Home > The Economics Profession > Instability – not stability – is what defines our economies

Instability – not stability – is what defines our economies

from Lars Syll

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.

  1. October 3, 2012 at 1:34 pm

    You are correct, belief in equilibrium is religious. A major problem for people is accepting that all warm blooded creatures will become extinct quite soon; including, of course, humans. Another major problem is comprehending what happens if uncountable gigatons of methane suddenly release into the atmosphere (it’s already happening hugely but could start happening more hugely tomorrow). None can find equilibrium in this without a complete change of direction, which is itself disequalibrium.

  2. Claude Hillinger
    October 3, 2012 at 1:43 pm

    Economists who identify themselves as ‘heterodox’ generally reject neoclassical economics as being based on completely unrealistic assumption and lacking any empirical support. If that is so, what does the failure of neoclassical economics to prove the stability of general equilibrium under plausible assumptions imply? Exactly nothing! Certainly not that the real economy is unstable.

    • Paul Schächterle
      October 3, 2012 at 3:47 pm

      Amen to that!

    • October 4, 2012 at 12:18 am

      So you think the real economy is stable?

      • Paul Schächterle
        October 4, 2012 at 1:47 pm

        First let me state that I am very bad at recognizing irony.
        So if this was a joke: Good one!!! :D
        If not let me try to clarify:
        Neoclassical theorists claim that from a set of axioms (A) follows a state of equilibrium (E).
        A ==> E.
        It is questionable whether from those axioms also follows the stability of this equilibrium (S).
        A ==> S?
        If we assume that stability can’t be deduced from those axioms,
        A =/=> S,
        this still does not necessarily mean that you can deduce a state of instability (I) from those axioms.
        (A =/=> S) =/=> (A ==> I).
        If you are heterodox economist, you will probably say that the axioms of neoclassical theory are false (or “unrealistic”) in the first place. Those axioms do not apply in the real economy.
        ¬A.
        Thus any deductions from A are worthless. Neoclassical theory can’t tell anything about the real economy, neither if there is an equilibrium, nor if it is stable or unstable.

      • October 4, 2012 at 3:44 pm

        Interesting. E = A is an equation made famous by China Mielville in Un Lun Dun. Millions of children are familiar with this equation as Effluence = Affluence, the calculation of profit in otherwise unprofitable corporations.

      • October 5, 2012 at 1:55 pm

        But isn’t the observation of recurring instability the reason we are having this debate?

      • Paul Schächterle
        October 5, 2012 at 5:38 pm

        Personally I agree that we can observe that the real economy is unstable.

        Independently from that observation this blog post however uses a flawed argument and was therefore criticized by Claude Hillinger.

        Lars Syll basically said: Neoclassical theory can’t “prove” that the economy is stable. It is therefore a useless theory.

        If you think that the real economy is in fact unstable this argument does not make any sense. On the contrary if neoclassical theory proved stability it would be even more contrary to the facts.

        Finally if you think that neoclassical theory is, frankly, pointless nonsense, then it is completely irrelevant whether neoclassical theory predicts stability or not.

        We should forget neoclassical theory and develop a good theory, which is one that can explain the observed instability.

    • robert r locke
      October 4, 2012 at 7:47 am

      The issue is not the economy but the neoclassical economists. They are clueless.

      • Alice
        October 4, 2012 at 12:43 pm

        Yep

      • Alice
        October 4, 2012 at 12:48 pm

        The problem is even marketing and advertising does a better job of sudying the behaviour of humans than economics.
        The difference? Advertising research studies real people.
        Modern neoclassical economics firstly invents the people and then invents the research based on invented people.

        At least (for god’s sake) Advertising studies real people.

        That is why modern economics is such a joke.
        They could start with studying real people instead of inventing fake “agents”.

        So far off track I just dont know how you can call the nutters who run the econ madhouse…even “academic” researchers.

  3. Bruce E. Woych
    October 3, 2012 at 3:42 pm

    Instability drives price theory and crisis driven debt has pushed debt driven crisis into a tailspin of opportunity for private equity interests to continue progressively advancing an unsustainable (yet ironically still growing) “wealth” class of luxury driven private markets: ,,,isn’t this “equilibrium” of sorts?

    What a shame that the Naked Capital article links Voodoo Economics at this latter end-stage of supply side snakeskin business logic to some level of a shaman’s role in society. An unfortunate analogy from an anthropological point of reference.

    Voodoo economics is supply side failure and profiteering;… is all about deception, miosinformation, inside trading, asymmetrical information and corruption; about collusion and power; about class warfare and domination under false pretenses and about crony capitalism writ large. The “heterogeneric” or “epigenetic” or empirical-based fact checking heterodox attack would probably fall upon deaf ears if you associated this false economy of the popular “psychology” of markets…”confidence” under veil of secretes and “spirits” within Stock Market mentality (another popular version written into the script of the money “mange” infestations of this flea bitten “neo-classical” dog…but that’s another story…)…perhaps better suited for Wall Street Shamans and Frauds in an economic “World View” counter-balancing between irrational markets and rational choice theory…witch craft more than Shamanism!). Outcome based rationalizations for an increasingly rationalization process that is separating wealth and austerity; or stability and instability that legitimates a new norm of austerity as rational equilibrium corrections. How stupid does it get?

    But let me digress from the distraction of the frame to get to the core of the matter.
    This is “asset seizing” behavior as sure as “land grabs” exist around the world …and financed by fiat money that has been fueling the buyout of American infrastructure…a product of aggressive and run away privateering …private equity…legitimating itself and sustaining its profiteering heights like a mafia tribal power lineage. After bankrupting the system…The 15 Trillian dollar seepage from the Occult (“asymmetrical information” in action) Federal Reserve…coupled with the now normative machinery of counterfeiting finance under “bailouts” with money that has no real “asset” value…and for what?…of course to secretly BUY UP the real assets so that down the road the foundation for elite supremacy will be successfully secured!

    You call this Shamanistic Economics…? This is high civilization at its corrupt best…conquest at occult financial machinations of the currency controls; and perhaps best seen as co-opted public wealth by tactical covert ops at the mass control fraud levels.

    The world is being made safe for capital controls and atrocities covered by stealth and austerity measures to manage unsustainable wealth with intensive billionaire stages of restructuring society.

    Heterodox exposes are long overdue. Theory rationalizes existing scale and misses the ultimate control fraud over ecological resource control fraud and monetary ratios of privatizing economics as a wealth system of libertarian free market tyranny.

    Until heterodoxy begins to whistle blow the top elite processes of economic globalization, it will get no where complaining that main stream economics (servant to the process) is getting away with “murder” by “other” means.

    • October 3, 2012 at 5:21 pm

      “Actively Purchasing the Family Jewels” is an ad that appears almost daily in the local papers of western Massachusetts. The same ads appear on the fold-out child’s seat on supermarket shopping carts.

      My translation is,

      “Aggressively converting keyboard stroke virtual digits into family jewels, land, public assets and anything else of value … inquire within.”

  4. Bruce E. Woych
    October 3, 2012 at 4:12 pm

    The fallacy of “Creative Destruction” should have been critically and comprehensively assessed long ago. The validity of equilibrium in closed or open system is quantitative and not qualitative.

    Destruction is equilibrium seeking behavior…and the relationship between closed and open systems have their definitive inter-relationship between a dynamic process that includes static equilibrium being disrupted by dynamic disequilibrium in constant revision.

    • Bruce E. Woych
      October 3, 2012 at 9:48 pm

      Both POSITIVELY AND NEGATIVELY…; indifferent to outcome but potentially directly subject to intentionality and never impartial!

  5. October 3, 2012 at 11:39 pm

    Many (many…) years ago – when I still remembered how to program computers using «classical« programming languages (Cobol & Fortran-like…) – I wrote an algorithm to demonstrate the falling tendency of the rate of profit. The resulting rudimentary «model» showed and oscillating behavior of the economy (and employment) with a period that depended on the rate of real investment that, curiously enough, almost coincided – graphicallt – with the «long wave» of Kondratiev. In other words a logical proof of the system’s inherent tendency for disequilibrium…
    More recently, with the help of a colleague (a PhD student in the «Complexity Sciences» program at ISCTE – the Lisbon University Institute) and using «agents based» techniques and «object oriented languages», we developed another rudimentary model (no funds available for fancier and more ambitious endeavors…) that allows for the operation of intervening factors that help explaining the influence of institutional variables and that shows that both Okishio and Marx were both right even if they defended opposite views regarding the behavior of the rate of profit.
    Go figure…
    Most conventional «economists» would do well reading Hegel’s «The Science of Logic»…
    8-)
    Sociologically yours
    Fonseca-Statter

  6. Bruce E. Woych
    October 4, 2012 at 2:34 am

    http://baselinescenario.com/2012/10/03/fiscal-confrontation-and-the-declining-influence-of-the-united-states/
    The notion of (political economic) “balance of power” in global economic realms is directly linked to the idea of market equilibrium and hierarchical counterbalances at different magnitudes in our domestic economies or private scope and public scale.

    Why is it that “economists” have not explained these empirical realities and instead we go back to prefabricated theory to disguise the realities that confront our everyday survival?

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