Debunking Economics Part 11

The modern theory of planetary behavior now recognizes that the stable orbits of our solar system can only have evolved over an enormous period of time from far less stable orbits, which must have led to collisions between proto-planets. It is now accepted that the moon, for example, was the product of a collision between another proto-planet and the early earth.

Collisions are not possible in a single-planet solar system the kind of system that Newton a.s.sumed to derive his initial theory. Though that heuristic a.s.sumption was a major step in the development of the scientific mode of thinking about astronomy, dropping it led to a better theory, not a worse one.

When heuristic a.s.sumptions are made consciously by a theorist in the course of developing a theory, they are normally explicitly described as such. For instance, when developing the theory of relativity, Einstein at one point stated that the distance covered by a person walking from one side to the other of a moving train is equal to the sum of the distance covered by the train, and the width of the carriage. However, he continued that 'We shall see later that this result cannot be maintained; in other words, the law that we have just written down does not hold in reality. For the time being, however, we shall a.s.sume its correctness' (Einstein 1961 [1916]). When Einstein dropped this heuristic a.s.sumption, the theory of relativity was the result.

The greater realism at the heart of Einstein's theory transformed our understanding of reality, and dramatically expanded the physical and intellectual capabilities of our species. Yet if we accept Friedman's methodology, then we would have to argue that Einstein's theory was poorer than Newton's because it was more realistic.

In general, then, and contrary to Friedman, abandoning a factually false heuristic a.s.sumption will normally lead to a better theory not a worse one.

Judging the a.s.sumptions Theories can therefore be evaluated by their a.s.sumptions to some extent, if one has an intelligent taxonomy of a.s.sumptions. A theory may well draw power from 'unrealistic' a.s.sumptions if those a.s.sumptions a.s.sert, rightly, that some factors are unimportant in determining the phenomena under investigation. But it will be hobbled if those a.s.sumptions specify the domain of the theory, and real-world phenomena are outside that domain.

These a.s.sumptions may be justified if they are merely heuristic devices used to simplify the process of deriving a more general theory but only if that more general theory is in fact derived. Economists often imply, when they fob off some critical student, that the unrealistic a.s.sumptions in introductory economics courses are dropped in more advanced theory which portrays these a.s.sumptions as heuristic tools. In fact, as preceding chapters have ill.u.s.trated, the a.s.sumptions used in more advanced theory are often more unrealistic than those presented in introductory lectures.

Scientific realism versus instrumentalism Musgrave also points out that most scientists reject an instrumental view of science in favor of 'scientific realism' the belief that scientific theories should not merely predict reality but should, in some sense, represent it.

Ironically, this is actually the belief that most economists have about economic theory. Friedman's instrumentalism is little more than a smokescreen behind which to hide when one wishes to quell a budding cla.s.s rebellion. It is often evident to the student objector that, though professing that the a.s.sumptions don't matter, his teachers continue to use the same small cla.s.s of a.s.sumptions over and over again: rational utility-maximizing individuals, profit-maximizing firms, and a plethora of ancillary a.s.sumptions built on these foundations.

These a.s.sumptions are used because economists believe that these a.s.sumptions do capture essential elements of reality, and regard any theory which does not use these building blocks as 'unrealistic.' This belief is most clearly seen in the manner in which the 'bibles' of economics, its academic journals, filter out papers that do not make this core set of a.s.sumptions.

a.s.sumptions do matter to economists The proposition that a.s.sumptions don't matter implies that economists would be quite willing to accept a theory which a.s.sumed irrational behavior if the model generated results which accorded with observation. It also implies that the development of economic theory would be driven primarily by the desire to produce theories that provide a closer fit to observed data.

Both these implications are strongly at variance with reality.

As any non-orthodox economist knows, it is almost impossible to have an article accepted into one of the mainstream academic economic journals unless it has the full panoply of economic a.s.sumptions: rational behavior (according to the economic definition of rational!), markets that are always in equilibrium, risk as an acceptable proxy for uncertainty, and so on. When it comes to safeguarding the channels of academic advancement, little else matters apart from preserving the set of a.s.sumptions that defines economic orthodoxy.

Similarly, the development of economic theory over time has been propelled by the desire to make every aspect of it conform to the preferred economic model. Macroeconomics, when it first began, bore little resemblance to microeconomics. Fifty years later, macroeconomics is effectively a branch of microeconomics. As I outline in Chapter 10, a major factor behind this tribal coup was the belief that, regardless of its predictive validity, macroeconomics was unsound because its a.s.sumptions did not accord with those of microeconomics. It was therefore extensively revised, especially during the 1970s and 1980s, so that macroeconomic theory was more consistent with microeconomic a.s.sumptions. Far from a.s.sumptions not mattering to economists, a.s.sumptions in fact drove the development of economic theory.

a.s.sumptions and logic a.s.sumptions matter in a more profound sense because, as this book shows, a.s.sumptions can be logically incoherent. For example, as discussed in Chapter 4, the economic model of the firm is internally contradictory. A theory that contains logically inconsistent a.s.sumptions will be a bad theory and, as this book shows, economics is replete with logical inconsistencies.

This is a science? The behavior of economists hardly fits the stereotype of scientists as dispa.s.sionate seekers of truth. But their behavior does fit modern, sociological theories of how scientists behave.4 Briefly, these theories argue that each 'science' is as much a society as it is an intellectual discipline. A collection of scholars in a science will share a perspective on what defines their discipline, and what const.i.tutes scientific behavior. This shared mindset includes core beliefs, which cannot be challenged without threatening your members.h.i.+p of the group (and hence your status as a scientist), ancillary beliefs which are somewhat malleable, a set of a.n.a.lytic techniques, and as yet unsolved problems to which these techniques should be applied. The core beliefs are known as the 'hard core' since they cannot be altered without rejecting, in some crucial sense, the very foundations of the science. The ancillary beliefs are known as the 'protective belt,' since their function is to protect the core beliefs from attack.

The scholars expect that their beliefs and techniques will be able to solve the outstanding problems, thus increasing the explanatory power of their science. If they fail, then the first response is to adjust the ancillary beliefs rather than the core propositions. Only when the problem proves both intractable and crucial is there any possibility that core beliefs will be abandoned, leading to the formation of a new school of thought or the ascendancy of an existing rival school. While a school of thought is expanding the range of phenomena it can explain using its core beliefs by experiments that confirm its predictions, or extensions of its theories to novel areas then it is said to be a 'progressive' scientific research program which manifests a 'positive heuristic.' If, instead, experimental results contradict its predictions, and its theories are adjusted to rationalize these failures, then it is said to be 'degenerative' with a 'negative heuristic.'

It is possible for more than one such collection of scholars to exist in a science at any one time, so it makes sense to speak of schools of thought within a science. Each school of thought will compete with the others, emphasizing their weaknesses and its own strengths.

Clearly this sociological description of a science fits the historical record of economics. At the beginning of the third millennium, there are at least five schools of thought. The neocla.s.sical school is clearly dominant, but there are several other competing schools in particular, the post-Keynesian, Austrian, and evolutionary schools of economics. Each is developing its own approach to explaining similar phenomena, and there is clearly a rivalry between the minority schools and neocla.s.sical economics the other schools criticize neocla.s.sical economics while it largely ignores its rivals.

However, it might be thought that this provides a fairly demeaning perspective on science itself. Surely this behavior is aberrant, and true sciences are beyond this petty bickering? No, strange as it may seem, a similar picture can be painted even of the queen of sciences, physics.

Quantum uncertainty? In order to comprehend some of the bizarre results of experimental particle physics, most physicists argue that matter is in some sense 'probabilistic,' and that the observer fundamentally affects reality. If an observer tries to 'tie down' one aspect of a particle say, its location then some other aspect becomes fundamentally unknowable. Physicists say that an elementary particle is always in a 'superposition' of both states, and testing for one leads to the other state resolving itself in a completely random way. The act of observing a particle thus directly but unpredictably alters its state. This is not because of any statistical properties of large numbers of electrons, but because randomness is an inherent feature of fundamental particles.

Two crucial aspects of this 'Copenhagen school' interpretation of quantum reality are (a) that particles can be treated as 'wave functions' in what is known as the waveparticle duality, so that a fundamental particle can be completely represented by its wave function; and (b) that there are two sets of physical laws, one which applies when there is no observer ('superposition') and one which exists when there is an observer.

The most famous popular representation of what this means, when put in terms of everyday objects, is 'Schrodinger's cat.' This is a thought experiment in which a box contains a cat, a radioactive element, and a vial of poison. If the radioactive element emits a particle, the vial opens and the cat dies. If it doesn't, the cat lives.

What state is the cat in before an experimenter opens the lid to see whether it is alive or dead? In the Copenhagen school interpretation, the cat is in a superposition of being both alive and dead. The act of the observer opening the box resolves the cat into one or other state.

But this is not the only way to make sense of the experimental data. A rival interpretation, established by David Bohm, provides a completely deterministic interpretation, with none of the 'quantum uncertainty' of the Copenhagen school. It can explain the same experimental results as can the Copenhagen school and some which it can't explain without resorting to the apparently metaphysical position that the observer somehow affects reality at the quantum level. In Bohm's theory, Schrodinger's cat is either alive and well if the radioactive element hasn't emitted a particle, or dead if it has, independent of the human observer who eventually opens the box to check.

How have physicists reacted to this coexistence of two rival explanations of reality? As the physicist David Albert sees it, in much the same way that economists have reacted to alternative schools of thought by refusing to take them seriously. It is worth citing Albert at some length to show that, quite possibly, scientists in other disciplines are no different from economists when it comes to their reaction to intellectual challenges to accepted dogma: Despite all the rather spectacular advantages of Bohm's theory, an almost universal refusal even to consider it, and an almost universal allegiance to the standard formulation of quantum mechanics, has persisted in physics, astonis.h.i.+ngly, throughout most of the past 40 years. Many researchers have perennially dismissed Bohm's theory on the grounds that it granted a privileged mathematical role to particles. The complaint was that this a.s.signment would ruin the symmetry between position and momentum, as if ruining that symmetry amounted to a more serious affront to scientific reason than the radical undermining, in the Copenhagen formulation, of the very idea of an objective reality. Others dismissed Bohm's theory because it made no empirical predictions (no obvious ones, that is) that differed from those of the standard interpretation as if the fact that those two formulations had much in common on that score somehow transparently favored one of them over the other. Still others cited 'proofs' in the literature that no deterministic replacement for quantum mechanics of the kind that Bohm had already accomplished was even possible. (Albert 1994) After the above was published in the first edition, several physicists contacted me and put forward criticisms of Bohm's theory. However, the relevance of his theory in the context of this chapter was the alleged behavior of physicists in rejecting this alternative perspective in the manner described by Albert.

At this sociological level, therefore, economics appears to have some similarities to the conventional sciences though the extent to which alternative perspectives are suppressed in economics is far greater than in physics.

A degenerate scientific research program There was a time when the neocla.s.sical school of economics was clearly progressive, while its main rival was clearly degenerate. When the neocla.s.sical school coalesced in the 1870s in the works of Jevons, Menger and Walras, the preceding cla.s.sical school was in crisis. The cla.s.sical school always had a difficulty in explaining the relations.h.i.+p between what it called value and prices; yet it insisted that value was in some way fundamental to the determination of price. This problem was accentuated by the work of the final member of the cla.s.sical school, Karl Marx (the subject of Chapter 17).

At the same time, the neocla.s.sical school was expanding its core belief that human behavior was driven by the desire to maximize utility. This had developed from a guiding principle, in Bentham's hands, to a coherent theory of consumer and producer behavior in the hands of Jevons, and to an explanation for the overall coordination of a market economy in Walras. At the turn of the nineteenth century, neocla.s.sical economists were confident that their science could continue expanding its explanation of the economy. It was clearly then a progressive scientific research program.

Though the majority of economists still believe that this is the case today, there are manifest signs that this is no longer true. Instead, the theory today is degenerate: rather than expanding the range of phenomena it can explain, the leading edge of the theory is dominated by adjusting the protective belt of ancillary beliefs to defend the hard-core beliefs from attack. For example, the Sonnenschein-Mantel-Debreu conditions (discussed in Chapter 3) are a way of maintaining the hard-core belief that individual behavior is driven by utility maximization, despite the proof that individual preferences cannot be aggregated. A similar interpretation could be given of responses of neocla.s.sical economics to the many logical problems doc.u.mented in this book.

But the problems with economics go beyond just this, since if economics were as fully a science as astronomy, eventually its litany of failures would lead to at least a general acknowledgment of crisis.

The incredible inertness of economics What makes economics different from and inferior to other sciences is the irrational tenacity with which it holds to its core beliefs in the face of either contrary factual evidence or theoretical critiques that establish fundamental inconsistencies in its intellectual apparatus.

The discovery, for example, that firms believe they experience constant or falling marginal costs (Eiteman and Guthrie 1952), and generally set prices by placing a markup on average cost, led not to the abandonment of the economic theory of price-setting, but to a welter of papers arguing that in a compet.i.tive market, the effect of markup pricing was the same as if firms did consciously equate marginal cost to marginal revenue (Langlois 1989). On the same note, Sraffa's theoretical argument that diminis.h.i.+ng marginal returns were unlikely to occur in practice was ignored.

As a result, students at the beginning of the twenty-first century are receiving much the same instruction about how firms set prices as did their counterparts at the end of the nineteenth century.

Physical sciences hold on to their core beliefs with some tenacity, but nowhere near this much even Albert's paper goes on to observe that 'serious students of the foundations of quantum mechanics rarely defend the standard formulation anymore' (Albert 1994). As a result, revolutions in physical sciences where one dominant paradigm is replaced by another occur much more frequently than they do in economics. Often, these revolutions outpace the popular understanding of a science.

Astronomy provides an example of this. I expect that most lay people think that the dominant theory of how the universe came into being is the 'Big Bang.' In this theory, the universe originated in a 'quantum singularity' some 1215 billion years ago. This explosion kick-started matter and time, leading to the immense universe we observe today. Back in the 1950s, this theory won out against its rival, that the universe had always been in a 'steady state' of expansion.

The Big Bang was indeed the dominant theory for some time until it was pointed out that, according to calculations from quantum mechanics, the Big Bang would have resulted in a universe consisting of a mere handful of elementary particles.

A rival theory then developed which argued that, for a substantial period of time, the laws of physics of the current universe did not apply. Matter, for example, could move much faster than the speed of light. This 'inflationary universe' theory has subsequently been embellished to predict that there are many universes as opposed to the one universe postulated by the Big Bang.

The s.h.i.+fts from the Big Bang paradigm to the inflationary universe, to 'multiverses,' are big ones conceptually. The first envisages a single finite universe, while the last muses that ours may be only one of many universes, each with different 'fundamental' physical laws. But the science of astronomy made this move over a period of about twenty years, and it continues to undergo development today. Now even the inflationary/multiverse theory is under challenge, as measurements imply that the rate of expansion of the universe is actually increasing with time.5 Economics, in contrast, has had only one acknowledged revolutionary episode in the last century the Keynesian revolution during the 1930s. Yet at the end of the twentieth century, the dominant school of thought in economics retains nothing from that revolution, and is in fact a direct descendant of pre-Keynesian neocla.s.sical economics.

Think of the many revolutions in our understanding of the physical world which have occurred in the twentieth century: from Newtonian to Einsteinian physics; from Mendelian genetics to DNA and the human genome; from determinism to chaos theory. Any scientist from the nineteenth century would be bewildered by what is commonplace today in his discipline save an economist.

Why is economics so resistant to change? Is it because everything economists believed at the end of the nineteenth century was correct? Hardly, as this book shows. Instead, to understand the incredible inertness of economics, we have to consider an essential difference between social sciences in general and the physical sciences, and the th.o.r.n.y topic of ideology.

My kingdom for an experiment In the nineteenth century, scientists and philosophers of science generally believed that what distinguished the social sciences from the physical sciences was that the latter could undertake experiments to test their theories, whereas the former could not. In the twentieth century, Popper instead argued that the distinction between a science like physics and a non-science like astrology was not that one could undertake experiments and the other could not, but that one made falsifiable statements, while the other did not. Popper's distinction between science and non-science wasn't completely relevant to the 'experiments versus no experiments' distinction, but it did tend to play down the importance of experimentation in deciding what was and what was not a science.

The history of economics implies that Popper's distinction does not give sufficient attention to whether or not a falsifiable statement can in fact be experimentally falsified. For example, Milton Friedman is famous as the father of the now defunct sub-branch of economics known as monetarism. One falsifiable statement he made was that inflation is caused by the government increasing the money supply more rapidly than the economy is going.

This implied that, to reduce inflation, all the government had to do was to increase the money supply more slowly than the economy was growing. This was the basis of the economic policies of Margaret Thatcher, yet eventually this approach was abandoned. One reason why was that the government was never able to meet its targets for the rate of growth of the money supply it might aim to increase it by, say, 6 percent, only to see it grow by 11 percent. Also, the relations.h.i.+p between the three crucial variables in Friedman's theory the rate of inflation, the rate of growth of the economy, and the rate of growth of the money supply was never as watertight in practice as it appeared to be in his theory.

You could thus argue that Friedman's statement that inflation is caused by the government expanding the money supply faster than the rate of growth of the economy had been falsified. Did this lead Milton and his supporters to abandon his theory? Of course not: monetarists instead argued that all sorts of attenuating features disturbed the results.

In other words, because the monetarist experiment in Great Britain wasn't a controlled experiment, monetarist economists could refuse to accept that their theory had been falsified.

The same observation can be made about Marxist economists, and their att.i.tude toward the data on Marx's theory that the rate of profit would tend to fall, or the inevitability of socialism, and so on. In other words, this isn't just a disease of the political right, but an endemic problem in economics: without the ability to undertake controlled experiments, statements which could be falsified will be unfalsifiable in practice. Economists of all persuasions are therefore liable to hang on to beliefs that they argue are scientific, but which in the end are ideological.

The experience of another social science, psychology, provides some support for the argument that the ability to undertake experiments is crucial to scientific progress. For much of the twentieth century, psychology was dominated by the 'behaviorist' school. This school argued that an organism's behavior had to be understood as a response to an external stimulus: it was 'unscientific' to postulate any un.o.bservable mental processes of the organism which mediated between the stimulus and the response. To this school, complex behavior such as playing a piano had to be understood as a chain of stimuli and responses. However, experiments showed that even average pianists move their hands too quickly for the tactile information to pa.s.s along the sensory nerves to the central nervous system and for the command to move the hands to be sent down the motor nerves [...] Therefore, the behaviorist hypothesis that each new action is a response to an external stimulus is implausible. (Bond 2000) This and several other experimental falsifications of behaviorism led to its demise, and replacement by cognitive psychology, which accepts that 'there are cognitive processes that determine our behavior which we, as psychologists, must explain, even if they are not directly observable' (ibid.). Thus psychology, with the help of experiments, was able to undergo a revolution from one dominant school to another while economics continues to be dominated by the same school (which, ironically, has a very behaviorist view of human behavior). Unless it develops a means to undertake experiments to test rival theories, economics may be unable to break from the grip of ideology.

Equilibrium and an invisible ideology Economics as a discipline arose at a time when English society was in the final stages of removing the controls of the feudal system from its mercantile/capitalist economy. In this climate, economic theory had a definite (and beneficial) political role: it provided a counter to the religious ideology that once supported the feudal order, and which still influenced how people thought about society. In the feudal system the preordained hierarchy of king, lord, servant and serf was justified on the basis of the 'divine right of kings.' The king was G.o.d's representative on earth, and the social structure which flowed down from him was a reflection of G.o.d's wishes.

This structure was nothing if not ordered, but this order imposed severe restrictions on the now dominant cla.s.ses of merchants and industrialists. At virtually every step, merchants were met with government controls and tariffs. When they railed against these imposts, the reply came back that they were needed to ensure social order.

Economic theory then rightly called political economy provided the merchants with a crucial ideological rejoinder. A system of government was not needed to ensure order: instead, social order would arise naturally in a market system in which each individual followed his own self-interest. Smith's phrase 'the invisible hand' came along rather late in the process, but the notion played a key role in the political and social transformations of the late eighteenth and early nineteenth centuries.

An essential aspect of this market social order was equilibrium.

From the outset, economists presumed that the market system would achieve equilibrium. Indeed, the achievement of equilibrium was often touted as an advantage of the free market over any system where prices were set by fiat. Equilibrium was therefore an essential notion of the economic defense of capitalism: the equilibrium of the capitalist market would replace the legislative order of the now defunct feudal hierarchy.

More importantly, whereas the feudal order endowed only the well born with welfare, the equilibrium of the market would guarantee the best possible welfare for all members of society. The level of individual welfare would reflect the individual's contribution to society: people would enjoy the lifestyle they deserved, rather than the lifestyle into which they had been born.

If, instead of equilibrium, economists had promised that capitalism would deliver chaos; if, instead of meritocracy, economists had said that the market would concentrate inequality, then economists could have hindered rather than helped the transition to capitalism (though they more likely would have been ignored).

By the middle of the nineteenth century, the transition to capitalism was complete: what was left of feudalism was a mere vestige. But rather than the promised equilibrium, nineteenth-century capitalism was racked by cycles and enormous disparities of wealth. A major depression occurred roughly every twenty years, workers' conditions would improve and then rapidly deteriorate, prices rise and then fall, banks expand and then collapse. New 'robber barons' replaced the barons of old. It appeared that, while promising a meritocratic equilibrium, capitalism had instead delivered unbalanced chaos. A new political challenge arose: that of socialism.

Once again, economics rose to the challenge, and once again equilibrium was a central tenet. This time the defense was mounted by what we today call neocla.s.sical economics, since cla.s.sical economics had been turned into a weapon against capitalism by the last great cla.s.sical economist, Karl Marx.

In contrast to the hand-waving of Smith, the neocla.s.sical economists of the late nineteenth century provided a substantive mathematical a.n.a.lysis of how equilibrium could be achieved by an idealized market economy, and how this equilibrium could be fair to all. However, unlike the earlier cla.s.sical championing of capitalism, this technical edifice provided very little in the way of libertarian slogans for the battle against the ideology of socialism. Instead of arming capitalism's defenders with rhetoric to deploy against socialists, it gave birth to the academic discipline of economics.

Capitalism eventually transcended the challenge of socialism, with little real a.s.sistance from economic theory. But while the economics had little impact upon capitalism, the need to defend capitalism had a profound impact upon the nature of economic theory. The defensive imperative, and the role of equilibrium in that defense, cemented equilibrium's role as a core belief of economic theory.

At the beginning of the third millennium, there is no competing social system against which capitalism must prove its superiority. Feudalism is long dead, and those socialist societies which remain are either socialist in name only, or bit players on the world stage.

Today, most economists imperiously dismiss the notion that ideology plays any part in their thinking. The profession has in fact devised the term 'positive economics' to signify economic theory without any value judgments, while describing economics with value judgments as 'normative economics' and the positive is exalted far above the normative.

Yet ideology innately lurks within 'positive economics' in the form of the core belief in equilibrium.6 As previous chapters have shown, economic theory has contorted itself to ensure that it reaches the conclusion that a market economy will achieve equilibrium.7 The defense of this core belief is what has made economics so resistant to change, since virtually every challenge to economic theory has called upon it to abandon the concept of equilibrium. It has refused to do so, and thus each challenge Sraffa's critique, the calamity of the Great Depression, Keynes's challenge, the modern science of complexity has been repulsed, ignored, or belittled.

This core belief explains why economists tend to be extreme conservatives on major policy debates, while simultaneously believing that they are non-ideological, and motivated by knowledge rather than bias.

If you believe that a free market system will naturally tend towards equilibrium and also that equilibrium embodies the highest possible welfare for the highest number then, ipso facto, any system other than a complete free market will produce disequilibrium and reduce welfare. You will therefore oppose minimum wage legislation and social security payments because they will lead to disequilibrium in the labor market. You will oppose price controls because they will cause disequilibrium in product markets. You will argue for private provision of services such as education, health, welfare, perhaps even police because governments, untrammeled by the discipline of supply and demand, will either under- or oversupply the market (and charge too much or too little for the service).

In fact, the only policies you will support are ones that make the real world conform more closely to your economic model. Thus you may support anti-monopoly laws because your theory tells you that monopolies are bad. You may support anti-union laws, because your theory a.s.serts that collective bargaining will distort labor market outcomes.

And you will do all this without being ideological.

Really?

Yes, really in that most economists genuinely believe that their policy positions are informed by scientific knowledge, rather than by personal bias or religious-style dogma. Economists are truly sincere in their belief that their policy recommendations will make the world a better place for everyone in it so sincere, in fact, that they often act against their own self-interest.

For example, there is little doubt that an effective academic union could increase the wages paid to academic economists. If economists were truly self-motivated if they behaved like the entirely self-interested rational economic man of their models they would do well to support academic unions, since the negative impacts they predict unions to have would fall on other individuals (fee-paying students and unemployed academics). But instead, one often finds that economists are the least unionized of academics, and they frequently argue against actions that, according to their theories, could conceivably benefit the minority of academics at the expense of the greater community. However ideological economists may appear to their critics, in their hearts they are sincerely non-partisan and, ironically, altruistic.

But non-partisan in self-belief does not mean non-partisan in reality. With equilibrium both encapsulating and obscuring so many ideological issues in economics, the slavish devotion to the concept forces economists into politically reactionary and intellectually contradictory positions.

Of course, if economists were right that equilibrium embodies the best possible outcome for the greatest number, then their apparently ideological policy positions would be justified if the economy always headed back to equilibrium when disturbed from its nirvana. In the next chapter, we'll put aside the critiques which establish that the building blocks of equilibrium are invalid, and instead ask whether economic equilibrium, as defined by economic theory, is in fact stable.

9 | LET'S DO THE TIME WARP AGAIN.

Why economics must finally treat time seriously.

Forget everything you know about riding a bicycle, and imagine that someone who purports to be a 'bicycle guru' has convinced you that there are two steps to learning how to ride a bike. In step 1, you master balancing on a stationary bike. In step 2, you master riding a moving bike, applying the skills acquired at step 1.

After several difficult months at step 1, you would know that to remain upright, you must keep your center of gravity directly above the point of contact between your wheels and the road.

Step 2 arrives. Applying the lessons in stage 1, you keep your bike at a perfect 90 degrees to the ground, balance against the uneven pressure of your legs, get up some speed and you're away.

So far, so good. But what if you want to change direction? The handlebars appear to provide the only means of turning, so you rotate them in the direction you wish to go and fall flat on your face.

What went wrong with this apparently logical advice? 'Elementary, my dear Watson': the gyroscopic force which keeps you upright when a bike is moving simply doesn't exist when it is stationary. Manipulating this force is what enables you to turn a moving bike, and the lessons learnt in the static art of balancing a stationary bike are irrelevant to the dynamic art of actually riding one.1 Replace the bicycle with the economy, and the point still stands: the procedures which apply in a static economy are irrelevant to a dynamic, changing one; the forces which apply in a static economy simply don't exist in a dynamic one.2 Lessons learnt from managing an economy in which processes of change either don't occur, or in which changes occur instantly, are irrelevant to an economy in which change does occur, and takes time to occur.

The kernel.

Neocla.s.sical economic models in general ignore processes which take time to occur, and instead a.s.sume that everything occurs in equilibrium. For this to be allowable, the equilibrium of the dynamic processes of a market economy must be stable, yet it has been known for over forty years now that those processes are unstable: that a small divergence from equilibrium will not set up forces which return the system to equilibrium. The dynamic path of the economy therefore cannot be ignored, and yet most economists remain almost criminally unaware of the issues involved in a.n.a.lyzing dynamic, time-varying systems.

The roadmap.

In this chapter I detail the roots of the economic propensity to ignore time, and to instead focus on what happens in equilibrium. Then I point out that economic research in the 1950s and 1960s established that the equilibrium of a market economy was unstable, so that the economy could never be in equilibrium. A brief discussion of chaos theory outlines the type of a.n.a.lysis which economists should undertake, but do not.

Cobwebs of the mind.

Economic processes clearly take time, and yet economists don't consider time in a.n.a.lyzing demand, supply, or any of their other key variables. For example, the quant.i.ty demanded of a commodity and the quant.i.ty supplied are both treated as functions of price, and the outcome is an equilibrium quant.i.ty. To ill.u.s.trate what they believe will happen if the demand for a commodity rises, neocla.s.sical economists compare one equilibrium with another, using what they call comparative statics. The time path from one equilibrium to another is ignored.

9.1 Standard neocla.s.sical comparative statics.

But what if the initial market price happens not to be the equilibrium price? Then demand and supply will be out of balance: if price exceeds the equilibrium, demand will be too low and supply too high. For equilibrium to be restored, this disequilibrium must set off dynamic processes in supply and demand which cause them both to converge on the equilibrium price. This dynamic process of adjustment will obviously take time. However, in general, economists simply a.s.sume that, after a disturbance, the market will settle down to equilibrium. They ignore the short-term disequilibrium jostling, in the belief that it is just a short-term sideshow to the long-run main game of achieving equilibrium.

A similar belief permeates even some of the alternative schools of economics. The dynamic process is ignored because it is believed to be a short-term, transitory phenomenon, and attention is focused on the long-term, allegedly enduring phenomenon of equilibrium. As a result, time itself, the change in variables over time, and disequilibrium situations are all ignored. Even econometric programs which attempt to forecast the future value of macroeconomic variables such as output and employment a.s.sume that the current levels are equilibrium values, and they predict what the future equilibrium values will be.

Economics has invented numerous intellectual devices to enable itself to ignore time, and focus upon the equilibrium situations rather than consider the processes of change over time in an economy. One of these devices is one to which many budding students of economics initially object: the 'all other things being equal,' or 'ceteris paribus' a.s.sumption that nothing changes outside the single market being considered. This a.s.sumption lies behind the a.n.a.lysis of supply and demand in a single market, which we've already debunked in Chapters 3 to 5.

Such troubled students are rea.s.sured that at higher levels of a.n.a.lysis, this 'partial equilibrium' a.s.sumption is dropped for the more realistic proposition that all things are interrelated. However, rather than this more general a.n.a.lysis being more realistic, dynamic, and allowing for disequilibrium as well as equilibrium, it is in fact 'general equilibrium': a model of how all aspects of an economy can be in equilibrium simultaneously.

Budding economists who object to the a.s.sumption of ceteris paribus would walk away in disgust if they were immediately told of the a.s.sumptions needed to sustain the concept of general equilibrium. However, their fears a.s.suaged by the promise of more realistic notions to come, they continue up the path of economic inculcation. By the time they confront general equilibrium in graduate education, they treat these a.s.sumptions and the a.n.a.lysis which goes with them as challenging intellectual puzzles, rather than as the asinine propositions they truly are. Normally, these students work at less rarefied levels of economic theory, and confidently presume that the leading lights of the profession will generalize the a.s.sumptions and solve the remaining puzzles.

As is so often the case with neocla.s.sical economics, the leading lights have done their job very well, but they have not delivered the goods expected of them by the troops. Instead, they have proved that, in general, general equilibrium is unattainable. Even economic models will not achieve general equilibrium, let alone the real economies that general equilibrium once purported to model. General equilibrium is at one and the same time the crowning achievement of economic theory and its greatest failure.

General equilibrium.

In the late nineteenth century, three economists in different countries independently gave birth to the neocla.s.sical school of thought: Jevons in England, Menger in Austria, and Walras in France. Today, Walras is the most exalted of these, because his model of general equilibrium set the mold by which economics has since been crafted.

Groping towards equilibrium According to neocla.s.sical theory, equilibrium occurs in a particular market when demand at a given price equals supply at the same price. For equilibrium to occur in all markets simultaneously, the price in every market has to be such that demand and supply are equal in all markets. However, a change of price in one market will affect consumer demand in all other markets. This implies that a move towards equilibrium by one market could cause some or all others to move away from equilibrium. Clearly it is possible that this 'dance of many markets' might never settle down to equilibrium.

This will be especially so if trades actually occur at disequilibrium prices as in practice they must, since who could ever know when one real-world market was in equilibrium, let alone all of them simultaneously? A disequilibrium trade will mean that the people on the winning side of the bargain sellers if the price is higher than equilibrium will gain real income at the expense of the losers, compared to the alleged standard of equilibrium. This s.h.i.+ft in income distribution will then affect all other markets, making the dance of many markets even more chaotic.

Walras provided a simple initial abstraction to sidestep this dilemma: he a.s.sumed that no trades take place until equilibrium is achieved in all markets. Having satisfied himself that, in the absence of trade, the jiggling of prices up and down would eventually converge to equilibrium, he extended the same faith to a system with production and exchange at disequilibrium prices.

Walras envisaged the market as being a huge, and very unusual, auction. The audience for this auction includes all the owners of the goods for sale, who are simultaneously the buyers for all the goods on sale. At a normal auction, the quant.i.ty of each commodity offered for sale is fixed. In Walras's auction, the total amount of each commodity is fixed, but sellers will offer anywhere from none to all of this for sale, depending on the price offered. The quant.i.ty offered rises as the price rises, and vice versa, with any amount not sold being taken back home by the seller for his/her own consumption (there are no stocks; everything is either sold or consumed by the producer).