The cost of focusing on general equilibrium theory
from Lars Syll
The largest problem with the economics profession’s focus on general equilibrium theory is the opportunity costs of that exploration. Important policy problems are not addressed. Consider Pareto optimality and the welfare theorems, which Fisher sees as the underpinnings of Western capitalism. In a world, such as ours, where property rights cannot be allocated effortlessly and costlessly, economist’s welfare theorems have little policy relevance. Does a policy maker care whether any Pareto efficient allocation can be decentralized as a competitive general equilibrium? The chance of discovering a real-world Pareto optimal policy that can be shown to harm no one in some infinitesimal way is essentially nil.
By focusing their theoretical policy analysis on Pareto optimal policies, economists avoid coming to grips theoretically with the messy value judgments that must be made in the policy space, which means that their theoretical models provide little guidance on how to deal with the messy problems of actual policy that are designed to achieve both efficiency and fairness. In its almost exclusive focus on efficiency, modern economists have moved away from Classical economist’s utilitarian moral philosophy that underlay Classical economist’s support of markets. Classical economists supported markets because they worked reasonably well in the real world, not because of any deductive proof of the benefits of markets.
In his paper of 1972 The Irrelevance of Equilibrium Economics (in The Economic Journal), Kaldor started his paper by this statement:
>>The purpose of my lecture today is to explain why, in my view, the prevailing theory of value-what I called, in a shorthand way, ” equilibrium economics “-is barren and irrelevant as an apparatus of thought to deal with the manner of operation of economic forces, or as an instrument for non-trivial predictions concerning the effects of economic changes, whether induced by political action or by other causes. I should go further and say that the powerful attraction of the habits of thought engendered by ” equilibrium economics ” has become a major obstacle to the development of economics as a science-meaning by the term ” science ” a body of theorems based on assumptions that are empirically derived (from observations) and which embody hypotheses that are capable of verification both in regard to the assumptions and the predictions.
Collander concluded his paper cited by Lars Syll as follows:
>>In conclusion, formal general equilibrium analysis is largely irrelevant to policy. In fact, the general equilibrium approach has the analysis precisely backwards. There is no need to prove that a decentralized system can exist or is best. We have a partially decentralized system that has evolved into a mixed system in order to assure continued existence. The policy question involves that real-world mixed system. The relevant policy question involves the nature of, and how much, centralization, and non-market coordination is needed to make our evolving decentralized system work. Theoretically that is a question that cannot be answered generally. But, by blending an understanding of markets with a study of history and institutions, it is a question that economists can shed light on.
Compared with Kaldor (1972), Collander’s conclusion is a big retreat, because Collander implicitly admits the relevance of General Equilibrium Analysis (GEA) as a scientific theory. What he contests aginst is its policy relevance. He admits that the GEA is a valid theory of decentralized or market economy. This is what is claimed by Frank Hahn in his Inaugural Lecture in 1973 as “the most important intellectual contributions” of economics” (Hahn 1984 p.64). Kaldor contended that equilibrium economics is irrelevant as “an apparatus of thought to deal with the manner of operation of economic forces”. Colander could only argue against GEA as a tool of policy making. He could not show how and why the GEA is wrong as scientific theory. A big retreat, isn’t it? I wonder why Lars Syll copied and pasted a part of Collander’s paper in his blog. Is he thinking that the biggest problem of the mainstream economics is only a policy irrelevance?
Yoshinori, it seems to me you are reading into Collander an implication (of the relevance of General Economic Analysis) which doesn’t exist: which in fact is being politely denied. Besides, we have here two lines of argument which are complementary rather than competitive. Why opt for one only?
I could not have said it better Dave. But your observation was exactly what I thought upon reading Yoshinori’s comment. One can, as Lars has done in his selection of quotations, agree with a specific point, without commenting on (or necessarily agreeing with) other points on the same essay.
Dave and Rob,
please read my reply at August 27, 2018 at 2:36 am.
If only your economics bods would focus like engineers do on the fact that equilibrium is a phenomenon created by inherent stability, and one which is never in perfect balance, all this discussion would be unnecessary!
I find it difficult to comprehend the extent of the mumpsimus of academic economists. My paper “Transient Development” passes the strong tests of both Poppler and Lakatos for validity. In predicting the characteristics of production, it is a counter example to equilibrium theory. Physically valid treatment of time is the key. The natural units of production are classical. It meets all the requirements of Occam’s Razor. Yet so far only Professor Yoshinori Shiozawa has seen any merit in it. Is it that the mathematics, well known in physics and engineering, are too unusual?
Transient analysis is how economic analysis will be conducted in the future. It works!
Nice word, Frank: “mumpsimus”. Never having heard it before, I had to look it up in my old dictionary, and found “an error cherished after exposure”. Delicious!
What was equally interesting was the origin of the word: apparently “An ignorant priest’s blunder (in an old story) for L. ‘sumpsimus’ we have received, in the mass”. The ignorance was actually on the part of the story-teller, for ‘substance’ as understood by Aristotle was not material but meaning (as in “the gist or substance of what someone was saying”), and the gist of Christ, the Word expressing the love of God, being received as heavenly food in the mass, is its conveying the same meaning in another language.
I’ll take a very practical approach, that of measurement. We have many definitions of employment/unemployment (largely number of hrs worked, in work force or not) as well as income (largely all those fringe benefits, how to deal with stock ownership). And the how do we measure price averages & interest rates of infinite variety? Without accurate & clear measurements there is no way we can test any hypotheses we may lay on the table, or am I wrong?
To Professor James Beckman, Germany
From my practical experience in the real world and the logic gained from it you are definitely right. I also support Frank Salter’s comments and reference to Professor Yoshinori Shiozawa.
In addition to earlier comments just now, including one on the necessity to avoid unhelpful confusions, I will only add the following from an undeniably genius of a man, Einstein.
“I wished to show that space-time is not necessarily something one can ascribe a separate existence, independently of the objects of physical reality. Physical objects are not in space, but these objects are spatially extended. In this way the concept “empty space” loses its meaning. In the note to the fifteenth edition of Relatively in English, the words in space and empty space are italicised, which my machine does not allow me to do. What wisdom! What humanity! What humility! I wish one could be a fraction of him, regardless of race, class or gender, or geography – Universal.
Great guy though Einstein was, he was wise enough to say it is “not necessarily” the case that “Physical objects are not in space, but these objects are spatially extended”. It might be less misleading to say that the objects are spatially localised; it is the spatial relationships between them that are extended.
What I want to say is simple. It is not good to cite this part or that part which supports ones own opinion. If economics is a science, it is a system of knowledge. It must be judged as such.
I feel there is a wide spread misunderstanding that we can evaluate economics by its policy implications. In reality, theory and policy are almost independent. It is rare that a theory produces one unique policy. Such a misunderstanding rarely occurs in natural sciences. It is also strange that a people who accuse economics to have wrongly imitated physics have a strong tendency to judge a theory by so-called policy implications.
So let’s not leave the economists out of economics. Would that scientists were always devoted to truth, but too many are more devoted to furthering their own ambitions. There is, sadly, fake science as well as fake news, especially when policy makers are also paymasters. Theory and policy are not independent if euphemisms, half-truths and misrepresentations can be used to divert attention from the real motives and wilful ignorance of policy makers.
I agree. Segmented descriptions, segmented models, and segmented conscience lead only to segmented confusions. This type of confusion is the worst type, because it is too focused on nothing and as such misses everything. It needs to stop. If these people (any of them) did have a conscience, let all this rest on theirs. If they did not, I hope they will remember this dialogue at their next seminar or public meeting.
Yoshinori wants a consequence free economics; to sit in an ivory tower and propose theories, which are then supposed to guide policy decisions, yet be immune from the consequences of those theories and their resulting welfare/illfare. Economics is not a natural science, it is social science, and removing the human being (culture, indeterminacy, etc.) is the attempt to turn it into a form of social physics. Dave is correct, “theory and policy are not independent,” and this is proven conclusively by the 2007-2008 GFC.
To claim that economic theory is not related to or influencing economic policy is, frankly, ludicrous and to flat out deny or turn a blind eye to empirical evidence and witness testimonial of those who admitted as much, e.g., Alan Greenspan:
In my view, Dave is right again, let’s not leave the economists out of economics. The scientist, not science, perceives the reality of an ever changing socially constructed economic reality reified as the ‘the market’. In my view, it is philosophical naivete that leads to such silly claims as theory is independent of policy when in fact theory is used to justify policy.
Theory lead Greenspan to not intervene to prevent the GFC. He was a faithful devotee of the religion of ‘logic-centred’ economics, despite clear signs where we were heading.
It is possible to show that a specific market in a specific time and place creates results that benefit some actors and not others. It is also possible to show that a specific non-market in a specific time and place creates results that benefit some actors and not others. How do we choose which route to follow? Human judgement. Neither mathematics, logic, nor empiricism of any sort is an escape from this obligation.
The Marx Brothers always figured it out before the rest of us.
From “Duck Soup”
Mrs. Teasdale: Your Excellency! I thought you’d left.
Chicolini: [Impersonating Rufus T. Firefly] Oh, no, I no leave.
Mrs. Teasdale: But I saw you with my own eyes!
Chicolini: Well, who you gonna believe? Me or your own eyes?
It’s always the same whether in everyday life or science. Accept what we think we see or what we’re told by others. Life is difficult.