General equilibrium theory — a gross misallocation of intellectual resources and time

15 August, 2015 at 10:30 | Posted in Economics | 2 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.getbourse 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 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.

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  1. I am not so sure that general equilibrium theory was useless, but the response to its admittedly abstract insights has been decidedly curious. Particularly in the early 1960s, it seemed as if ge theory would be the theoretical equivalent of a contrast medium, introduced as an inert idea of the economy, into the systematic observation of the actual institutionalized economy, as a way of highlighting the structural features of the institutional economy and providing the contrast necessary to illuminate the functions of the institutional structure.
    .
    Common-sense intuition, which was certainly apparent in the suggestions offered by Arrow, for example, post-Nobel, seemed to be to notice that the actual economy bears no resemblance to the market economy of ge theory. In fact, on the basis of observation alone, no one would be justified in describing the advanced economies as “market economies” at all, actual as opposed to purely metaphorical markets being rare and exceptional: prices are reached not by tatonnement but rather by administrative process in the presence of cost structures (e.g. increasing returns) that suggest no “market” clearing equilibrium would be possible, even if we were able to conjure a counterfactual market to govern the allocation of resources in place of actually existing corporate bureaucracy. Noting an economy of markets and hierarchies actually existing, with a preponderance of hierarchy, one might have hoped for curiosity.
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    Instead, for whatever reason, economists marginalized institutional approaches, and continued to insist on ge as analog and even simulacrum, despite the abundant indications that the actual economy does not work in that way, is not especially governed by market-clearing prices. The simple and apparent truth that prices are administered is admitted only indirectly in the highly stylized and ad hoc articulation “sticky prices” and “menu costs”. Instead of a useful contrast, many economists insist on a sterile denial of and disinterest in observable facts. Odd, that.

  2. Like all fairy tales, the GET serves at least a didactic purpose if nothing else.


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