General equilibrium theory — still dead after all these years
from Lars Syll
Raphaële Chappe has written a very interesting article about the value of general equilibrium theory, concluding in the following words:
For a student of real world markets, general equilibrium theory appears strangely distant. It is not surprising that a highly abstract framework consisting of hyper-rational agents might be ill equipped to provide a sufficiently credible account of markets in modern capitalism. What is more surprising is that despite these obvious limitations (some even claim that general equilibrium has been “dead” since the Sonnenschein-Mantel-Debreu results in the 1970s) the framework is still central to the Ph.D. curriculum, and continues to play a preeminent role in the high theory of economics. To the extent it shows the limits of the way of thinking, this is fair enough, but that is not how the subject is approached, by Mas-Colell/ Whinston/Green or any other major text. Is this an example of the greater importance given in our ‘science’ to the rites of justification than to the task of explanation? When a way of thinking limits our thinking then it’s time, with due appreciation for those who built it, to ‘throw away the ladder’.
The economist considering general equilibrium since the SMD results dead, is Frank Ackerman, and this is what he has to say on general equilibrium:
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.
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 Ackerman’s and Chappe’s articles 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.
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 from its own instability.