REVERIES OF EQUILIBRIUM - It is time for an alternative economics

Ashok Mitra
The Telegraph
February 20, 2006

Walras showed through his mathematical exercise that if all these conditions, which define a perfect market, were satisfied, the market would reach a state of equilibrium at the end of the day, yielding maximum possible satisfaction to all buyers and all sellers. His exercise became known as general equilibrium analysis; the conclusion was drawn that, under conditions of perfect competition, the market, any market anywhere, all markets in the country would reach a situation where welfare would be optimized for all participants in the market transaction. Walras was succeeded in the chair at Lausanne by another engineer-turned-economist. Vilfredo Federico Damaso Pareto, who spelt out the Walrasian exercise in the form of a theorem, which was formally described as the Pareto Optimum: equilibrium is that state of affairs where nobody in society can be better off without making somebody else worse off, and vice versa.

This idyllic system set rivers of enthusiasm on amongst economists in the generations that followed. A dream, a beautiful dream, where welfare is maximized for each and all, but only if conditions of perfect competition obtained. Economic analysis proceeded at breakneck speed to unravel the different facets of general equilibrium. The fulfilment of the dream was contingent upon perfect competition being the market reality. Over-zealous economists, however, performed a neat reversal trick. The assumption, they pretended, was the reality, and markets everywhere were taken to be as perfect as the conditionalities of the Walrasian equilibrium required them to be.

This was nothing short of outrageous. The perfect market, where all sellers and buyers have the same economic clout and are imbued with the same stock of knowledge and communicability, is a rarity. On the contrary, conditions of monopoly (domination of one seller over others) and monopsony (domination of one buyer over others) tend to be the rule. The best text in English on general economic analysis is John Hicks?s classic, Value and Capital. Having explored the nooks and corners of general equilibrium analysis in severe detail, Hicks suddenly has an attack of conscience. He cannot deny the reality that the typical firm often exercises a major influence over the prices at which it sells its products and is therefore, to some extent, a monopolist, which means that market conditions deviate from the conditions of perfect competition.

He follows up this admission by the somewhat apologetic observation: ?it has to be recognized that a general abandonment of the assumption of perfect competition, a universal adoption of the assumption of monopoly, must have very destructive consequences for economic theory. Under monopoly, the stability conditions become indeterminate; and the basis on which economic laws can be constructed is therefore shorn away.? This, he admits, will make a ?wreck? of economic theory. So what is to be done?

Please listen to what he says: ?It is, I believe, only possible to save anything from this wreck ? and it must be remembered that the threatened wreckage is that of the greater part of general equilibrium theory ? if we can assume that the markets confronting most of the firms with which we shall be dealing do not differ very greatly from perfectly competitive markets.?

Does it not sound like a version of the rake?s progress? What was a dream is converted into a hypothesis. The hypothesis is establishable only on the basis of an assumption. Since the assumption is at variance with market realities, the armchair economist is overtaken by panic: what is going to happen to his pet economic theory if this fact is candidly acknowledged? Saving the theory, the conclusion is reached, is the more important task. The final recourse, therefore, is in pretending that the world is not what it is, but what the sophisticate set of economists wish it to be.

It would not have mattered much if such economists were left to their devices in the confines of the lecture rooms. Unfortunately, the fudging done by them has become the dogma of those who control the international economic system. The tenets based on the general equilibrium analysis, it is now being insisted, must be observed by all, including the weakest economies of the world. Existing global conditions however hardly reflect those of the perfect market. Countries entering international trade differ widely in their economic strength. They differ widely in their political and military prowess as well; the economic divergences consequently grow even wider. The World Trade Organization nonetheless proceeds as if all countries have the same economic capability and the same resource endowment. Even if, for historical and other reasons, some countries lag behind, they must, the WTO ordains, take measures ignoring the existence of such inequalities of status and conditions.

Would it not be sin though to give in to the monstrous conspiracy that is on? Perhaps social scientists in countries at the receiving end of the inequities resulting from the distorted use of the general equilibrium system should form core groups of their own and return economics to its ancient pledges. Economics in its early phases, was intended to further the wealth and welfare of people. Classical political economy ? as developed by Adam Smith, and then by David Ricardo and, in the final round, by Karl Marx ? did not deviate from the objective. Adam Smith directed his ire against those masters who exploited their employees; that is why he favoured free competition which, he hoped, would restrain the monopolists.

Ricardo?s principal campaign was against the landlords whose precepts and policies retarded economic growth and thereby stifled the welfare of citizens at large. Marx, of course, travelled the furthest and strove to prove that whatever production takes place in society is the exclusive contribution of labour, both direct and ?embodied? in capital; the fruits of such production should therefore belong in entirety to the working class.

It is time for an alternative economics, an economics which would be much more faithful to its classical roots than what is preached by the vandals at large, blabbering about general equilibrium.