Instability – not stability – is what defines our economies

24 September, 2012 at 12:58 | Posted in Economics | 1 Comment

With an almost religious conviction many neoclassical economists seem to still think of modern market economies as being in a blissful state of stable equilibrium. How that is even conceivable today – in the fifth year of the latest economic and financial crises that started back in 2008 – is really beyond my wildest imagination.

And it was also beyond the imagination of  Dan Kervick, who last week wrote an interesting article – Shamanistc Economics - lambasting neoclassical economists for this unfounded theoretical assumption.

Canadian neoclassical economist Nick Rowe was not pleased and wrote a more than usual pompous and condescending comment, telling Kervick that “before writing about this stuff” he really did ought to think about the difference between “a system with multiple equilibria … where befiefs about intrinsically irrelevant events can change which equilibrium is the outcome” and a “dynamic system with a unique equilibrium time path, where beliefs about that future equilibrium path are part of what determines the current outcome.”

Kervick was non-plussed. His answer is a good read:

You guys in economics are supposed to be empirical scienctists, not philosophers. You are supposed to develop the a priori elements of your science only so that you can produce empirically testable models of the real world, and then bring those models to bear on the world we actually live in. You are also supposed to help develop techniques that are relevant to decision-making and govenment policy in having predictable outcomes. You need to map the terrain of the actual world in detail, so you can help others navigate through it. To the extent you want to give policy advice that deserves to be taken seriously, your focus needs to be on contingent reality, not a priori possibility.

My criticism is that an awful lot of the policy advice we are getting lately is from theorists who are lost in the clouds of a priori models, and who don’t have a clear understanding of the structure of the actual economic order we live in, based on the functioning of actual, highly contingent and specific economic and political institutions.

If you are trying to navigate your way through a mountain range, you don’t ask a geologist; you ask a guide who has explored the mountain range in detail. If the guide has geological knowledge that can definitely help, but the geological knowledge itself is not sufficient to guide people through the terrain. If you want to fix a broken airplane engine, you don’t ask a theoretical thermodynamicist, you ask an engineer. The engineer’s knowledge of thermodynamics can help, but the thermodynamical knowledge itself is not sufficient to know how to fix an airplane engine.

It is not enough for you to desciibe logically coherent possible worlds with possible sets of beliefs about possible equilibria and possible time paths to those equilibria, where possible statements, and possible ections have possible effects as a result. You need to show we live in such a world – and this is a task for which you don’t seem to have much patience. When challenged on the score of institutional facts, you have repeatedly retreated back into the contruction of other models and thought experiments.

Almost a century and a half after Léon Walras founded general equilibrium theory, economists still have not been able to show that markets lead economies to equilibria.

We do know that – under very restrictive assumptions – equilibria do exist, are unique and are Pareto-efficient.

But after reading Franklin M. Fisher‘s masterly article The stability of general equilibrium – what do we know and why is it important? one has to ask oneself – what good does that do?

As long as we cannot show, except under exceedingly special assumptions, that there are convincing reasons to suppose there are forces which lead economies to equilibria – the value of general equilibrium theory is nil. As long as we can not really demonstrate that there are forces operating – under reasonable, relevant and at least mildly realistic conditions – at moving markets to equilibria, there can not really be any sustainable reason for anyone to pay any interest or attention to this theory.

A stability that can only be proved by assuming “Santa Claus” conditions is of no avail. Most people do not believe in Santa Claus anymore. And for good reasons. Santa Claus is for kids, and general equilibrium economists ought to grow up, leaving their Santa Claus economics in the dustbin of history.

Continuing to model a world full of agents behaving as economists – “often wrong, but never uncertain” – and still not being able to show that the system under reasonable assumptions converges to equilibrium (or simply assume the problem away), is a gross misallocation of intellectual resources and time.

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  1. There is complete confusion over the divergent goals of equilibrium vs. navigating unpredictable survival paths. Pity that economists study reality starting from an entirely anthropomorphic point of view.

    http://mikenormaneconomics.blogspot.com/2012/08/economics-gaping-separation-between.html


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