Saturday, April 17, 2010

Robert Solow Criticises Important Micro-Foundations of Modern Economics

Hat Tip to: ‘Aaron Anderson ‘ at ‘to compete with phrase mongers’ Bog HERE
for re-publishing
a review by Robert Solow (Institute Professor of Economics emeritus at MIT and winner of the Nobel Prize in Economics in 1987) (12 January) in The New Republic (HERE):

Hedging America

How Markets Fail: The Logic of Economic CalamitiesBy John Cassidy
( Farrar, Straus and Giroux, 390 pp., $28

“If this is how more or less free, more or less competitive markets can deal with something as simple as a spiral notebook, how much more remarkable it is that they can do the same for something as complicated as a computer or a refrigerator. But there seems to be no other practical way to run a modern economy efficiently. That is what Adam Smith understood: a competitive market economy, motivated primarily by individual pecuniary self-interest, can produce coordination where one might expect only chaos.

He invented for that process the memorable image of the Invisible Hand. In the following two centuries and more, an army of economists has spent an enormous amount of time and intellectual effort refining and elaborating Smith’s initial insight, teasing out exactly how far that logic can be carried, how the hand operates, investigating when and how it breaks down, and elucidating odd or complex special cases such as professional team sports, or Internet services, or health care. (A recent issue of the highbrow American Economic Review contains highly technical articles aimed at understanding particular aspects of oil prices, gasoline taxes, urban transit, art auctions, and “two-sided matching markets” like that connecting graduate students and graduate schools.)

In one way it is an interesting intellectual game; in another, it is a deadly serious battle for very high stakes. For in the course of producing and distributing goods and services, market outcomes generate incomes, wealth, status, and power. Any modification of market outcomes modifies the allocation of incomes, wealth, status, and power. So it is no wonder that the discussion has become thickly encrusted with ideology. And one convenient way to turn subtle argument into ideology is to create dichotomies where there are originally fine gradations of more and less. For example: are you for or against “the free market”?

…By “utopian economics,” Cassidy means, in the first instance, the careful elaboration of the precise scope of Adam Smith’s Invisible Hand. It turns out to be a lot more complicated and attenuated than sloganeering can afford to acknowledge. To begin with, if a market economy is to be advertised as doing an acceptable job, we need a definition of a good economic outcome

I urge you to read Professor Solow’s review of John Cassidy’s in full by following the link. It is a first class exposition of what modern economists contributed to elaborating on the myth that Adam Smith’s use of the simple metaphor was a theory of markets, supply and demand, price determination, perfect competition and all that was derived for these subject by economists in the 20th century, most of which had little to do with where Adam Smith left 18th-century economics when he died in 1790.

Professor Solow does not see it quite like that, but he dissects modern micro-economics meticulously to show that the (‘utopian’) theories of perfect competition, Pareto optimality and General Equilibrium are flawed as descriptions of the real world and that policies derived from them are – and remain – unsound. He does not derive his arguments from the strange gap between Adam Smith’s use of the metaphor and the assertions of modern economists that their inventions about the invisible hand (as an actual entity) are not valid, as is reported regularly on Lost Legacy. Instead, he accepts, as did Paul Samuelson and many others, that these assertions were valid and they deserve to be linked to the full authority of Adam Smith.

John Cassidy’s book is on order, so I cannot include his book in my comments until I read it. However, Solow’s demolition of modern versions of how perfectly competitive economies are supposed to work is masterly, even on their own terms. Smith was not ideological about competitive markets; he analysed their benefits and took account of the real-world practicalities from their 18th-century mercantile nature and realistic possibilities for their reform on a case-by-case basis. The political realities of the way legislators made decisions, largely under the influence of
Interest groups, precluded root-and-branch changes, as they still do today.

In an imperfect world, Smith preferred markets to state interventions, but always recognised where state interventions were necessary. I think readers of Solow’s review of John Cassidy’s book will understand Smith’s caution and why modern economic ideologues of right and left are not really relevant in a practical sense.

Solow's criticism of aspects of modern micro-economics is flawed in that he links them to Adam Smith's alleged inventions of the invisible hand, a charge of which he is wholly innocent.

Labels: ,


Post a Comment

<< Home