Savitri Era of those who adore, Om Sri Aurobindo and The Mother.

Friday, June 06, 2008

Change takes time and is not synchronous

Walraisian General Equilibrium a Dead End
from Adam Smith's Lost Legacy by Gavin Kennedy
Edward Lotterman teaches and writes in St. Paul, Minn, and posts an interesting piece in the Idaho Statesman (here) (6 June)...

This is a ptetty good account of the Walrasian auctioneer, both illuminating what he is supposed to be doing and what actually happens, crowning the account with the futility of general equilibrium economics.In fact, Lotterman brings out something very important for all economists truing to model real world economies – there ain’t no such thing as equilibrium. This is a futile quest that was initiated in the 1870s that helped to re-direct economics into the pursuit of mechanical perfections akin to how the physical universe was supposed to work, using 19th century mathematics under the auspices of turning economics into a ‘hard science’.

The habit of extracting conclusions from such models overcame the reality that changes in economic variables are not made with infinite velocity. The humans in the system do not switch on an off immediately. Change takes time and is not synchronous.

Read Lotterman’s full article (via the link) to see how he expresses this simple and immovable fact.Indeed no economic state starts at equilibrium. The variables are already changing, probably unnoticed, because the people who make the changes are already under the influence of pressures not captured in the models, some responding positively and some negatively. Some are going out of business and others are joining the complex supply chains that affect with their outputs the inputs of many businesses.

The auctioneer model is a nice try. It still leads to a dead end, even if elegantly imaged as a general equilibrium equation.

Adam Smith used the metaphor of ‘an invisible hand’ (WN IV.ii.9: p 456) to explain the consequences of varying degrees of risk avoidance among some, but not all, trading merchants who decided, some totally, some partially and some not at all, to allocate their capitals between the foreign trade of consumption (mainly with the British colonies in North America under the protections of the trading monopoly of the Cromwellian Navigation Acts, as amended, but also to the East India Company) and their domestic markets close to their home domiciles.

His account of the making of the common labourer’s woollen coat showed the complexities, extent and multiple locations of the supply chain that made them in 18th century Scotland. The multiple opportunities for disequilibria even in this single supply chain makes it obvious that the economy as a whole was beyond being modelled in a state of general equilibrium without the most unrealistic prior assumptions and the necessary absence of people. Change in real time is not instantaneous. Speeding up the work of the Walrasian auctioneer will not solve the problem.

For a start, economic equilibrium does not exist in the real world and the real world does not change with infinite velocity. Adam Smith did not make this mistake and nor did he make the mistake that inexorably follows from it: he didn’t try to predict the future. He preferred to look backwards in time to try to explain what had happened, not what might happen in future.

Firms and governments that hire forecasters, supply them with powerful computers, add their research staff and administrators, simply waste the money that pays for them all, at some cost to their alternative uses. Worse, firms and governments that act on their forecasts are yet more prodigal with scarce resources, net of the purchases by deluded other users of the outputs, but gross of all the resources spent on following the ‘predictions’

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