Home > Uncategorized > Neoclassical economics is great — if it wasn’t for all the caveats!

Neoclassical economics is great — if it wasn’t for all the caveats!

from Lars Syll

I think that modern neoclassical economics is in fine shape as long as it is understood as the ideological and substantive legitimating doctrine of the political theory of possessive individualism. As long as we have relatively-self-interested liberal individuals who have relatively-strong beliefs that things are theirs, the competitive market in equilibrium is an absolutely wonderful mechanism for achieving truly extraordinary degree of societal coordination and productivity. We need to understand that. We need to value that. And that is what neoclassical economics does, and does well.

Of course, there are all the caveats to Arrow-Debreu-Mackenzie:

adb_poster_red_kickitover1   The market must be in equilibrium.
2   The market must be competitive.
3   The goods traded must be excludable.
4   The goods traded must be non-rival.
5   The quality of goods traded and of effort delivered must be known, or at least bonded, for adverse selection and moral hazard are poison.
6   Externalities must be corrected by successful Pigovian taxes or successful Coaseian carving of property rights at the joints.
7   People must be able to accurately calculate their own interests.
8   People must not be sadistic–the market does not work well if participating agents are either the envious or the spiteful.
9   The distribution of wealth must correspond to the societal consensus of need and desert.
10 The structure of debt and credit must be sound, or if it is not sound we need a central bank or a social-credit agency to make it sound and so make Say’s Law true in practice even though we have no reason to believe Say’s Law is true in theory.

Brad DeLong

An impressive list of caveats indeed. Not very much value left of “modern neoclassical economics” if you ask me … 

what ifStill — almost a century and a half after Léon Walras founded neoclassical general equilibrium theory — “modern neoclassical economics” hasn’t been able to show that markets move economies to equilibria.

We do know that — under very restrictive assumptions — equilibria do exist, are unique and are Pareto-efficient. One however 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 negligible. 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.

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.

And then, of course, there is Sonnenschein-Mantel-Debreu!

So what? Why should we care about Sonnenschein-Mantel-Debreu?

Because  Sonnenschein-Mantel-Debreu ultimately explains why ‘modern neoclassical economics’ — New Classical, Real Business Cycles, Dynamic Stochastic General Equilibrium (DSGE) and ‘New Keynesian’ — with its microfounded macromodels are such bad substitutes for real macroeconomic analysis!

These models try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent. That is, with something that has absolutely nothing to do with reality. And — worse still — something that is not even amenable to the kind of general equilibrium analysis that they are thought to give a foundation for, since Hugo Sonnenschein (1972) , Rolf Mantel (1976) and Gerard Debreu (1974) unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equlibrium solution.

Opting for cloned representative agents that are all identical is of course not a real solutionto the fallacy of composition that the Sonnenschein-Mantel-Debreu theorem points to. Representative agent models are — as I have argued at length here — rather an evasionwhereby issues of distribution, coordination, heterogeneity — everything that really defines macroeconomics — are swept under the rug.

Instead of real maturity, we see that general equilibrium theory possesses only pseudo-maturity.kornai For the description of the economic system, mathematical economics has succeeded in constructing a formalized theoretical structure, thus giving an impression of maturity, but one of the main criteria of maturity, namely, verification, has hardly been satisfied. In comparison to the amount of work devoted to the construction of the abstract theory, the amount of effort which has been applied, up to now, in checking the assumptions and statements seems inconsequential.

  1. Thornton Hall
    January 18, 2018 at 12:58 pm

    Look to Darwin and evolution. Newtonian metaphors for Darwinian processes are the problem. More than 100 years of this nonsense is very strong evidence that the heterodox critique is missing the mark in some crucial way, sharing the underlying wrongness of the orthodox:

    From “Why economics is not an evolutionary science” by Veblen:

    This is the deductive method. The formula is then tested by comparison with observed permutations, by the polariscopic use of the “normal case”; and the results arrived at are thus authenticated by induction. Features of the process that do not lend themselves to interpretation in the terms of the formula are abnormal cases and are due to disturbing causes. In all this the agencies or forces causally at work in the economic life process are neatly avoided. The outcome of the method, at its best, is a body of logically consistent propositions concerning the normal relations of things — a system of economic taxonomy. At its worst, it is a body of maxims for the conduct of business and a polemical discussion of disputed points of policy.

  2. Frank Salter
    January 19, 2018 at 11:19 am

    I am in total agreement with your comment

    Only when analyses are subjected to critical examination, which meet the necessary conditions required by the scientific method, will any concensus emerge. At present most discourse is at the level of “I disagree” not at the “your analysis fails the tests of scientific validity”. When validity is shown to fail, any repeated presentation of the disproved analysis should receive maximum censure of the authors and any peer review academics involved.
    Without this, the nonsense continues unabated.

  3. January 20, 2018 at 12:48 pm

    Not an inspiring story. My take’s a little different. A bunch of guys – yes, mostly men; most women are too sensible for such nonsense – wanting to be scientists but not measuring up to the IQ demands of science write down some random thoughts about how people buy and sell, and how markets function for this. They circulate these thoughts around to others just like themselves, then publish them in journals operated by others just like themselves with readership mostly just like themselves. What they don’t do is observe people who buy/sell or interview people who buy/sell. They consider such people irrelevant to the story they tell. They’re good at math, but not good enough to be mathematicians, so their thoughts often end up in equation form, with lots of graphics to go with the equations. Like their other thoughts, they check none of these equations/graphics with people whose job is buying/selling. They then insist that any deviations between their thoughts (now made into mathematical models) and how people buy and sell in markets must be corrected by buyers and sellers. Finally, based on the “success” of these models they offer (sometimes insist) their services to governments and businesses of all sizes and intents as experts on fixing markets and buying/selling. Many outside observers take them as sociopaths or at a minimum “village idiots.” In their own eyes, however, they are men of substance, scholars, and the saviors of western civilization. Don’t you just love salvation?

  4. Rob
    January 21, 2018 at 1:13 am

    Lars, add a space in “evasionwhereby” for clarity. Love the post.

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