Critical inspiration

11 July, 2016 at 09:28 | Posted in Economics | 4 Comments

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Almost a century and a half after Léon Walras founded neoclassical general equilibrium theory, economists still have not been able to show that markets move economies to equilibria. What we do know is that — under very restrictive assumptions — unique Pareto-efficient equilibria do exist.

But what good does that do? As long as we cannot show, except under exceedingly unrealistic 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.

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.

In case you think this verdict is only a heterodox idiosyncrasy, here’s what one of the world’s greatest microeconomists — Alan Kirman — writes in his thought provoking paper The intrinsic limits of modern economic theory:

If one maintains the fundamentally individualistic approach to constructing economic models no amount of attention to the walls will prevent the citadel from becoming empty …

kirman[The results of Sonnenchein (1972), Debreu (1974), Mantel (1976) and Mas Collel (1985)] shows clearly why any hope for uniqueness or stability must be unfounded …

The idea that we should start at the level of the isolated individual is one which we may well have to abandon … we should be honest from the outset and assert simply that by assumption we postulate that each sector of the economy behaves as one individual and not claim any spurious microjustification …

Economists therefore should not continue to make strong assertions about this behaviour based on so-called general equilibrium models which are, in reality, no more than special examples with no basis in economic theory as it stands.

Getting around Sonnenschein-Mantel-Debreu using representative agents may be — from a purely formalistic point of view — very expedient. But relevant and realistic? No way!

Although garmented as a representative agent, the emperor is still naked.

4 Comments »

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  1. The equilibrium condition is an asymptotic one like parallel lines meeting at infinity. This extrapolation is important, although the practical expression of it is simply a tendency and when it is towards equilibrium then the system is stable. Naked emperor or otherwise, we don’t have to look to understand the concept of bespoke tailoring. Like the child who voiced his opinion about the emperor’s lack of attire, the obvious failure of our social system to reach equilibrium does not spoil its idealization.

  2. I dont think economists will abandon logic, regardless of the consequences. The only time you see clearly what a mistake it is to base theories on individuals is when looking at species survival over multiple generations. Difficult to model with logic unless you use agent based modeling.

    • Whats wrong with agent-based modeling? I find it the best, because it can be set to represent functions and not individuals. Then this enables great reductions in the complexity and better understanding of what is happening.

      • I don’t think anything is wrong with ABM but it isnt frequently used. I think the theory and the tools are still very primitive.
        Conways game of life isnt exactly an ABM but shows why ABMs arent used more frequently. CGoL has only 4 simple rules but the emergent behaviour is unknown and impossible to predict (unless you run the simulation).


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