Tuesday, March 22, 2011

equilibrium and an invisible ideology

DebunkingEconomics | Economics as a discipline arose at a time when English society was in the final stages of removing the controls of the feudal system from its mercantile/capitalist economy. In this climate, economic theory had a definite (and beneficial) political role: it provided a counter to the religious ideology that once supported the feudal order, and which still influenced how people thought about society. In the feudal system the pre-ordained hierarchy of king, lord, servant and serf was justified on the basis of the ‘divine right of Kings’. The King was God’s representative on earth, and the social structure which flowed down from him was a reflection of God’s wishes.

This structure was nothing if not ordered, but this order imposed severe restrictions on the now dominant classes of merchants and industrialists. At virtually every step, merchants were met with government controls and tariffs. When they railed against these imposts, the reply came back that they were needed to ensure social order.

Economic theory–then rightly called political economy–provided the merchants with a crucial ideological rejoinder. A system of government was not needed to ensure order: instead, social order would arise naturally in a market system in which each individual followed his own self-interest. Smith’s phrase ‘the invisible hand’ came along rather late in the process, but the notion played a key role in the political and social transformations of the late 18th and early 19th centuries.

An essential aspect of this market social order was equilibrium.

From the outset, economists presumed that the market system would achieve equilibrium. Indeed, the achievement of equilibrium was often touted as an advantage of the free market over any system where prices were set by fiat. Equilibrium was therefore an essential notion of the economic defence of capitalism: the equilibrium of the capitalist market would replace the legislative order of the now defunct feudal hierarchy.

More importantly, whereas the feudal order endowed only the well-born with welfare, the equilibrium of the market would guarantee the best possible welfare for all members of society. The level of individual welfare would reflect the individual’s contribution to society: people would enjoy the lifestyle they deserved, rather than the lifestyle into which they had been born.

If, instead of equilibrium, economists had promised that capitalism would deliver chaos; if, instead of meritocracy, economists had said that the market could concentrate inequality, then economists could have hindered rather than helped the transition to capitalism (though they more likely would have been ignored).

By the middle of the 19th century, the transition to capitalism was complete: what was left of feudalism was a mere vestige. But rather than the promised equilibrium, 19th century capitalism was wracked by cycles and enormous disparities of wealth. A major depression occurred roughly every 20 years, workers’ conditions would improve and then rapidly deteriorate, prices rise and then fall, banks expand and then collapse. New ‘robber barons’ replaced the barons of old. It appeared that, while promising a meritocratic equilibrium, capitalism had instead delivered unbalanced chaos. A new political challenge arose: that of socialism.

Once again, economics rose to the challenge, and once again equilibrium was a central tenet. This time the defence was mounted by what we today call neoclassical economics, since classical economics had been turned into a weapon against capitalism by the last great classical economist, Karl Marx.

In contrast to the hand-waving of Smith, the neoclassical economists of the late 19th century provided a substantive mathematical analysis of how equilibrium could be achieved by an idealised market economy, and how this equilibrium could be fair to all. However, unlike the earlier classical championing of capitalism, this technical edifice provided very little in the way of libertarian slogans for the battle against the ideology of socialism. Instead of arming capitalism’s defenders with rhetoric to deploy against socialists, it gave birth to the academic discipline of economics.

Capitalism eventually transcended the challenge of socialism, with little real assistance from economic theory. But while the economics had little impact upon capitalism, the need to defend capitalism had a profound impact upon the nature of economic theory. The defensive imperative, and the role of equilibrium in that defence, cemented equilibrium’s role as a core belief of economic theory.

At the beginning of the 3rd millennium, there is no competing social system against which capitalism must prove its superiority. Feudalism is long dead, and those socialist societies which remain are either socialist in name only, or bit players on the world stage.

Today, most economists imperiously dismiss the notion that ideology plays any part in their thinking. The profession has in fact devised the term ‘positive economics’ to signify economic theory without any value judgments, while describing economics with value judgments as ‘normative economics’–and the positive is exalted far above the normative.

Yet ideology innately lurks within ‘positive economics’ in the form of the core belief in equilibrium.[3] As previous chapters have shown, economic theory has contorted itself to ensure that it reaches the conclusion that a market economy will achieve equilibrium.[4] The defence of this core belief is what has made economics so resistant to change, since virtually every challenge to economic theory has called upon it to abandon the concept of equilibrium. It has refused to do so, and thus each challenge–Sraffa’s critique, the calamity of the Great Depression, Keynes’s challenge, the modern science of complexity–has been repulsed, ignored, or belittled.

This core belief explains why economists tend to be extreme conservatives on major policy debates, while simultaneously believing that they are non-ideological, and are in fact motivated by knowledge rather than bias.

If you believe that a free market system will naturally tend towards equilibrium–and also that equilibrium embodies the highest possible welfare for the highest number–then ipso facto, any system other than a complete free market will produce disequilibrium and reduce welfare. You will therefore oppose minimum wage legislation and social security payments–because they will lead to disequilibrium in the labour market. You will oppose price controls–because they will cause disequilibrium in product markets. You will argue for private provision of services–such as education, health, welfare, perhaps even police–because governments, untrammelled by the discipline of supply and demand, will either under or oversupply the market (and charge too much or too little for the service).


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