Reformas de la Ley XXX del 28 de setiembre de 1887 y sus reformas

The neoclassical world view boils down to a certain, calculable world where markets equilibrate and Pareto optimality is a central focus point (Mair & Miller, 1991, p. 13) This framework has been the basis for over a century of neoclassical economics. It is widely regarded as the dominant paradigm in economics, at least until the 2008 financial crisis (Hodgson, 1992, p. 749; Palley, 2009, p. 18). Modern neoclassicism abides to the methodological standpoint that theories should not adhere to realism of assumptions, but to the correctness of the predicted outcomes (Mair and Miller, 2012, p. 136). The elements and features that ultimately inform neoclassical policy prescriptions are 1) its assumption on agent rationality, 2) the automatic equilibration of supply and demand, and 3) the view of money. Current neoclassical thinking is mainly represented by the New Neoclassical Synthesis. This modern variant can bring about significant deviations from the original theory, yet they rely on the same framework. Below I shall provide a description for each element and feature in order to have a proper understanding of the neoclassical framework. In reality, there are vastly more variations, but for reasons of simplicity and space I have selected the essentials.

Rational agents and markets

Neoclassical economics can be seen as a meta-theory with three underlying assumptions identified by Weintraub (1997):

 People are rational in their outcome preferences which can be identified and expressed in numbers.

 People are utility maximizers and firms are profit maximizers.

 People act individually on the basis of full information.

These are the implicit rules and understandings for constructing neoclassical theories. They inform a model of exchange, in its original form commonly attributed to Leon Walras. Rational agents weight the utility they gain from procuring one unit of a product. Thus when comparing the utility of one product to that of another, rates of exchange can be established through a

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process similar to an auction (Mair and Miller, 1991, p. 77). Later these models were refined to find the extra utility agents gain from procuring one additional unit of a product: the marginal utility. Marginal utility can decrease or even increase (exponentially) and thus individual consumer utility functions for various amounts of products were thought up, resulting in marginal exchange values for product consumption. In this sense neoclassical economics can be seen as a theory of barter. Diminishing marginal utility of good consumption defines the characteristics of demand. This leads to graphical representations of diminishing demand for a product as indifference curves (Mair and Miller, 1991, p. 77). As these exchange processes and utility information are assumed to work transparently and efficiently, hence making market outcomes pareto efficient: agents are better off without making anyone worse off. As the theory assumes it to work directly as well, markets are always in the equilibrium position- meaning they are static.

The Neoclassical assumptions of agents with rational expectations and market that clear automatically due to competition leads to an optimistic view of markets (p. 134). Later additions to these models included the possibility monopolistic competition, meaning that prices included a mark-up and hence profits, even when output would be lower. Nonetheless, the price plus the profit (marginal-cost-plus price) would behave float up and down with demand as in competition (Dullien, 2012, p. 29).

Business cycles

Modern neoclassical theory seeks to explain macroeconomic fluctuations, hence why markets are not static but dynamic. Still, the neoclassical microfoundations of atomistic individually acting actors which equilibrate to stasis or stability is used as the basic model. Individual demand/supply curves are aggregated to find the macroeconomic amounts (Lavoie, p. 5). Explaining fluctuations is done through (a) real business cycle (RBC) models and (b) complementary labour and product market frictions and staggered price and wage setting, which will be explained further below.

Adhering to the microfoundations is believed to be done most rigorously by General equilibrium models such as the model by Arrow and Debreu (Vercelli, p. 420). This model still functions as a Walrassian auction (Rogers, 2013, p. 9). However it integrates production, exchange and consumption (Arrow and Debreu, 1954, p. 265). Each person would have a positive amount to trade in the market (Pugh & Johnston, p. 7). While early neoclassical models see markets as constantly in equilibrium and hence cleared, later models also work through the assumption that markets clear towards supply and demand in equilibrium and can be in

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disequilibrium for some time. Currently most models see fluctuation as the movement of equilibrium itself, and always cleared yet fluctuating ((p. 134).

In these models, individuals maximize utility through variations of paths of three elements: (a) their demand for consumption, (b) their supply of labour, and (c) their money holdings. Variation in output is caused by variation of labour supply. This happens when real wage deviates from the steady state value- the state of dynamic equilibrium staying balanced at a certain level- causing individuals maximize utility by changing the hours worked (Dullien, 2012, p. 431).

Firms are understood to know what their own and others possible output plans are and how they affect the general price level in the future based on previous periods. Thus they make corresponding plans to maximize profits. In this light macroeconomic fluctuations are explained. As firms only know their own prices, their estimates of the general price level may be wrong (Mair & Miller, 1991, p. 101). If a shock occurs – e.g. a natural disaster or policy change- and goes unnoticed, firms might adjust assuming it must be their own relative prices that has changed due to changes utility driven demand (p. 101). If the actual general price level has become higher (or lower), firms may perceive a shock as a (un)favourable change of their own relative prices and increase (or decrease) output expecting higher profits in the future. Thus fluctuations occur.

Two types of shocks can be found. A first type of shock that cause fluctuation are “real” shocks: positive or negative changes in productivity. Contemporary mainstream economics regards them more important than monetary shocks.Real shocks are (un)favourable changes in technology, raw materials prices, or the organization of production (Hoover, 2008). The Real Business Cycle (RBC) theory by Prescot and Kidland (1982) describes such up- or down-turns. Runs of price changes may come in waves and explain the persisting character of business cycles (Hoover, p. 2008).

A second type of shock that explain cycles and make neoclassical models dynamic, is found in Lucas’s (1972) model with policy shocks: changes by governments and central banks. These are exogenous to the real economic indicators and are unpredictable or random, as they are determined by a central authority causing price level change (p. 421). This approach is based on Friedman’s idea of anticipated monetary change, which holds that financial markets think in real terms and that countercyclical policy has no influence and thus takes prospective inflation into account (Fitzgibbons, 2012, p. 271). Nominal –money supply- changes merely result in a change in the price level but have no real effects and leave interest rates unchanged. (p. 271). In similar vein, changes in fiscal policy would not have positive effects. Although

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government spending is seen as a direct economic and employment stimulant, the negative consequences to the government budget would be known by rational agents. They would understand that taxes would have to finance the budget which would roughly offset the value of government expenditures (p. 273). This also can be seen as the source of contemporary neoclassical thinking that disapproves of government intervention.

Other more recent neoclassical explanations for cycles provided additional explanations for the existence of the business cycle3. These are found in the market rigidities that prevent short-run market clearing in the case of shocks. (Mair & Miller, p. 136;, pp. 425-6). Rigidities are overlapping staggered contracts: contracts that span periods of time and expire at different time points in a year. Thus, when the economic environment changes and new expectations arise, contracts cause nominal fixities in prices or wages or real fixities by real or relative prices or wages (© the price level) (p. 276).This last variant hence does not rely on fully competitive equilibrating markets, but monopolist, imperfect markets at the supply side of the economy (Cornwall, 2012, pp. 425-6).

Time

Eearly neoclassical economics assumed everything to happen simultaneously without any process or sequence of events, and hence allows no place for time. However, pervious paragraphs show later theory understands firms to know what their past and future output plans are, and consumers to know their lifetime income and act upon this information to maximize profits and utility. This provides an account for time. Models using such theory assume perfect information and rely upon the past for decisions about the future. If this was correct, the models would be deterministic with perfect foresight. Hence the possibility of random estimation errors are made unrelated to previous periods (e.g. shocks). This makes the models stochastic (Mair and Miller, p. 1991, p. 135)

As such, to explain features in dynamic systems neoclassical theory employs time-series econometrics. These time-series models are often sequences of observations of the same variable at equal intervals in time, and results on the future are taken as explanations also in the absence of theoretical frameworks. Such models often identify and accredit probabilities to a full range of potential futures in all instances. Hence, Glickman (2012) explains that they see no real distinction between risk and uncertainty- as the latter is seen as intrinsically quantifiable. Risk situations are situations with a numerical probability of possible outcomes of that decision.

3 _{These are found in New Keynesian models, which despite their name are framed in neoclassical market} theory.

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Yet, to real uncertainty such probabilities cannot be assigned and cannot be treated as ergodic: the principle that values in a random (stochastic) process ultimately coincide. This would mean that variables have stationary means, creating a linear trend as they converge with increased numbers of observations. As time passes, events will repeat themselves and hence market economies tend to equilibrium in the long run (Glickman, 2012, p. 557). Therefore, in the long run things are time and path dependent (Lavoie, 2014, p. 312) As such Neoclassical models present a world of logical time. In this world of automistic, rational acting agents always tends to an equilibrium status. Here, past and future variables have the same probability distribution regarding. Therefore, future prospects at a moment of choice govern future outcomes (Dantas, 2012, p 533-4).

Employment & Output

Considering the previous part employment fluctuations must always be caused by market conditions. Real wage increases cause individuals to work more and have less leisure and a wage decrease leads them to work less. Involuntary unemployment is thus absent. Individuals make work/leisure decisions by taking their lifetime income into account (p. 431). A fundamental assumption of taking lifetime incomes into account is that agents are not only rational, but also that they act as if they have and understand economic models used by economists and policy makers (Mair & Miller (1991, p. 101In such models, markets are expected to continuously clear or be in equilibrium, making it impossible to have persistent excess supply of labour, as wage is expected to equate continuously. Also neoclassical competitive equilibrating markets are assumed, meaning that employment offered automatically adjusts to the appropriate level ratio of work and leisure (p. 134).

In regards to output, a typical assumption of neoclassicism is its adherence to Say’s law: the production of goods is regarded to create equal-value to income which generates equal demand without the threat of overproduction. This means that the theory emphasises the supply side as potential demand deficiency is not accounted for, also not in regards to fluctuations (Vercelli, 2012, p. 420). Examples of wage changes in expectations do therefore not result in direct adjustment and falling demand cannot be directly translated into wage adjustment, supposedly leaving lay-offs as the only option. Another possible reason for involuntary unemployment is identified by Cornwall (p. 426) in the nominal rigidity of efficiency wage use. These are wages containing a premium on the expected wage level on the basis of reduced slacking or absence of workers because workers believe they are treated well. This lets firms employ higher-quality workers and binds these workers more thoroughly, increasing output and decreasing costs by

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decreased turnover. She explains demand shocks would not reduce these wages as that would result in lower productivity and increased costs, but result in lay-offs, As nominal wage rigidities prevent wage adaption to shocks, there is the possibility of unwanted idleness and an output gap- the difference between actual output and potential output and hence GDP.

Trade

New classical international economics can be split out between a ‘micro’ part called international trade and ‘macro’ part called international finance. International trade is concerned with exports and imports and effects of trade policies on welfare and income distribution are assessed with ‘real’ or barter models. Free trade – Heckscher-Ohlin model of international trade based on Ricardo’s comparative advantageInternational finance looks at balance-of-payments adjustment mechanisms with aggregative models that focus on monetary and financial factors. In trade systems these monetary and financial systems are presumed to adjust automatically through comparative advantage with full employment and balanced trade (Glickman, 2012, p. 557).

International Finance

Because logical-time series explain stability- the equilibrium position around which markets tend- finance models using econometric techniques essentially assume the stability of financial markets (Altuzarra, 2012, p. 524). Hence it is assuming complete financial markets, which have financial assets completely span the relevant uncertainty faced by agents (Henry, 2012, p. 529). Securitization via econometric models can spread risks and increases stability. Because market competition and international trade are also assumed to lead to efficient allocation. Hence regulation is not necessary, except for activities that are regarded illegal or curbing competition. Money and monetary policy

Original neoclassical theory sees money as funds that can be loaned which come from savings. Savings and investment work as supply and demand in a Walrassian auction determining the interest rate. Yet money can be exogenously issued by the central bank. In this regard it adheres to the quantity theory of money (QTM), meaning that issued money, is directly neutral and therefore changes in the amount of money proportionally adjust prices. This makes it possible to analyse real and nominal economic variables separately without issue, called the classical dichotomy. Due to QTM the central bank can only adjust the money supply, but not the interest rate. Such mainstream views are easily recognizable because they treat money as exogenously controlled by the central bank (Lavoie, 2014, p. 184). This also means that outside debts as loaned savings, there is no theory of debt.

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Other theories include money multiplier theory where central bank reserves control the creation of credit by commercial banks. Lavoie (p. 184) explains that these see the central bank as in control of the creation of credit and money entirely through central bank reserves. Hence bank money is also exogenously controlled by the central bank. Moreover, money is not directly neutral as the original QTM, but ´superneutral´ meaning that in the short run the illusion of money would have real effects on the economy, but not in the long run (the long run QTM). Such views implied that central bank reserves created stable money multiplication, depending on constant velocity of money, as higher rates of money transaction create more consumption (p. 185).

Unlike previous thinking, modern neoclassical economics allows for endogenous money: money supply that is not determined externally by a central authority but instead by agents in the economy (Smithin, 2012, p. 289). This seemingly removes it from the classical dichotomy because money is also created by bank credit. Yet, still savings and investment are regarded to determine interest rates, merely adding endogenous money creation by banks. To add endogenous money it relies on monetary theory in the tradition of Knutt Wicksell. In this theory, the central bank sets the rate of interest at the level where the required investment to achieve potential national output equals the required national saving for potential output. This rate is called the natural rate of interest. It is thought to be determined in the market for real capital and labour. This is influenced by productivity of capital and the time preference of economic agents for the supply of labour (Smithin, 2012, p. 289; Lavoie, 2014, p. 189). Savings amounts are based on utility form future interest returns versus that from current consumption.

This view is sometimes referred to as the loanable funds theory of interest rates because it treats funds in the form of national savings as a guide for the loans possible (Lavoie, p. 341). It does not equate savings and investment ex ante, instead it only sees the necessity to have ex- post savings and investment equilibrium which is in the long-run (p. 191). It is because of this necessity of savings eventually covering investment that one can talk of loanable funds, even though it could be argued that this name would be more apt to classical theory. The loanable funds view leads the interest rate to be the main tool for the central bank. Lavoie (p. 189) explains that in neoclassical thinking the long term interest rate adjusted for expected price inflation is regarded the best measure of the natural interest rate. He further explains that as such short-term interest rates cannot deviate too much from the long-term rate because this would lead the real rates to deviate from the natural rate and create disequilibria in the economy for example in the form of inflation.

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Growth

Neoclassical growth theory relies on supply side economics, as supply is assumed to create its own demand growing is depended on increasing output. The limitations to growth are found in scarcity, namely resources and productivity (2003, p. 178). Prominent growth models are the Solow-Swan model which understands growth as an exogenous phenomenon, and endogenous growth models (Lavoie, 2014, p. 55-56). The Solow-Swan model focusses on technological innovation and increase in labour supply to assess productivity. The endogenous growth model however looks at the marginal product of capital. Increase in productivity by growthof capital (savings and investment) is the causal factor in growth models. This relies on the competitive market model that leads such operation at the supply side to find the best way to grow. Growth is determined by the rate of profits which is invested in capital goods.

As growth depends the increase of the supply of labour, flexibelization of the labour market would induce growth. Moreover having low government spending, to prevent cost push inflation would increase growth. Privatization or deregulations to reduce costs at the supply side and increase capital investments are hence natural growth conductors for Neoclassical Economics.