A Random Walk Down Maple Lane? A Critique of Neoclassical Consumption Theory with Reference to Housing Wealth

Abstract

The development of the permanent income/life cycle consumption hypothesis was a key blow to Keynesian and Kaleckian economics, and, according to George Akerlof, it ‘set the agenda’ for modern neoclassical macroeconomics. This paper focuses on the relationship of housing wealth to neoclassical consumption theory and, in particular, the degree to which homes can be treated collectively with other forms of ‘permanent income.’ The neoclassical analysis will be evaluated as a partly normative and partly positive one, in recognition of the dual function of the neoclassical theory of rationality. The paper rests its critique primarily on the distinctive role of homes in social life; theories that fail to recognize this role jeopardize the social and economic goods at stake. Since many families do not own large amounts of assets other than their places of residence, these issues have important ramifications for the relevance of consumption theory as a whole.

Acknowledgments

The author thanks Elizabeth S. Anderson, Philip Arestis, Steven Pressman, L. Randall Wray, and an anonymous referee for very valuable comments.

The author presented this paper at the 2006 Eastern Economic Association conference, where Giuseppe Fontana and other participants provided useful suggestions. He is also grateful to Ajit Zacharias for organizing that session. A conversation with the late Bernard Saffran provided the germ of part of the paper. Discussions with Edward Chilcote and Ellen Liebowitz resulted in improvements in the article. None of these individuals would endorse every statement in this paper.

Notes

¹ To be fair, Fisher was concerned with capital theory, and not merely consumption, in the sense that he did not take income as given, as have many consumption theorists since him. So, modern economists who cite Friedman and Modigliani and Brumberg are not being unreasonable in neglecting Fisher, the Austrian capital theorists, and other previous intertemporal economists. Consumption theory as distinct from intertemporal theory in general was largely stimulated by Keynes's work, which postdated the development of capital theory. Of course, modern textbooks and articles have freely combined Friedman and Modigliani and Brumberg's thought with ‘capital theory,’ in the form of production functions, and in fact, textbooks tend misleadingly to place consumption theory prior to neoclassical capital theory (such as it is), reversing the order in which the two fields historically developed.

² Graduate textbook macroeconomics almost literally matches this ideal type (Obstfeld & Rogoff, 1996).

³ A related issue is whether homeowners are like capitalists because they hold a large asset. This claim is sometimes made, but convincing arguments have been marshaled on the other side (Lauria, 1976; Wray, 2005).

⁴ This argument agrees with Redmond (2000) in stressing the importance of a non-neoclassical form of rationality based on values; but it places greater emphasis on the plurality of goods and values, as opposed to Redmond's somewhat dualistic contrast between an instrumental rationality and a moral rationality. Redmond cites the thought of Weber and Etzioni. Both of these authors do the service of emphasizing that neoclassical rationality is not the only, or best, account of rationality. Both adopt dichotomies that may attenuate the range of values at stake in consumption choices. Weber separates affective considerations from rational behavior. On the other hand, Anderson's ‘pluralist/expressive theory’ says that actions express the attitudes (feelings) we rationally have toward the goods at stake. Etzioni, on the other hand, contrasts a rationality of economic values and moral ones, which involve commitment or obligation. This view is strongly influenced, in turn, by a Kantian dual-good model, which concentrates on matters of obligation and duty. But Anderson (1993) believes that non-economic values come in many forms, not just duty, obligation, or morality. This paper, for example, in arguing for a separate mode of valuation for housing, makes no claim that it would be immoral to reject the ideal of homeownership or that homeownership is an obligation. On the other hand, the model adopted later in this paper does emphasize obligations incurred once one has established a home: obligations to help neighbors and to help maintain the community. Nevertheless, the affinities of this paper for Redmond's outnumber the divergences.

⁵ A referee suggests that houses may fall in the category of status symbols more than bonds in part because they are consumption goods, not just investments. In this respect, the phenomenon I discuss here is a form of conspicuous consumption. Two aspects of housing make it a particularly good item for a public display. First, like cars, houses are especially expensive. Second, it is virtually impossible to hide a house; financial assets are not publicly visible, and taboos prohibit displaying them in most instances, unless the owner appears in Fortune magazine or similar media. Perhaps if such taboos did not exist, financial assets would be visible status symbols, even though they are not consumption goods.

⁶ Elizabeth S. Anderson has suggested to me that new markets in housing futures and options (Case et al., 1992; de Aenlle, 2004) might reduce the weight of homes in consumer portfolios and so reduce problems of ‘white flight’ and self-fulfilling expectations of declining home values. Most such instruments relate to indexes of real estate values in an entire urban area or region. Futures or home equity insurance for individual homes would introduce severe problems of moral hazard and fraud, however. If capital losses in homes can be recouped from insurance companies or financial markets, incentives to engage in ‘proneighborhood’ efforts would be reduced. Insurance for citywide fluctuations in home values would be immune from such problems, but it would be of little help for the problems of individual neighborhoods.

⁷ This phenomenon has been used lately to explain why consumption appears to drop upon retirement. It turns out that when flows of consumption from homes are included, this drop may be smaller than previously thought (Fisher et al., 2005).

⁸ I thank Elizabeth S. Anderson for this point.

⁹ I believe Barry Schwartz was the first to give me this example, or one like it.

¹⁰ See Obstfeld & Rogoff (1996) for an example. The use of a homogeneous form of value has been one strategy used to circumvent in capital theory problems associated with multiple produced means of production. Philip Mirowski (1989) has discussed the use of ‘conservation laws’ for homogeneous substances throughout the history of economics.

¹¹ This argument was first called to my attention by the late Bernard Saffran in about 1984.

¹² It is perhaps important not to overemphasize recent change. Transactions costs for liquidating a house are still much higher than for selling securities. But this also casts further doubt on the original homogeneity thesis.

¹³ Viviana A. Zelizer (1994) has perceptively described how different social categories of money are given, stored, allocated, understood, and honored in different ways. For example, women's ‘pin money’ (a hoary term for their own earnings) has (especially in the not-to-distant past) been constructed as frivolous and inessential for the support of the family. Similarly, we argue that housing wealth is in a different social category from other assets and should therefore be treated differently.

¹⁴ It is important to emphasize here that notions of the best life for community and the individual are what is at stake here. In most cases, these do not amount to issues of right and wrong. Further, conceptions of the good forwarded here should make allowance for the uniqueness of individuals and the wide variety of their potential social contributions.

¹⁵ ‘Maintaining’ or ‘preserving’ a community and keeping its residents in place may seem at times to conflict with the ideal of a racially and ethnically integrated society. Some may seek to deploy these terms to prevent social progress, but there is no reason why they should necessarily imply a continuation of economic and racial and ethnic segregation. A complete neglect of the need to maintain communities may be just as harmful to the objectives of integration as deliberate efforts to keep certain residents out. Introducing minority group members into predominantly white neighborhoods should be viewed as part and parcel of other activities that aim to increase the quality of residential areas.

¹⁶ There is a long tradition in economics of attempting to explain differences in behavior by differences in constraints, rather than differences in objective functions (Stigler & Becker, 1977). But in doing so, economists neglect an important function of policy: to encourage various commitments that have social and individual benefits.

¹⁷ Note that Minsky's Ponzi finance primarily related to firm spending, rather than consumption.