Posted by: Dirk | June 7, 2013

The Irrelevance of Equilibrium Economics

The title of this post refers to a paper by Nicholas Kaldor from 1972. He starts his article on p. 1237:

I should go further and say that the powerful attraction of the habits of thought engendered by “equilibrium economics” has become a major obstacle to the development of economics as science – meaning by the term “science” a body of theorems based on assumptions that are empirically derived (from observations) and which embody hypotheses that are capable of verification both in regard to the assumptions and the predictions.

I find this hard to swallow. As many say, economics is an art rather than a science. Historians think the same way. You cannot be objective because your choice of the problem is already biased: inflation, unemployment or growth – why should you care? Also, it is hard to believe that in economics you can falsify – let alone verify – ideas. And if you would, then almost all of the models that we teach must be discarded. Central bank controls the money supply in the IS/LM model? There goes the IS/LM model. Labour market equilibrium free from distortions? There goes the neo-classical model. Intertemporal optimization always works and there is no default ever? There goes the DSGE model.

Kaldor provides a quote by Einstein which offers a way out:

“The skeptic will say: ‘it may well be true that this system of equations is reasonable from the logical standpoint. But it does not prove that it corresponds to nature’. You are right, dear skeptic. Experience alone can decide the truth.

There is some truth in this. It takes an economist to judge whether it makes sense to use one abstraction (model) or the other. And that economist should be independent from outside influence, since otherwise he will not be neutral in his judgements. So, maybe independence of academic economists is a good idea. If it must be accepted that economics cannot deliver ultimate truths, then the consequence is to open up the discipline to engage into more conversations with other disciplines. Also, pluralism seems like a good idea. Students would then be “free to chose”, to use Milton Friedman’s phrase. If you embrace competition as an economist, why is it not applied at university? Why are courses only mainstream, with no alternatives? It seems like those that argue for competition have themselves opted out of it.

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