Still dead after all these years — general equilibrium theory

6 Nov, 2014 at 10:47 | Posted in Economics | 4 Comments

General equilibrium is fundamental to economics on a more normative level as well. A story about Adam Smith, the invisible hand, and the merits of markets pervades introductory textbooks, classroom teaching, and contemporary political discourse. The intellectual foundation of this story rests on general equilibrium, not on the latest mathematical excursions. If the foundation of everyone’s favourite economics story is now known to be unsound — and according to some, uninteresting as well — then the profession owes the world a bit of an explanation.

Frank Ackerman

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 Frank Ackerman’s article — or Franklin M. Fisher’s 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 cannot really demonstrate that there are forces operating — under reasonable, relevant and at least mildly realistic conditions — at moving markets to equilibria, there cannot 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. As Ackerman writes:

The guaranteed optimality of market outcomes and laissez-faire policies died with general equilibrium. If economic stability rests on exogenous social and political forces, then it is surely appropriate to debate the desirable extent of intervention in the market — in part, in order to rescue the market fromits own instability.

4 Comments

  1. Last night I had a long conversation with an acquaintance about neoclassical economics being a fairy tail. We both agree on this. ok, It is politically managed economy what we have. And then there is this question of how can you morally justify capitalism if the fairy tail isn’t there no more? Now politicians can tell people that poor are not less worthy may be but it is their own fault and government cares but can’t do everything for them. When income distribution is a political choice, then you have to explain to those people (the disadvantaged ones) why the hell this political choice was made in the first place. I am not trolling, this is a serious issue IMO. End of capitalism? Until someone can solve this dilemma, Krugman, Mankiw etc will continue with ISLM and other bs.

    • It seems to me that wealth can buy power, including the power to increase one’s wealth, so capitalism has a positive feedback, which inheritance increases. This seems to have been essential to growth in Adam Smith’s time but now I think that we need to rely on our democratic institutions to remedy things. Piketty et al think that they are failing, and most commentators seem to think that the issue is all about tax and benefits, in which case there would seem to be no justification for capitalism other than the lack of a credible alternative. There seems to be a gap where the vision should be.

  2. I think there are good reasons to stick with an equilibrium assumption. Who doesn’t know that it is just an abstraction. Plenty of models have emerged that have done creative things with the equilibrium assumption. The critics against it seem to assume that there is some “realist” idea (theory) that offers a better alternative. I have yet to see it. This is one of the reasons I like Kartik B. Athreya’s Big Ideas in Macroeconomics and even the more convoluted book by Don Ross, philosophy of economics.

    • dewayne woods recycles Krugman correctly. in woods’s telling it is more obvious how stupid Krugman’s position is. the fact that people know that “all models are wrong but some are interesting” is not significant in and of itself. the question is, given all models are wrong:
      a. what is interesting about wrong?
      b. do economists properly limit the scope of their claims given what they know about the universal wrongness of models?
      Nothing and no.


Sorry, the comment form is closed at this time.

Blog at WordPress.com.
Entries and comments feeds.