[OPE-L:972] Re: Makoto Itoh's request

Alan Freeman (100042.617@compuserve.com)
Wed, 7 Feb 1996 04:46:14 -0800

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Hello Makoto

I wonder if Chines academic circles are aware that Kenneth Arrow
himself has publicly renounced the general equilibrium theory with
which he, along with Debreu and perhaps Hahn, is most closely
associated in the public mind. His criticism of the project extends
also to rational expectations.

I think his testimony does the neoclassical project quite a lot of
damage. Arrow as witness has the advantage of great seniority and
almost universal respect. And since Arrow was a member of the general
equilibrium 'team', and a Nobel Prize Winner as well, I would
have hope his testimony might carry some weight in these circles.

His criticism, though phrased politely, is exceedingly harsh and
thorough if its content is studied carefully. A flavour of it
comes through in an article in the Guardian, 4/1/94, where he writes
among other things:

"a long list of empirical failures mark the application of general
competitive equilibrium. Some are literal falsifications of the model;
some are omissions, important aspects of the economy which the theory
does not address; and some are questions about the theory's
presuppositions. I list only a few.

"the best-known falsification is the recurrent and now chronic
existence of mass unemployment, which is a straightforward
contradiction of equilibrium. Closely related is the fact that
sales are constrained by the demanders, not by a company's
willingness to produce at given prices.

"Second is the excess volatility of share, oil, metal and other
mineral prices, which are hard to explain as movements in
expected discounted values of future prices. There is an even
deeper difficulty with minerals prices. GCE and rational
expectations imply steadily rising prices for exhaustible
resources, yet even long-term trends have often proved
remarkably flat.

"as for share prices, there are a number of other difficulties
in reconciling the actual course of prices with any form
of rational expectations. In particular, the observed data on
neither the excess return on equities compared with bonds
nor the volume of trading on securities (and other financial
markets) can be explained in these terms.

"Two very different omissions in GCE are long-term growth
in percapita income and the widespread existence of contracts
which depart from the price system, (eg limits on insurance
contracts, executives' incentive payments, rationing of
bank credit)

"GCE in a straightforward form has only capital accumulation
as an explanation for growth, but this implies falling and
eventually zero rates of per capita income growth.

"It can be saved by assuming that increasing productive
knowledge is available from outside the system ("exogenous
growth") But this is unsatisfactory intellectually and does
not fit the real world"

I think if the marxists were as willing to take as outspoken
and self-critical a line against the equilibrium elements in their
own heritage, it is likely we would have more modern work in the
marxist tradition to set against Lucas. As it is, almost the
only major work I know of that partially breaks from the
general equilibrium tradition is Grossman's.

A very informative and practical book which I think would be
of great relevance to the present Chinese debate is a work
by Richard M. Day (Verso 1986) entitled 'The Crisis and the
Crash'. This is a very detailed account of the debate among
Soviet economists in the twenties about whether capitalism
would stabilise or not. It traces the Bukharin's evolution
towards his 'equilibrium' interpretation of Marx's reproduction
schemes which has since, I think, become virtually hegemonic.
It also traces how the empirical inadequacies of this
approach was reflected in Soviet policy debates and in academic
debates around issues such as long waves, growth policy, planning
and so on. I would imagine Bukharin must be at least indirectly
influential in Chinese Marxist circles: at least his general
approach, for example towards the peasantry. Perhaps a critical
examination of Bukharin would be politically acceptable and
also fruitful in terms of unearthing alternatives from within

Arrow himself has moved into complexity theory, and an account
of his involvement is contained in M. Mitchell Waldrop,
"Complexity", USA:Simon and Schuster 1992 and UK:Viking, 1993
ISBN 0-670-85045-4. I find this new theory not particularly
useful either as a critique of existing theory or a source
of new theory. So Arrow's criticism is perhaps more valuable
than the alternative he has espoused. But the criticism is

One aspect of Lucas's work which has been making headway, I
feel, is the attention he has focussed on business cycles and
this also is important in the context of the Chinese debate since
I imagine the question of stabilisation must be a topic of

In the the rational expectations account, as far as I can
ascertain, fluctuations in output or growth must be the result
of external shocks and their propagation in time through the
adjustment process. Lucas's 1975 'monetary equilibrium business
cycle' is, I think, the antecedent of this type of model which
is now very fashionable. This is detailed in Lucas, R.E.(1975)
'An equilibrium model of the business cycle', Journal of
Political Economy 4, pp103-24

I think the apologetic character of this kind of study is
as follows: it denies, in essence, any *endogenous* characteristic of
capitalist economy which will lead to instability. But at the
same time it contains a 'plausible' account of observed fluctuations
which makes it appear to be applicable empirically to the rather
disturbed behaviour of an actual market economy. The policy
conclusions which follow are that the most sensible thing is
that there is no *intrinsic* problem with the market; it will
stabilise, allocate resources, and so on just as in GCE; but
external interference instead of dying away, can propagate
in time. So not only is external interference or 'shocks' (particularly
monetary shocks) the main course of market failure, but the
effects of this external interference are long-lasting and

Obviously with this theory you can explain almost any fluctuation
as the work of the devil. But if we regard GCE as the view that
disharmony is the work of the devil, I think the modern theory
says that the devil moves in mysterious ways. It has to, since
it is obliged to explain much disharmony in which the devil's hand
is not immediately evident.

Since marxism on the whole refrains from discussing either this
disharmony or these fluctuations either,it places itself in a weak
position to counter Lucas. I think the most useful counter is to be
found in those theories which successfully identify endogenous features
of the market as responsible for cyclic behaviour and instability.

The mainstream work "Business Cycles" by Mullineux, Dickinson and
Wengsheng Peng(Blackwell 1993) contains a comparative treatment of a
number of business cycle theories including the equilbrium business
cycle model with which, they say, Lucas was originally associated and the
real business cycle model which is essentially a more recent development
of this.

It contains an excellent, objective and empirically-sound rebuttal
of these models. It speaks favourably of the work of Goodwin and
his co-workers in developing endogenous business cycle models
citing among other works the proceedings of the Siena conference
of 1983, available as Goodwin, Kruger and Vercelli, 1984, Nonlinear
Models of Fluctuating Growth, An International Symposium 'Lecture
Notes in Economic and Mathematical Systems 228', Berlin and New

It charts the major offshoots of this work up until about 1991.

The book is very readable and I use for second-year undergraduate
courses; but it contains a thorough bibliography.

Goodwin is one of the major serious theoretical traditions studying
endogenous growth and business cycle models in a framework which
openly acknowledges Marx's influence.

But also in a heterodox tradition generally sympathetic to Marxism or
avowedly Marxist, I think Willi Semmler and Peter Flaschel have been
working with collaborators to plough a fairly productive furrow in
the study of possible endogenous causes of business cycles, which I
think makes it a clear source of alternatives to the Lucas account
of cycles.

I would be very glad to hear from OPE members of any other work
on endogenous business cycle models or in a non-equilibrium marxist
tradition. I constantly run across work I have not heard of before
in this field.

I think the Schumpeterian tradition also yields trenchant criticms
of Lucas. I will enquire. I wonder if Riccardo has any suggestions?

A series edited by Peter Flaschel is called 'Dynamische
WirtschaftTheorie' (dynamic economic theories), published by
Peter Lang Verlag Frankfurt.

Good luck in a very important enterprise and thank you for
what you have done so far.