From: thompson@atlas.socsci.umn.edu (T. Scott Thompson)
Subject: Re: Problems with Neo-Classical Economics
Reply-To: thompson@atlas.socsci.umn.edu
Organization: Economics Department, University of Minnesota
Date: Wed, 7 Oct 1992 16:21:04 GMT

vadim@bolvan.ph.utexas.edu (Vadim S. Kaplunovsky) writes:

>In article <thompson.717719660@hermes.socsci.umn.edu>  
>thompson@atlas.socsci.umn.edu (T. Scott Thompson) writes:
>> .......
>> 6.  ... the real question, namely whether or not the mechanisms
>> by which free trade is _potentially_ suboptimal are empirically
>> important enough to upset the general validity of the theory.
>> 
>> The assumptions made by Newtonian physics are also "wrong".
>> Nevertheless, I have never observed an obvious violation of them in my
>> daily life, and find it useful to plan my life as if they were true.
>> If I were designing microelectronic circuits I might take a different
>> view.

>The neo-classical assumptions of perfect rationality and perfect
>information are more like zero-friction approximation to the Newtonian
>mechanics rather than the Newtonian approximation as such.

I guess my ignorance about Newtonian physics is showing.  I thought
that frictional "forces" were a part of the Newtonian physics.  (It's
hard to believe that my rather pathetic high school physics course
went beyond Newton in its analysis of mechanics!)

>The neo-classical theorem (sorry, I forgot the name) that the initial
>allocation of property does not affect the economic behavior seems to me
>just as sound as the no-walking theorem of the no-friction mechanics.

I'm afraid I don't know of any neoclassical theorems that make this
claim.  There is a theorem that states that any Pareto optimal outcome
can be achieved by arranging _some_ initial allocation of resources
and then letting the competitive market do its thing.  And there is
another theorem that says that the outcome of any competitive
equilibrium will be Pareto optimal.  But Pareto optimal outcomes are
not unique -- the particular Pareto optimal allocation chosen by
market forces definitely depends on the initial allocation of
property.

Consider two initial allocations: (1) I get everything; (2) I get
nothing, everyone else gets an equal share of all resources.  Economic
theory is not so crazy as to claim that observed behavior of the
economy will be the same in these two cases.

Perhaps you have a different definition of "economic behavior" than I
am using here.

However, your point about "friction" is well taken.  It is very
difficult to model economic "friction" well.  Most approaches simply
impose ad hoc restrictions on rates of change of various prices and
quantities, without making any attempt to get at the root causes.  The
better models attempt to account for slow reaction of prices to market
forces (for example) in terms of explicit costs of adjustment.
Exactly where these costs of adjustment come from, and their
magnitude, is rarely explained, but is crucial for analyzing the
welfare effects of various policies when frictions are present.

I recall one article on trade theory published about 8 years ago that
imposed an ad hoc restriction on how fast the allocation of capital
could be changed in reaction to changes in the rates of return in
different sectors.  The dynamic equilibrium adjustment path of this
economy in response to a one time change in the terms of trade is to
slowly converge to a new steady state national income (that is higher
than the old national income when measured at the new steady state
prices).  The author concluded that a "capital adjustment" subsidy
would be beneficial since it would accelerate the movement to the new
higher steady state income level.  Such a conclusion ignores the issue
of _why_ capital is adjusting slowly in the first place.  It is quite
possible that the slow adjustment is the socially efficient reaction
to real adjustment costs that were left out of the model, in which
case the adjustment subsidy would lower welfare in the short run by
promoting too much (costly) adjustment.

>(Not that the no-walking theorem is totally useless -- it helps to explaing
>why it's so hard to walk on wet ice.  I presume that the initial-allocation-
>independence theorem is also useful under some conditions, I just do not
>know what kind of ice it needs.)

I would be very interested in getting a reference to this theorem if
you can provide it.

>The real question, as Scott correctly sais, is not whether are economic
>theories are exact or approximate, but whether the approximations are
>empirically justifiable, and under what conditions.

Exactly.
--
T. Scott Thompson              email:  thompson@atlas.socsci.umn.edu
Department of Economics        phone:  (612) 625-0119
University of Minnesota        fax:    (612) 624-0209