"growth theory the foundation of macro"
Source Julio Huato
Date 07/04/21/12:05

Michael Lebowitz quotes me and asks:

>> Economists call them "altruistic preferences." In fact, a big chunk
>> of modern growth theory is based on that implicit assumption.

> really? could you elaborate a bit on this?

Bad phrasing. Not a discrete "big chunk" of modern growth theory, but
its very foundations. And, therefore, the very foundations of macro
-- since growth theory is viewed as the foundation of today's macro.

And maybe "implicit" is too weak an adjective. Ages ago, one could
say the assumption was merely "implicit." But since the 1960s, not
only these but many other hidden implicit assumptions of the mother of
all economic theory (i.e. general equilibrium) have been increasingly
revealed under closer scrutiny.

If one looks at it as a whole, two main tendencies characterize the
evolution of economic theory after the 1960s. One has been towards
endogenizing the old *parameters* of general equilibrium: endowments
(the distribution of wealth), technology (technical relations between
goods, means of production, and labor power), preferences (relation
between goods, social, and individual wellbeing), and "institutions"
(market structures, firms, groups, classes, polities, contracts,
etc.). The other (related) tendency has been towards tweaking the
usual *postulates* of general equilibrium, i.e. introducing explicit
time and uncertainty, externalities, misbehaved preferences and
technology, information "impurities," etc.

Basically (because things are always much more complicated), these two
tendencies have been split perpendicularly into two schools: One of
them, highly ideological, has been twisting itself every which way to
rationalize or reconcile the new results with the prejudice that,
although markets and inequality are far from perfect, conceivable
alternatives to them are much worse. The other school seems more
willing to entertain alternatives. I insist: I'm talking about
economic theory as I see it evolving. I'm not referring to the
empirical side of economics, which is not disconnected, but quite
another thing.

Every respectable graduate macro I textbook (e.g. Stokey & Lucas,
Blanchard & Fischer, Barro & Sala-i-Martin, etc.) starts by posing the
growth problem in a decentralized-market economy. Then, instead of
solving it directly, it jumps to the problem of a "benevolent social
planner." It solves the latter and uses it as the baseline. In plain
words, perfect communism is the baseline of economic optimality in
growth economics. Then the authors try to show that the communistic
planning solution is, under some conditions, identical to the
decentralized market solution to the growth problem. Therefore,
markets are efficient.

Let me say in passing that the paradigmatic, general-equilibrium model
of growth is the 1928 Ramsey model, which -- as David Laibman told me
yesterday (as we lunched at the beautiful Brooklyn Botanical Garden)
-- is all but a model of decentralized markets. And these is how the
economists appropriated the Ramsey model.

What conditions are required for (1) communist planning and, its
antipod, (2) decentralized markets to generate identical results?
Remember Marx on Say: Turn M-C-M' into C-M-C, declare that C-M and M-C
are identical, assume that the money mediation is merely phenomenic.
You end up with C-C, barter. Perfect harmony is one step away. All
the troubles characteristic of developed markets and capitalism will
vanish. In other words, abstract from the social conditions that make
markets markets and capitalism capitalism.

It turns out, the conditions that allow to equate perfect communism to
decentralized markets are the conditions that make the separation
theorems underlying general equilibrium stick. Thanks to those
mathematical theorems, economists have established that optimal
production and consumption decisions can be split (made by two
different agencies) and remain optimal. That the consumption or
production decision by each individual can be split from the decisions
of all others, and remain optimal. Etc. But that's if and only if a
system of economic signals emerges or is somehow devised such that it
gives individual choice makers the right data to plug into their
models, so that they make the right choices.

If, for some reason, the signals are distorted or the system fails,
then the outcome won't be socially optimal. At first, it seemed that
little could be said about the welfare implications of market failure.
So, initially, these cases were viewed as "anomalies" to general
equilibrium. The markets in a general equilibrium setting could fail
for all sorts of reasons, but the baseline was the case in which
markets exist, are complete, and perfect. A lot has been learned

What ensures the existence of such perfect system of economic signals?
And what ensures that the signals are not distorted? Economists used
to say no or -- more precisely -- perfect government. But what
ensures perfect government or, in other words, what ensures the
(political) unity of the people around a certain economic arrangement?
In general, the requirement is that, outside of the market economy,
as a result of unexplained social processes other than those
associated with markets, the agents get along. And the most direct
way to ensure this is by intertwining the preferences of the agents in
this economy. That's the definition of altruistic preferences.

There has been a gradual but steady shift from viewing
decentralized-market general equilibrium as the general case
(violations to its assumptions as anomalies or exceptions) to viewing
it as a special case of a more general form of general equilibrium. I
know these are sinful thoughts to people who have strong negative
associations attached to the term "equilibrium," but I can see the
latter framework evolving into an analytically-turbocharged version of
historical materialism.

[View the list]

InternetBoard v1.0
Copyright (c) 1998, Joongpil Cho