The essence of neoclassical economics is a free market competition mechanism that yields prices whose fluctuations provide signals between demand and supply. According to these signals, the distribution of social wealth and the allocation of social resources readjust. In this process, commodity prices are determined by the market as are wages, interests, and land rents. There is no room for power in this economic process; power of all types subdues non-personified market effects. All decisions are the response to market orders. The limitation of neoclassical economics lies in its excessively idealistic presumptions and conclusions.
After Keynes, the neoclassical synthesis incorporates social economic reality. However, there is irreconcilable contradiction between market clearing and unemployment under this framework. Macroeconomics pays attention only to aggregate demand adjustment, while microeconomics is only concerned with the emergence of costs and prices. Macroeconomics and microeconomics are not necessarily connected, leading to a lack of individual rational choice based on macroeconomics, while microeconomics cannot explain macroscopic reality sufficiently. One cause of this phenomenon is an overemphasis on the formalization of economic theories. From Ricardo’s abstract deduction (1891) to Marshall’s economic modeling (1961), when economics became a science, the curse of formalism was entrenched. As neoclassical studies highlight the pure economic factors of social phenomena in the models, the relationship between individuals transforms into relationships between individuals and things, even between one thing and another thing, based on the rational choice of economic subjects in a market environment. The economic agent was completely materialized; there is no difference in labor, but the subjective initiative is ignored. As a result, economics has lost its vigor and become blackboard economics.
The formalization of economics has another deleterious consequence; economic research is completely separate from politics. Since Keynes, government intervention in the economy has always been the center of the argument. Neoclassical economics believes that the market mechanism will automatically lead to optimization of resource allocation, and government intervention will only bring deadweight loss to the economic system since the government has no better information than the market. The opposite opinion is that the economy cannot reach optimal levels through market mechanisms; even if it does have such capability, the adjustment will be long and painful. In fact, economy and politics were not initially separated, and economics was born out of politics. The purpose of classical economics is to formulate relative national policies based on economic research results to promote social development, which is the logical order according to old institutional economics. Galbraith (1992), the institutional economist, states that the attempt to separate the economy from politics and political intentions is completely meaningless; it obscures true economic power and its intention. This attempt to separate the two is also the main reason for economic decision errors and misjudgment. Pure economic theory that does not integrate the political environment and institutions will inevitably ignore the effects of political intentions on the economy. Such ignorance usually has serious consequences. In fact, there is no economic process that leaves behind the socio-political system or a pure political process that does not pursue benefits. The economy and politics are always со-mingled, and the relationship between them is not as simple as one of influencer and the influenced. Economic theories can provide politics with a decision framework, but they also do more. Government procurement and investment are economic acts in themselves. The government does not have to be the third party in the process of institutional change. Friedman (2009) believes that the economy and politics cannot be separated, and the political arrangement cannot be integrated with the economic arrangement all the time. Friedman argues that there are limited ways to integrate the economy with political arrangements.
Unlike neoclassical economics, new institutional economics emerges from the concept of the market mechanism and believes that transaction costs exist in the market. Therefore, there are other organization forms, such as firms that complete transactions, which completed the transformation by studying the relations between individuals and things with the relations between individuals. The starting point is Coase’s attempts to open the black box—firms. In his research, Coase raises the significance level of firms to that of the market and no longer treats firms as simply the supply side of products or the demand side of market production factors (Coase, 1995). We are still unable to define the nature of the firm because economists have not reached a consensus on this subject, transaction costs, or the relations between firms and markets after Coase.
Alchian and Demsets (1972) believe that the market is more universal than firms as firms are nothing but a complex set of market contracts. Production technology may require team production in some sense; however, for such a production process, the residual claims of firms can solve the monitoring and pricing problems of different production factors. Unlike the theory espoused in these studies, Williamson (1975) regards the hierarchy as the main feature that differentiates firms from the market and notes that it is obvious that the employment relationship differs from the equal transaction relationship in the market. The hierarchy weakens opportunism through an authority relationship. In other words, due to high market transaction costs, the firm mechanism can replace the market mechanism to solve resource allocation problems.
Later, Grossman and Hart (1986) suggested the residual control model based on Williamson’s work. One of the core viewpoints of both principal-agent theory and corporate governance theory is that operators possess residual control and private information after ownership and management rights are separated. Therefore, principals must select or design optimal contracts to overcome the agency problem. The principle of contract design and selection is that the arrangement of corporate power should unify residual claims and control (Grossman & Hart, 1986). Still, the reality is less ideal than people expect. In modern firms, residual control belongs to managers or human capital. Residual claims not only include the contribution of production factors but also risk. Human capital obtains residual control but cannot fully bear the risks. When operation losses threaten firms, those losses can only be made up by material capital even though human capital also bears the risk of future income loss. However, firm residuals cannot be naturally divided into two categories; that is, residuals for material assets that bear risks and those that correspond to residual control. It is safe to say that it is never possible for modern firms to have residual control unified with residual claims on a certain production factor. The reason for this lies in the concepts of residual claims and control. The concepts developed through a comparison of traditional and modern corporate systems can explain the evolution of corporate systems although they cannot solve the problems faced by modern firms.
In fact, although new institutional economics has begun to pay attention to the cooperation for mutual interests and the distribution process as economic subjects, the theory has indirectly explained the relationship between people through the relationship between people and things (Property right system and Corporate system). When institutions become the research object and, hence, endogenized, a more fundamental institutional system is required because only under this framework can the choice constraint be spelled out for economic agents. The secondary institutional change depends on the institutional environment, and fundamental institutional change is attributed to ideology and morale (North, 1990). New institutional economics only recognizes the importance of both institutions and their innovations in social economic development and has not satisfactorily answered the questions of how institutions originate and how they change.
The theory of institutional economics represented by Commons suggests that the determinant of resource allocation is not the market but the power structure under social institutions (Commons, 1934). Galbraith (1983) even states that economics is meaningless and unrealistic if the role of power is not considered. He notes that the economic behavior of modern individuals should be described as the pursuit of wealth as well as the pursuit of power. Consequently, economic theories that ignore social institutional structure cannot explain the reality of capitalism. According to different means of power operation, Galbraith (1983) classified three types of power: condign power, compensatory power, and conditioned power. The corresponding1 sources of power are personality, property, and organizations. In modern industrial society, organization, adjustment, and control are the main sources and means of exercising power. The allocation of resources, to a great extent, depends on a producer’s power that stems from the possession of production means.
In this respect, Galbraith and Marx have similar views. According to Marx (1911), there is never pure economics nor pure political science; the allocation of resources can only be carried out under given power relationships, and the basis of this power can be summarized as a means of production. Another similarity between Galbraith and Marx is that they both adopted the method of contradiction analysis instead of equilibrium analysis.
Marx (1911) claims that the contradiction and conflicts between productive forces and relations of production promote social development. Galbraith (1983) considers that the power imbalance between a planned economy and a market system thwarts a capitalistic society.
Both Galbraith and Marx conduct power analysis based on class, which is one of the main reasons they are not accepted by mainstream economics. Studies on the concept of power are limited to a narrow and specific scope, and their implications and significance have not been recognized practically (Acemoglu & Robinson, 2000, 2001; Palermo, 2000; Young, 2000). The situation has changed fundamentally only recently. Acemoglu2 (2005) believes that economic institutions are affected by other factors, such as political power, and depicts a complete framework of economic institutional change within which the major factor for institutional choice is the power possessed by every group involved. The source of such power comes from the form of political power as well as the actual political power. The former is endowed by political systems, and the latter is the power that can affect political decisions derived from economic resource distribution, essentially, economic power. The form of political power and actual economic power in the current period determine the political systems in the next period while the political systems determine the allocation of resources in the next period of economic development. This theory clearly notes that power plays a critical role in institutional change. It is the distribution of power that determines economic institutions, resource allocation, and economic growth.
Ren (2000) suggests the concept of power economics. He argues that western economics is reflected by the privately owned economic system and market competition, but the basis for the survival of western economics was destroyed by China’s unitary system of property rights and imperial ownership. Therefore, western economics cannot explain such a special economic institution. Ren believes that the analytical framework of power economics might help and hopes to establish an economic theory that is entirely different from western economics under the premise of a unitary property rights system and capable of explaining the history and reality in China. What Ren expounds is merely an economic explanation of power rather than a power theory of economics. This book argues that power plays the determining role for the existence of and change in institutions. Only when the significance of power is again recognized in social affairs can history be explained correctly (Russell, 2004).
Economic research is concerned with the interest relations among people. Whether a concept discusses market competition or transaction cost, such concepts cannot fully capture the relations. However, this is not the case with the concept of power. Power relations are mutual, and the exercise and realization of power depends on the choice of objects by power. The concepts of contracts, property rights, and institutions describe the interest relations between people, but they assume the existence of priori-super rationality or mandatory regimes, which weakens the explanatory ability of the concepts. Particularly, these concepts cannot explain where the institutions come from and how institutions change. Based on the above ideas, we suggest a power paradigm of economic studies based on a rethinking of both the neoclassical and old as well as new institutional economics. The paradigm is defined as an analysis of some problems according to a certain type of logic under certain assumptions and premises. The power paradigm of economic studies re-expounds economics from the perspective of power to provide a complete framework for studying economic reality. Such a paradigm reveals, in depth, the essential elements of economic activities and solves problems naturally, such as the fracture between macroeconomics and microeconomics and the relationship between economics and politics.
The power paradigm presented in this book focuses on the study of the concept of power and analyzes it in the context of three power games: the market, firms, and government. Such an analysis reveals the relations among power, institutions, and resource allocation mechanisms.