This article is part of the Economics Week series in which we explore flaws in and alternatives to our current economic system.
The goal of economics is to improve the living conditions of people (Mankiw 2019). Hence, economics should focus on increasing human prosperity rather than simply increasing material consumption. Of course, material wealth strongly correlates with well-being, as material wealth provides a sense of security, a roof over one’s head, food, and clothing. Yet, empirical evidence shows that this is only true up to a certain income. In the US, average income almost quadrupled while average happiness decreased.
That material wealth is not the only factor determining a good life is somewhat common sense. In basic psychology terms, what neoclassical economics concerns with are the “basic needs” in Maslow’s Pyramid of Needs:
Mainstream, neoclassical economics defines utility-maximization – utility being the satisfaction gained from the consumption of goods and services – as the ultimate goal of every human. This is indeed a necessary simplification for economic modelling, as material goods are tangible opposed to utility gained from action fulfilling “psychological needs”.
Thus, this is a perfectly fine assumption to hold in the spheres of economics that do not directly require a prior stance on normative beliefs (like, for example, the belief that economic inequality is meritocratically justified because we live in a society with equal access to opportunities), say accounting, or econometrics. Indeed, there are parts of neoclassical economics that do concern psychological and self-fulfilment needs, for example through utility functions differing between individuals. Yet, utility is defined only in terms of how material goods are valued.
The problem is not the use of this assumption ipso facto but that this definition of utility as being formative for human happiness shapes economics and thus permeates into economic policy and shapes everyday economic interaction, set of beliefs, and society. Economics influences not only our access to basic needs but our psychological needs profoundly. It is fundamentally tied to the other social sciences in understanding and providing human prosperity. This is also why – how some economists may argue – the statement that “psychological needs” are not directly the responsibility of economists, is, frankly, wrong.
To equate utility with material goods worked great in times of material scarcity; for example after the two World Wars or in economically developing countries. Yet, in times of material over-abundance in developed countries, an economy governed by this principle may erode the fundamentals necessary for our psychological needs whilst over-providing materials for basic needs. As a famous – neoclassical! – economist pointed out, “the art in economics lies in judging when a simplifying assumption clarifies our thinking and when it misleads us” (Mankiw 2019).
The neoclassical definition of utility is neither a doctrine nor a depiction that is supposed to perfectly reflect human nature. It serves rather as a proxy, as an instrument in economic science to predict human behaviour as good as possible. Yet, it is a testimony of poverty that this oversimplified definition of what constitutes “human happiness” guides political goals and influences societal and cultural norms. When this assumption may erode, in the very long-run, the necessary focus on psychological needs whilst leading to an oversupply for basic needs, this assumption is misleading.
To put it simply, especially in developed countries with a robust welfare state the fixation on material goods seems outdated. The seemingly inherent truth to any ‘utility-maximization’ assumption only holds up if the accuracy of any definition of utility is constantly assessed, assessed, and assessed. Assessing utility with material goods as measure works (arguably) well in times and places of dire scarcity; however, in times and places of over-abundance, this assumption is inaccurate for many. It will, perhaps even lead us to orientate ourselves towards the wrong objectives. Mainstream economics should be open-minded for heterodox approaches that shift the emphasis from material goods as utility towards a broader definition of what constitutes “utility”. Many economic alternatives are already available – such as the doughnut economy, the Genuine Progress Indicator (GPI), or the economy for the common good. By starting at the root problem with changing the definition of “utility”, policy change will follow – to something more adequate than GDP maximization and achieving full employment.
Emma Eiermann is an open-minded, dynamic member of the German and European Green Youth and Green Party. She is particularly passionate about finding ways to reconcile the environment and the economy to avoid climate catastrophe. Emma furthermore loves to explore other cultures and is a strong proponent of a united and diverse Europe. She advocates against a culture of capitalism and for a global just transition towards a carbon-neutral economy.