General equilibrium

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What Would Smith Say?

Sometimes I pity poor Adam Smith. I really do. He’s an accidental icon of all that’s wrong in economics. And let’s face it that’s a lot of wrong to be an icon of. How many times have we all been reminded that his metaphorical reference to an invisible hand performing some wild and strange magic is the root of most modern economics? And how often are we reminded that he used those words just once in a book of over eight hundred pages?

The invisible hand was just not that important to Smith. He didn’t mean to launch economics into a century or more of quixotic and ever more bizarre search for something that he meant as a passing reference to the superficial order he saw around him.

Smith spent no more time on the invisible hand metaphor than he did on other phrases that are much more concrete. How about this one:

“Regulation is in support of the workman, it is always just and equitable.”

Where in the corpus of mainstream economics is this phrase worked up into a fully fledged and extended effort in the manner that the throwaway reference to the invisible hand is?

Well we don’t need to explain much further: economics was and is an extension of politics. It is politics waged by other means. It doesn’t exist as a coherent entity, it exists as variations to be deployed preferentially to support some other argument. And that other argument is usually political.

So early economists latched onto the magic of the invisible hand to explain why state interference was a ‘bad thing’. They worked away at establishing what looked like a scientific explanation of what they called the ‘market system’ or the ‘price mechanism’ and why those magical and, I must admit, mythical phenomena produce an ‘order’ that cannot be improved upon by government intervention. The conclusion of their epic trek into the intellectual desert was that any form of government intervention is perverse, no matter how well intentioned.

Take that you regulatory fools!

Except they could just as easily have started with that other quote I gave above. They could, had they been so disposed, have started with the magic of regulation and its unchallengeable efficacy in the ‘regulatory system’. At least I think so. The real economy is so darned complex and inscrutable that pretty much any grand theory can be created to explain it. There’s sufficient evidence to support all sorts of wild and contradictory ideas. That’s why the economy is so much fun to talk about. It’s an intellectual playground. The only way you can ever actually ‘prove’ a theory is to take a look at its plausibility and especially at the foundational assumptions upon which it stands.

Which brings me back to poor Adam Smith: the ultimate end point of that trek into the market magic desert and the quest for a ‘proof’ of the invisible hand’s status as the ultimate allocator-in-chief in an economy is the edifice known as General Equilibrium. The great crescendo of work that ended up with Arrow-Debreu is nothing short of stunning. It is architecture of the highest order. It is an analytical tour de force. And it proves beyond reasonable doubt that there is no such thing as general equilibrium. The restrictions economists have to place on the world in order to arrive at their hold grail totally destroy its relevance and utility. They have proved the trek was worthless.

Not that they stopped. Economists rarely do. They are too proud of their efforts. Even if those efforts were in vain.

So, having invested so much effort into such an elaborate fiction, and no doubt so embarrassed by its utter futility, they plod on as if nothing happened. They use general equilibrium as if it is indeed general and as if indeed there is such a thing as an equilibrium. Whilst the world around us suggests that neither is remotely a plausible explanation  an actual economy.

But never mind: it keeps economists employed. And it provides useful input for another of my pet peeves about mainstream economics. Which is that marginal productivity theory must be bogus. The employment and remuneration of economists is disproof of it.

Anyway I am plunged into this dishumor by the spectacle of economists ranging far and wide over the current presidential election and, in particular, pronouncing that the reform of the rotten American health care system and its replacement with some form of a single payer system is ‘impractical’.

The evidence from around the world suggest this is not true. Indeed, on the contrary, the evidence suggest it is overwhelming probable.

So why are so many of our leading economists lamenting want they call the ‘misleading’ and ‘impractical’ quest for a single payer system here? What would Smith say?

That they are referring to the political practicality. They are referring to various cultural and institutional rigidities that apparently channel our economy down a path that other economies do not follow. They are, in short, announcing that they believe the economy is deeply and profoundly influenced by its historical and institutional setting.

Which, seems to me, to be a considerable blow to their mainstream thought that economics is somehow independent of such trivia. In fact, were I so bold, I would argue that their own argument against the impracticality of single payer is an admission that their entire mainstream enterprise of so-called ‘positive’ economics unconstrained by mere politics, history, and so on is a farcical and dangerous illusion. It is so dangerous to the commonwealth – now there’s a thought – that it ought to be heavily regulated.

Regulation! What was Smith saying about that? …

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Ideas That Must Be Forgotten

Much of what we are told as being advances in economics are diversions or delusions that serve only to trap us in a cul-de-sac. Sometimes that becomes a very long road to nowhere. Sometimes, it seems, economics will never return to being about actual economies, but will always be doomed to stay the plaything of a select group of very clever savants separated from the world by their contempt for its complex messiness.

I am not one of those to indulge in endless territorial fights over purity of thought. What matters to me is practical application. I measure the usefulness of an economic idea by the illumination it throws on a real world problem and on its ability to assist us better our collective lots in life. I frankly don’t care if it is the precise meaning that some long ago dead theorist gave to an idea. Our current divination of that meaning may have strayed from purity, but it might also work. Battles over intellectual turf are meaningless except for a very few whose reputations are involved. Other than that, who cares?

Thus I admit I find the current argument over IS/LM a sideshow. I realize that the Hicksian version of Keynes is impure. I realize that Hicks himself came to regret having given life to it. But, in a crude and first cut kind of way it works. Does that imply I want to dump the pure Keynes? No. No it doesn’t. But I would prefer to go into battle with the impure kind rather than with the absurdity of the orthodox alternative. It would be better to go into battle with the pure kind, but that isn’t in most arsenals nowadays. And we must go to battle. There’s an economy to understand.

This leads me back to my problem: all those ideas that block progress.

You see in a recent blog post Paul Krugman tells us about the origins of Keynes-via-Hicks, and how jolly useful it has been — to him anyway — as he thinks about the economic crisis that began in 2007/2008. Buried in that post is a question:

“What’s the minimum interesting general equilibrium problem? The answer is, an economy with three goods, which means that there are two relative prices. You can think of such an economy as having three markets, but because of adding up you only need to look at two – if any two are in equilibrium, so is the third.”

Actually I don’t find any general equilibrium problem interesting. Not even minimally. I don’t think of general equilibrium as being an interesting topic, at least not in the context of a modern and vastly complex economy. I have said this before, but let me repeat myself: I wish that economics would forget about equilibrium for a while and focus on disequilibrium which, to me at least, is the more normal, empirically abundant, and thus interesting topic.

And I know I have said this before too: I regard the landmark effort of the likes of Arrow and Debreu with the utmost respect. They demonstrated clearly the irrelevancy of general equilibrium. They showed it cannot exist except under the most extreme and utterly unreal circumstances. Their work ought to have killed off the idea for good, but it didn’t. General equilibrium arose from that death stronger. It became the central plank of all subsequent orthodox thought. I have no idea why because it makes no sense. Then again, sense and economics are uneasy bedfellows at the best of times.

This is not to say that economies don’t sometimes display periods of stability. Many complex systems settle periodically into such periods where the moving parts, their relationships, and the outcomes seem to act in some sort of harmony. Then something disturbs that harmony and off the system goes through a period of disequilibrium searching for new stability somewhere else.

Economic orthodoxy places the source of the disturbance outside the system. In other words the source of disequilibrium, the impulse for change, sits outside the economy — or at least the economy as defined by those who adhere to equilibrium analysis.

I find this deeply unsatisfying. It is like saying that the cause of the change in today’s weather wasn’t a change in weather, but was something else. Something made the weather change, but that thing cannot be weather itself. This is ludicrous.

At a basic level this is simply an admission that economists don’t understand the economy as a process through time, but have isolated it at a particular point in time, frozen it, and then described it. It is freeze frame economics. In freeze frame economics we need a projector attendant to restart the motion. We need something outside the movie to get us to the next frame. This reliance on outside influences means that the narrative of the movie — the story we are trying to understand — is also situated outside the frozen frame. Indeed it is outside all the frozen frames because each one has to be compelled into motion by an external force and that external force is the narrative.

Economists have thus removed the very object we need to get a handle on: why economies change through time. Which is not the same as understanding how the integral parts relate and fall into a stable relationship with each other.

I suppose this is just my way of saying that economics is more than the study of the allocation of scare resources against the endless needs/wants of humanity. It is also the history of the development of those needs/wants, and the arc of the complex set of relationships that allows us to invent, produce, move around, exchange and ultimately consume the things that satisfy those needs/wants. For within that complex history is the impulse that keeps the entire system in motion.

Economists, because of ideas like equilibrium, place that impulse outside the sphere of their analysis. This is unfortunate. It is what makes economies interesting things to think about.

Let me leave you with this quote from a wise book called “The Great Wave” by David Hackett Fischer:

“In economic history, equilibrium is the exception rather than the rule. A free market restores equilibrium only to break it down again, and to set in motion a new sequence of imbalances and instabilities with all the troubles that follow in their train. In the full span of modern history, most free market have been in profound disequilibrium most of the time — often dangerous and destructive disequilibrium.”

Economists have, I think, settled on the easier side of the problem. Perhaps they ought to move on to the other, more difficult side.

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