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Problems with Neoclassical Economics A Case Study in China

1. Introduction Economics is the study of exchange between goods and services. However, many people do not know about the development of modern economics and what neoclassical economics is. This article will discuss the evolution of neoclassical economics, the three axioms, the problems associated with the three axioms of neoclassical economics, and finally, how a case study about educational fairness in China shows that there are many problems with neoclassical economics.
2. A Brief History of Neoclassical Economics
Neoclassical economics was born out of classical economics. The term “classical” was first termed by Karl Marx, who was referring to David Ricardo’s theories on economics, such as the theory of value. The British economy collapsed in the 1870’s due to the classical economic approach that value was based on the affiliation between costs of production and the supply and demand. The Marginalist Revolution was founded by three economists; Jevons, Walras, and Mengar, which led to neoclassical economics. These economic scholars found that Marginalism and utilitarianism became more significant in dealing with the modern economics of the time. They also realized that there needed to be a new economic category to define these new approaches in economics and to be able to differentiate between classical economics from this new qualitative approach to economics. This new category of economics, neoclassic economics, was first used by Thorstein Veblen in his published a book called “Preconceptions of Economic Science.” His only intention in using this term was to characterize the theories of classical economists, while being critical to their theories (Colander, 131).
3. Definition of Neoclassical Economics: The Three Axioms
According to Christian Arnsperger and Yanis Varoufakis, in order to define neoclassical economics, there are three axioms; methodological individualism, methodological instrumentalism, and the axiomatic imposition of equilibrium. Methodological individualism is the “body” of neoclassical economics, stating that everyone is well informed and rational. Methodological instrumentalism describes how preference is used to maximize the demand of goods, services, and/or profit. The axiomatic imposition of equilibrium is described as when a … “agent’s instrumental behavior is coordinated in a manner that aggregate behavior becomes sufficiently regular to give rise to solid predictions” (Arnsperger and Varoufakis, 5).
The neoclassical approach can be better explained by using an example from E. Roy Weintraub .
“Buyers try to maximize their gains from getting goods, and they do this by increasing their purchases of a good until what they gain from an extra unit is just balanced by what they have to give up to obtain it. In this way they maximize “utility.” The satisfaction associated with the consumption of goods and services. Likewise, individuals provide labor to firms that wish to employ them; by balancing the gains from offering the marginal unit of their services (the wage they would receive) with the disutility of labor itself the loss of leisure. Individuals make choices at the margin. This results in a theory of demand for goods, and supply of productive factors” – E. Roy Weintraub.
4. Problems with Neoclassical Economics: The Three Axioms
There are many problems with the neoclassical economic theory. First, methodological individualism assumes that everyone has a rational way of thinking and is thoroughly informed, but this axiom is dubious. Humans are vulnerable in situations they are put in, which causes them to be irrational. Second, according to methodological instrumentalism, humans usually use their first choices of action in order to maximize the situation, such as in acquiring goods, services, and products. If taken into consideration that humans can be irrational, then how will they know if their preferences will maximize their situation? Third, the axiomatic imposition of equilibrium focuses on the fact that when the key behavior works with the collective behavior in a consistent manner predications will be stable. Nonetheless, it does not consider that if humans are vulnerable in a given situation, then they can react in an unpredictable way that can imbalance the collective’s behavior.
4.1 Educational Fairness in China: A Case Study
Educational fairness has become a bigger issue over the years in China. The meaning of educational fairness considers equality in education, whether it be regarding finances or the access to education. Because this article is only focusing on an economic aspect, it will concentrate on the financial aspect concerning the equality of regional educational funding. Concerning the fairness of the Chinese educational system, there are four major problems; educational funding in rural areas, the allocation of funds, inequality of funds between private and public schools and the uneven acceptance of examination scores (Peng, 2009).
Rural areas of China have been less developed in their education system compared to the metropolitan areas because of inadequate resources available for the local governments to give to the mandatory, nine year education system. This falling behind is also due the economic and social changes in the last half millennium. Pertaining to the distribution of funds, most of the funds of education go to universities (Peng, 2009). According to Wang Shanmai, a pedagogical economist, “…the money input in higher education accounts for 20% and middle and junior education 80%. For higher education, 80% of the expenditure comes from the government funding. However, only 60% is allocated for compulsory education” (Ping, 200).
Another problem with China’s educational fairness is that public schools receive more funds than private schools. Private schools do not have any rights to compete fairly in development, such as awarding certified diplomas independently, students receiving discounts, and receiving student loans (Peng, 2009).
The last problem concerning educational fairness in China comes from admitting students with different college entrance examination scores. The main concern is that many students cheat on their college entrance exams in order to be accepted at a university, and there is hardly any supervision when giving out the entrance examinations. The reason why many students get away with it is because the laws related to cheating are not strict enough and the consequence received is only at the minimal level (Peng, 2009).
In order to prove that the neoclassical approach in economics is not reliable, Peng used two separate sets of data; one concerning educational spending and the other about public attitude in China concerning educational fairness. In the educational spending data, there are two parts. The first part was about the yearly educational spending from 1978-2007 and the second part was about the yearly educational spending in 2006 for different provinces in China (Peng 2009)
Concerning the public interest, Peng created two indexes. The first index was about how many academic articles there were with the term “educational fairness” in their title and the other index was about how many public posts that had educational fairness as their subject. Figure 1 and 2 showed that the more money spent on education, the more likely people consider educational fairness as a more important issue in China. Even though the spending increased every year, the public’s reaction about educational fairness became more indignant. In Figures 3 and 4, they show that the more money the region receives for education, the more public would discuss about education fairness in that region (Peng, 2009).
FIG. 1. Annual Education Spending (in billions) (Peng, 2009)
FIG. 2. Annual Publications on Educational Fairness (Peng, 2009)
FIG. 3. Educational Spending in 2006 by Provinces (Peng, 2009)
FIG. 4. Number of Posts on Educational Fairness Online by Provinces (Peng, 2009)
In order to show that the neoclassical theory is unreliable, the case study concerning educational fairness in China and the three axioms will be used to prove that the theory has many pitfalls. According to methodological individualism, everyone is rational in thinking and is well informed. However, according to the study, although the educational spending increased every year, public sentiment about educational fairness became more resentful. This is irrational because more people should be content with receiving more money from the government. One reason why the people might be unsatisfied might be because they were not well informed about which area it will go to in the education program, but this is just a theory. According to methodological instrumentalism, the first choice is used to get the most out of the demand of goods and services. So if the Chinese government prefers to give more money to urban areas and public schools to maximize the profit in investing into the young generation for a stronger economy in the future, then why not invest in rural areas as well? For the Chinese government to give more money to urban areas and public schools than rural areas is irrational and hurts the neoclassical theoretical way of thinking. The last axiom, the axiomatic imposition of equilibrium, believes that when an individual person works with a group without fail, predications will be steady. China is a collectivist nation, meaning that they do not take into account of their own interests but think of only of the interest of the collective, whether it may be for family, community and/or government. So according to the axiomatic imposition of equilibrium, an individual in China working with the collective should bring a stable predication that the more money a region receives for education, the collective should be more content. Predications should have been stable but were not. The people became disgruntled when they received more money so this predication was not constant.
5. Conclusion
In conclusion, neoclassical economics can be defined by merging the three axioms; it is the supply and demand to an individual’s rationality and preference by means of their ability to maximize utility and/or profit. However, using Peng’s study about the educational fairness in China, the neoclassical theory in economics has many pitfalls. People should be rational, informed, work with the collective, and use their preferences to gain the most profit; however, this is not the case with China. The Chinese people should be more content with receiving more money for their education, but Chinese citizens gave the opposite reaction than expected. Even though regions are getting more money for education, there is still inequality where cities and public schools are receiving more money. If the government wants to invest in the future, they should also invest in the education in rural areas so that the country will benefit economically in the future. In conclusion, neoclassical economics can be very disputable because of the fact that this theory does not take into consideration that humans can be irrational and unpredictable.

The gold standard as a monetary system

What is Gold Standard? The Gold Standard is a monetary system in which the standard unit of currency is a fixed weight of gold or freely convertible into gold at a fixed price. Under the Gold Standard system, paper money which circulates as a medium of exchange is convertible into gold on demand. The exchange rate between paper or fiat money and gold is fixed. Same thing happened to the rates of exchange between national currencies, it is fixed.
The Gold Standard can be divided into two types: full Gold Standard and “partial” Gold Standard. A 100 percent reserve Gold Standard or full Gold Standard occurs when all circulating money can be represented by the appropriate amount of gold. Whilst in “partial” Gold Standard, circulating notes can be redeemed for their face value; it can be either higher than its actual value or lower.
Why gold being selected as a reserve for most countries and even for today? Many nations hold the gold reserves in significant quantity in order to defense their currency and hedge against the US dollar which forms the bulk of liquid currency reserves. Some more, the weakness of the US dollar can be offset by strengthening the gold prices. Yet, compared to other precious metals or major competitors such as US dollar and real estate, none of them has the stability as the gold as well as its rarity and durability. Gold is also used as a store of value starting from the early monetary system since it is high value enough due to its utility, density, resistance to corrosion, uniformity, and easy divisibility. As we know, banking began by depositing the gold into a bank and it could be transferred from one bank to another bank. Until today, gold remains to be a principal financial asset of almost all central banks.
By looking back at the past, before 2000 BC, the first metal that human being used as a currency in trade was silver. According to the history, we know that gold has been used as a mean of payment since long time ago. After 1500 years, the first coinage of pure gold was introduced. The adoption of Gold Standard was preceded after that. Yet, the fiat monetary system came and took over the Gold Standard system during the outbreak of World War I. This happened for most of the nations are due to the excessive public debt and the government is unable to repay all the debt in gold or silver.
As a banking and finance student, we have to study and understand any history that regard to the field, included the topic of our assignment this time – Gold Standard. This is because people live in present and they have to plan for and worry about the future. History is the study of past. It gives the information of the past in order to anticipate what is yet to come. Understanding history is important to develop the linkages to predict the future. Yet, history also provides us abundant of information about how the Gold Standard was formed and how it operated. Understanding the operations of the Gold Standard is difficult currently since it was collapsed and we cannot be exposed ourselves to it. The current data that we have is relied on what happened into the past. By using the historical materials, we can make our own analysis on the Gold Standard and understand its weaknesses and problems.
Besides, the study of the Gold Standard can help us to understand the changes of the monetary system and how the financial world affects the global economies. From the historical information, we know when the adoption of the Gold Standard was and when the collapse of the Gold Standard was. Yet, we also know that the monetary system had been changed over time to time and which system was being created in order to take over the original system. For instance, Gold Standard was took over by Bretton Woods System and followed by Contemporary Monetary System. There is always a reason there for the changes made. This is because of the discovery of the shortages of the system. Once the deficiencies being located, the new system would be established. If there is still do not have any actions taken, it will affect the economies of the world since finance cannot be separated with the economy.
In addition, as a financial student, we have to understand about the differences between fiat money and Gold Standard. From the project we done, we know that fiat money is money that no have intrinsic value and cannot be redeemed for any commodity. The paper currencies and coins that are available in markets nowadays are considered as fiat money and the strength of the economy of the issuing nation is the determinant used to determine the value of fiat money. Mostly, inflation will follow with the enormous issuing of fiat money. Whilst, The Gold Standard is a monetary system in which the standard unit of currency is a fixed weight of gold or freely convertible into gold at a fixed price. Under the Gold Standard system, paper money which circulates as a medium of exchange is convertible into gold on demand. The exchange rate between paper or fiat money and gold is fixed.
2.1.1 History of Gold Standard
The first nation that officially adopted the Gold Standard system is England (also called as Great Britain) in 1821. The list below is the dates of adoption of the Gold Standard system:
1821 England
1871 Germany
1873 Latin Monetary Union
1875 Scandinavia(Monetary Union)
1875 Netherlands
1876 France
1876 Spain
1879 Austria
1893 Russia
1897 Japan
1898 India
1900 United States
During that century, there was a dramatic increase in global trade and production which brought enormous discoveries of gold. The discoveries aided the Gold Standard remain intact well on the following century. As all trade imbalances between nations were settled with gold, governments had strong incentive to stockpile gold for more difficult times. The emergence of the International Gold Standard is on 1871 since the Germany also started to use the system. By 1900, most of the developed countries were linked to the Gold Standard system, but surprise that the United States was the last nation to enter. This is because there was a strong silver lobby that prevented gold from being the sole monetary standard with the U.S. throughout the 19th century.
The Gold Standard was at its pinnacle from 1871 till 1914. During the period, there were near ideal political conditions existed in the world. Governments tried to corporate nicely in order to make the Gold Standard system work, but the system was collapsed during the duration of outbreak of the Great War in 1914. In 1925, it was reestablished. But due to the relative scarcity of gold, many countries adopted a gold-exchange standard, supplementing their gold reserves with currencies convertible into gold at a stable rate of exchange. Unfortunately, the gold-exchange standard was ended during the Great Depression. The United States had set a minimum dollar price for gold in order to aid for the restoration of international gold standard after World War II. In 1971, dwindling gold reserves and unfavorable balance of payments led the U.S. to abandon the Gold Standard system.
2.1.2 Timelines of Gold Standard
1717 The Kingdom of Great Britain went on to an unofficial Gold Standard.
1816 Gold was partially displacing silver as a standard.
1821 The Gold Standard was first out into operation in Great Britain.
1873 The Coinage Act of the United States Congress came into operation on 1st April and constituted the gold one-dollar piece as the sole unit of value.
1900 Gold Standard Act was established on 14 March 1900 and gold was the only standard for redeeming paper money.
1914 The abandonment of the Gold Standard by Russia.
1925 The return of the Gold Standard.
1971 The abandonment of the Gold Standard by the United States.
2.1.3 Timelines of Fiat Money
1690 There are three types of currency according to American History:
Fiat money
Certificates based on coin or bullion
Bank notes
(Fiat money is one type of currencies that being used during the time.)
1789 France was undergoing economic downturn and due to lack of money, fiat money being used.
1862 There was a paper currency that printed upon one side in green has been created with a promise to pay – Greenbacks.
1878 An argument in favor of honest money and redeemable currency.
1896 Paper-based global economy has been collapsed.
1913 Establishment of Fed.
Fiat money became the United States legal tender.
The mercy of the fiat money system has led to the greatest debt bubble in world history.
1933 Inflation occurred.
2008 Under the fiat money system, money as debt.
2.1.4 History of Shifting Between Fiat Money and Gold Standard in U.S.
As stated as below, there were a lot of shifting between a fiat money and gold standard had been made by the United States over the past 200 years which in order to avoid hyper-inflation. Hyperinflation occurs when the confidence in money had gone and it leads to no value in the money. As mentioned as earlier, the gold standard was over due to the reason of the government was unable to repay for the excessive of public debt in gold or silver that its countries owe.
1785-1861 Fixed Gold Standard : 76 years It was issued by American colonists for the Continent Congress in order to finance the Revolutionary War.
It was produced by the United States Federal Government.
It was authorized by the Act of March 3, 1849.
1862-1879 Floating Fiat Currency : 7 years The fiat money of the United States above is Greenbacks.
It was created to pay for the enormous cost of the Civil War.
It was the debt of the U.S. government which could be redeemable in gold at future without any specified date.
It was circulated along with the Gold certificates.
1880-1914 Fixed Gold Standard: 34 years It was ended due to the financial needs of World War I.
1915-1925 Floating Fiat Currency : 10 years It was created to pay for World War I countries.
There was insufficient of gold to support the paper currency.
1926-1931 Fixed Gold Standard : 5 years It was ended due to most of the nations tried to deposit their pounds and dollars for gold when the depression occurs.
1931-1945 Floating Fiat Currency : 14 years It was ended due to the outbreak of World War II.
1945-1968 Fixed Gold Standard : 26 years On 24 June 1968, a proclamation that Federal Reserve Silver Certificates could not be redeemed in silver was issued by President Johnson.
1971 Floating Fiat Currency : 5 months It was established by President Nixon on August 1971.
1971-1973 Fixed Dollar Standard : 2 years It was passed by the Smithsonian Agreement.
1973-today Fiat Currency : 37 years It was established by the Basel Accord.
2.1.5 Evolution of International Monetary Systems
International Monetary System had been undergoing several stages of evolution which are stated as below:
Bimetallism (before 1875)
A “double standard” in the sense that both gold and silver were used as money.
Some nations were on the gold standard, some on the silver standard, and some on both.
Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents.
Classical Gold Standard (1875-1914)
During this period in most major countries:
-Gold alone was assured of unrestricted coinage.
-There was two-way convertibility between gold and national currencies at a stable ratio.
-Gold could be freely exported or imported.
The exchange rate between two countries’ currency would be determined by their relative gold contents.
Highly stable exchange rates under the classical gold standard provided an environment that was conducive to international trade and investment.
Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism.
Interwar Period (1915-1944)
Exchange rates fluctuated as countries widely used “predatory” depreciations of their currencies as a means of gaining advantage in the world export market.
Attempts were made to restore the gold standard, but participants lacked the political will to “follow the rules of the game”.
The result for international trade and investment was profoundly detrimental.
Bretton Woods System (1945-1971)
Named for a 1944 meeting of 44 nations at Bretton Woods, New Hampshire.
The purpose was to design a postwar international monetary system.
The goal was exchange rate stability without the gold standard.
The result was the creation of the IMF and the World Bank.
The system was a dollar-based gold exchange standard.
Flexible Exchange Rate System (1971-today)
The system was declared acceptable to the International Monetary Fund (IMF) members.
Central banks were allowed to intervene in the exchange rate markets.
Gold was abandoned as an international reserve asset.
Managed Float System (1973-today)
2.2.1 Chronology of Gold and International Monetary System
1717 Master of the Mint, Sir Isaac Newton gave guinea statutory valuation of 21 shillings.
Commence of the United Kingdom Gold Standard.
1797 Occurrence of Napoleonic Wars.
Bank of England abandoned gold payments.
1816 Establishment of UK Coinage Act.
1844 Bank of England obliged to buy gold.
1870-1900 Except of China, most of the nation abandoned Bimetallic Standard and switched to Gold Standard.
1913 The United States system of reserve banks was established by Federal Reserve Act.
At least 40% of notes were gold-backed.
1917 U.S. prohibited gold exports.
1919 UK went off Gold Standard.
Establishment of London Gold Fixing.
1925 Return of Gold Standard in the United Kingdom.
Establishment of UK Gold Standard Act.
1931 The United Kingdom abandoned Gold Standard.
1933 Suspend of the United States convertibility.
Prohibition of exports, transactions, and holding of gold.
1934 Presidential Proclamation of making dollar convertible to gold again.
1936 Establishment of Tripartite Agreement (Countries involved: U.S., UK, and France)
1939 Close of London gold market due to the outbreak of war.
1944 Establishment of Gold Exchange Standard as a result of Bretton Woods Conference.
1945 International Monetary Fund (IMF) Articles of Agreement became effective.
1954 Reopen of London gold market after World War II.
1961 Establishment of Gold Pool (Members: Belgium, France, Germany, Italy, Netherlands, Switzerland, UK and Federal Reserve Bank of New York)
1967 Buying of gold increased due to the devaluation of sterling.
1968 Close of London market.
Abolishment of Gold Pool and establishment of 2-tier market.
Establishment of Special Drawing Right (SDR).
1971 Suspend of U.S. convertibility to gold.
Establishment of Smithsonian Agreement.
1972 Devaluation of the United States dollar.
1973 Suspend of dealing in foreign exchange markets by most of the central banks.
Adoption of floating exchange rate regime.
Abandonment of 2-tier gold market.
1975 Abolishment of restriction on citizen buying, selling or owning gold by U.S.
First U.S. gold auction on January.
Establishment of agreement between G10 countries and Switzerland on no attempt to peg the gold price.
1976 First gold auction by IMF on June.
1978 Disappear of formal role of gold in International Monetary System.
1979 Establishment of European Monetary System.
Final U.S. gold auction on November.
1980 Last 45 IMF gold auctions on May.
1982 The United States Gold Commission reported to Congress.
1985 Establishment of Plaza Agreement on currencies.
1987 Establishment of Louvre Accord on currencies.
1992 Sign of treaty on European Union at Maastricht.
1998 Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain joined Economic and Monetary Union (EMU).
1999 Began of EMU.
Announcement of Central Bank Gold Agreement (CBGA).
2004 Announcement of Second Central Bank Gold Agreement.
2.2.2 Gold Standard Went International
*The picture above the gold and silver coins that available around the world during 19th century.
From the chronology above, we know that most of the countries (except China) had abandoned their silver or bimetallic standard and went for a full gold standard between the years of 1871 to 1900. There is always a reason. German asked for “war indemnity” to be paid in gold by France right after the Franco-German War. German used this gold to finance a new gold standard in their home country. This had lead to an increase in the demand of gold and there was unload of tons of silver on the neighboring nations. Due to the fear towards silver inflation, the neighboring countries decided to follow German.
The list below is the date of first gold standard:
1871 German
1873 Belgium
1873 Italy
1873 Switzerland
1874 Scandinavia
1875 Denmark
1875 Norway
1875 Sweden
1875 Holland
1876 France
1876 Spain
1879 Austria
1893 Russia
1898 India
1900 USA
International Gold Standard existed when the following condition being fulfilled:
Gold alone is assured of unrestricted coinage.
There are two way of convertibility between gold and national currencies at a stable ratio.
Gold may be freely imported and exported.