Sunday, June 05, 2011

New Book Exposes Modern Economics to Scrutiny

Yanis Varoufakis writes on a “A Manifesto for Modern Political Economics

Yanis Varoufakis, Joseph Halevi, Nicholas J. Theocarakis,

‘Blanchard had this to say about the Nash-Debreu-Arrow formalist project and the theorems it spawned:

“More than 200 years ago, Adam Smith explained that in a market economy individual egoisms combined to bring about the best possible outcome for the community. This proposition was so surprising and so full of consequences that it became necessary to understand its nature and its limits. Thanks to Walras at the beginning of the 20th century, and furthermore thanks to economists like Arrow or Debreu fifty years later, and especially thanks to a huge effort of abstraction and to powerful mathematical tools, the conditions of Adam Smith’s theorem have been clarified.”

Leaving aside serious doubts that Adam Smith would approve of what Walras and the formalists allegedly did in his name, Blanchard goes on to interpret the Nash-Debreu-Arrow theorems as follows:

Having clarified the necessary conditions required to satisfy the Adam Smith theorem, research has been directed almost entirely into investigating what happens when the conditions are not satisfied. Namely, why some markets work badly, and what type of institutions have to be put in place in order to improve their working.”

Note the leap of undiluted faith from the formalist model to the real world. Blanchard’s claim is that the formalism can help us understand why some real markets work badly. It is as if Gerard Debreu had never issued his legendary warning that “…the theory…is logically entirely disconnected from its interpretations”.

The whole Blanchard argument is a complete non sequitur. No investigation of the circumstances under which a Walrasian General Equilibrium will not obtain can illuminate the causes of real market failures. Why? Because the theory hangs together only under assumptions that push it onto a universe in which real capitalist markets could not, physically, exist. Is it not the duty of a leading textbook writer to spell this out? Anything less, we submit, is intellectual poison, especially for the young minds who treat a famous textbook writer as an authority on the subject-matter.

Alan Kirman (1989), one of formalism’s leading lights, sums up our conclusion thus:

“In conclusion, then, it is worth repeating that recent theoretical work has shown how little the Walrasian model has to say about aggregate behaviour. Economists therefore should not continue to make strong assertions about this behaviour based on so-called general equilibrium models which are, in reality, no more than special examples with no basis in economic theory as it stands.”

Does Olivier Blanchard not know this? He ought to, and we think he does. But such is his ideological inner drive to argue that his policy recommendations are founded on a bedrock of good mathematics, that he is being economical with the truth. More disturbing even than this naked act of dishonesty is what Blanchard and his merry colleagues do in order to arrive at their policy recommendations (e.g. the ones he pushes onto the world community as Chief Economist at the IMF): Given the utter inability of Walrasian or Nash-Debreu-Arrow theorems to say anything tangible about the real world, they return to the single sector or Robinson Crusoe types of economies. There is nothing like strong (often austere) economic policies derived from false premises to inspire sheer horror in the hearts and minds of those in the know.

I am glad that Yanis Varoufoakis made this comment in passing because this otherwise treats the invention of Paul Samuelson in 1948 in his ‘Economics: an analytical introduction’ of Adam Smith’s use of the invisible hand metaphor as something that Smith actually said as regular readers of Lost Legacy will know by now.

However, the new book looks very interesting and gives a fierce critique of general equilibrium economics and much else in modern economics, which causes me to urge that it be consulted. From the article, of which the above is only a snippet, I recommend that your follow the link.

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