Kate Raworth on new classical critique of equilibrium theories

Kate Raworth Doughnut Economics      2017 hardback  p 134 :

(G)eneral equilibrium theories dominated macroeconomic analysis through the second half of the twentieth century , and all the way up to the 2008 financial crash . The ‘ New Classical ’ variants of equilibrium theory – which assume that markets adjust instantly to shocks – jostled for attention with so – called ‘ New Keynesian ’ variants that assume there will be adjustment delays due to ‘ sticky ’ wages and prices . Both variants failed to see the crash coming because – being built on the presumption of equilibrium , while simultaneously overlooking the role of the financial sector – they had little capacity to predict , let alone respond to , boom , bust and depression . With such ill – fitting models dominating macroeconomic analysis , some big – name insiders began to critique the very theories that they had helped to legitimise . Robert Solow , known as the father of neoclassical economic growth theory and long – time collaborator of Paul Samuelson , became an outspoken critic , first in his 2003 speech bluntly entitled ‘ Dumb and Dumber in Macroeconomics ’ , then in analyses that mocked the theory’s stringent assumptions . 6 The general equilibrium model , he pointed out , in fact depends upon there being just one single , immortal consumer – worker – owner maximising their utility into an infinite future , with perfect foresight and rational expectations , all the while served by perfectly competitive firms . How on earth did such absurd models come to be so dominant ? In 2008 , Solow gave his view :

“I am left with a puzzle , or even a challenge . What accounts for the ability of ‘ modern macro ’ to win hearts and minds among bright and enterprising academic economists ? … There has always been a purist streak in economics that wants everything to follow neatly from greed , rationality , and equilibrium , with no ifs , ands , or buts … The theory is neat , learnable , not terribly difficult , but just technical enough to feel like ‘ science . ’ Moreover it is practically guaranteed to give laissez – faire – type advice , which happens to fit nicely with the general turn to the political right that began in the 1970s and may or may not be coming to an end .”

One thing that is clearly coming to an end is the credibility of general equilibrium economics . Its metaphors and models were devised to mimic Newtonian mechanics , but the pendulum of prices , the market mechanism , and the reliable return to rest are simply not suited to understanding the economy’s behaviour . Why not ? It’s just the wrong kind of science .

No one made this point more powerfully than Warren Weaver , the director of natural sciences at the Rockefeller Foundation , in his 1948 article , ‘ Science and Complexity ’ . Looking back over the last three hundred years of scientific progress , while simultaneously looking forward at the challenges facing the world , Weaver clustered together three kinds of problems that science can help us to understand . At one extreme lie problems of simplicity , involving just one or two variables in linear causality – a rolling billiard ball , a falling apple , an orbiting planet – and Newton’s laws of classical mechanics do a great job of explaining these . At the other extreme , he wrote , are problems of disordered complexity involving the random movement of billions of variables – such as the motion of molecules in a gas – and these are best analysed using statistics and probability theory .

In between these two branches of science , however , lies a vast and fascinating realm : problems of organised complexity , which involve a sizeable number of variables that are ‘ interrelated in an organic whole ’ to create a complex but organised system . Weaver’s examples came close to asking the very questions that Newton’s apple failed to prompt . ‘ What makes an evening primrose open when it does ? Why does salt water fail to satisfy thirst ? … Is a virus a living organism ? ’ He noted that economic questions came into this realm , too . ‘ On what does the price of wheat depend ? … To what extent is it safe to depend on the free interplay of such economic forces as supply and demand ? … To what extent must systems of economic control be employed to prevent the wide swings from prosperity to depression ? ’ Indeed , Weaver recognised that most of humanity’s biological , ecological , economic , social and political challenges were questions of organised complexity , the realm that was least understood . ‘ These new problems , and the future of the world depends on many of them , require science to make a third great advance , ’ he concluded .

That third great advance got under way in the 1970s when complexity science – which studies how relationships between the many parts of a system shape the behaviour of the whole – began to take off . It has since transformed many fields of research , from the study of ecosystems and computer networks to weather patterns and the spread of disease . And although it is all about complexity , its core concepts are actually quite simple to grasp – meaning that , despite our instincts , we can all learn , through training and experience , to be better ‘ systems thinkers ’ .

A growing number of economists are thinking in systems too , making complexity economics , network theory , and evolutionary economics among the most dynamic fields of economic research . But , thanks to the lasting influence of Jevons and Walras , most economics teaching and textbooks still introduce the essence of the economic world as linear , mechanical and predictable , summed up by the market’s equilibrating mechanism . It’s a mindset that will leave future economists deeply ill – equipped to handle the complexity of the contemporary world .

In a playful ‘ look back from 2050 ’ the economist David Colander recounts that , by 2020 , the majority of scientists – from physicists to biologists – had already realised that complexity thinking was essential for understanding much of the world . Economists , however , were a little slower on the uptake and it was not until 2030 that ‘ most economic researchers believed that the economy was a complex system that belonged within complexity science ’ . 9 If his history of the future should turn out to be right , it may well be too late . Why wait until 2030 when we can ditch the ill – chosen metaphors of Newtonian physics and get savvy with systems now ?”