainability. 
These developments suggest that other ideas and tools must be added and some things changed if the operating manual is to explain capitalism. The stakes are high, not just for the status of economics. Policy formation depends on a systematic understanding of capitalism. So too do most of the social sciences and law. To put it in Kuhnian terms, we can say that it is likely that the problem cannot be solved from within the current paradigm. Kuhn teaches that paradigms do not shift easily in the natural or the social sciences and, in fact, require a “revolution” in order to be overturned. Recognition of important anomalies is necessary but not sufficient. An alternative paradigm of economic thought must be ready in waiting.
William Milberg is Dean and Professor of Economics, The New School for Social Research and Director of the Heilbroner Center for Capitalism Studies at The New School. His research focuses on the relation between globalization, income distribution and economic growth, and the history and philosophy of economics.
The author is grateful to Drew Landes for research assistance, to Teresa Ghilarducci, Chris Hughes and Rick McGahey for comments on a previous draft and to the Hewlett foundation for research support.
 Minsky’s hypothesis can be found in Minsky, Hyman P. (1982) Can “It” Happen Again? Essays on Instability and Finance, Armonk, NY: M.E.Sharpe. On financialization, see William Lazonick (2009) Sustainable Prosperity in the New Economy?: Business Organization and High-Tech Employment in the United States. Kalamazoo, MI: W.E. Upjohn Institute for Employment Research. A treatment of wealth inequality by race is Darrick Hamilton and William Darity, Jr. (2010) “Can ‘Baby Bonds’ Eliminate the Racial Wealth Gap in Putative Post-Racial America?” Review of Black Political Economy, 37, No. 3-4: 207-16. On gender discrimination see Nancy Folbre (1994) Who Pays for the Kids?: Gender and the Structures of Constraint, Taylor & Francis. On distribution and growth, see Robert Blecker (2016) “Wage-led versus profit-led demand regimes: the long and the short of it,” Review of Keynesian Economics, V. 4, No. 4, October.