ARROW WAS RIGHT TO BE SCEPTICAL
Mark Buchanan:The Misunderstanding at the Core of Economics posts (9 March) on Bloomberg HERE
“In the 1950s, Arrow and others proved a theorem that, many economists believe, put a rigorous mathematical foundation beneath Adam Smith's idea of the invisible hand. The theorem shows -- in a highly abstract model -- that producers and consumers can match their desires perfectly, given a particular set of prices. In this rarified atmosphere of “general equilibrium,” economic activity might take place efficiently without any central coordination, simply as a result of people pursuing their self-interest. It’s an insight that economists have used to argue for de-unionization, globalization and financial deregulation, all in the name of removing various frictions or distortions that prevent markets from achieving the elusive equilibrium.
Yet the theorem trails a dense cloud of caveats, which Arrow himself recognized could be more important than the proof itself. For one, it worked only in a perfect world, far removed from the one humans actually inhabit. Equilibrium is merely one of many conceivable states of that world; there’s no particular reason to believe that the economy would naturally tend toward it. Beautiful as the math may be, actual experience suggests that its magical efficiency is purely theoretical, and a poor guide to reality. …
… This perversion isn’t Arrow’s fault. He merely helped to prove a mathematical theorem, and was no blind advocate for markets. Indeed, he actually thought the theorem illustrated the limitations of capitalism, and he was prescient in understanding how economic inequality might come to impair the workings of democratic government.’
Bloomberg is always worth reading, as Mark Buchanan’s article on Kenneth Arrow illustrates.
I have long been sceptical of the supposed, of what I call, the “Marshallian Cross” in every elementary textbook, supposedly showing the equilibrium of supply and demand where the respective supposed curve of demand prices cross the supposed curve of supply prices and intersect. The logic is impeccable. First year students are required to be able to reproduce the diagram and explain its significance.
But does anybody question its significance? Are markets replete with equilibrium prices? Is that how markets work? Or are consumers buying decisions made differently? Are suppliers price decisions the result of searching for an equilibrium price? Does anybody know what the equilibrium price is at any one moment in a market or do both parties make purchase/sale decisions on whatever price is on the ticket - subject to possible haggles - “how much for two instead of just one?”; “What’s the discount, if I order and pay for a dozen for delivery on Tuesday? And so on.
I often wonder if economists actually experience real markets and the behaviours of real people in them?