Realistic Abuses of the General Equilibrium Theory
As already mentioned several times, the theoretical system of the mainstream economics is based on the static balance, such as that the economy is always in balance and economic subjects behave rationally, and even if they are temporarily out of balance they restore equilibrium quickly. By the way this logic needs the precondition that economic subjects get complete informations quickly and cheaply. According to this precondition, economic informations must be available quickly and inexpensively so that economic subjects can act rationally. However, the reality rejects simply the logic of mainstream economics.
This problem has been pointed out by many economists. The articles such as ‘Impossibility of Informationally Efficient Market’ published in 1980 by Sanford Grossman and Joseph Stiglitz and ‘Information, Trade and Common Knowledge’ published in 1982 by Paul Millgrom and Nancy Stokke are some of the best examples. However, these papers are merely very difficult explanations of the very easy problem. Rather, the simple view of George Soros which was pointed out in his book titled [The Crisis of World Capitalism] is far more convincing than any professional paper. ‘If we act on the basis of scientifically sound knowledges, the reality that some people buy stocks while others sell does not happen. Participants in the stock market can not predict the outcome of their decisions as in the way that scientists predict the movement of the heavenly bodies. The consequences of their decision are inevitably contrary to expectations.’
In the stock market, either the buyer or the seller gains profits while the others make losses, which simply denies the hypothesis of rational behavior. If everyone gets the perfect information quickly, it can not be happened that someone gains profit by buying stocks while others lose by selling the stocks. The real stock market is the closest to the ‘perfectly competitive market’ that meets well the theoretical framework of the mainstream economics, but selling and buying stocks is happening everyday. This means that complete and rapid acquisition of information which is a prerequisite for rational behavior is not even performed in the fully competitive market.
Above all, the theoretical framework based on perfect competition and general equilibrium has a crucial problem that can not accommodate everyday economic fluctuations and economic growth in reality. To overcome this problem, the community of economics has tried various ways. The rise of the Keynesian school, the Austrian school and the monetarist school can be seen as such attempts, although they are subordinate to the neoclassical economics and they do not have replaced the paradigm of the neoclassical economics. In addition, institutional and historical scholars have also emerged to overcome the problems of neoclassical economics but they failed to overcome it. In the early 1980s, supply-side economics emerged, but the theoretical basis was fragile and somehow disappeared already.
In recent years, economic psychology or behavior economics, chaos economics, evolutionary economics and complex system economics have attracted attentions of many economists. They are aesthetically superior and highly persuasive, so many economists are enough to feel attractive. Unfortunately, however, they are somewhat practical for side issues but have little usefulness for basic and important problems. Indeed, scholars who pursue the above several economics which are collectively called as complex system economics acknowledge their limitations by declaring that ‘economics is not for predictions of the economy, but for explanations.’
If economics is to extract the laws from repetitive phenomena of the economy and to theorize the principles of the laws, at least the repetitive phenomena should be predictable, but the complex system economics abandons the possibility. Even if prediction fails and fails, economists should continue to make efforts to evolve economics. Even if it is accepted that economic forecasting is impossible, it is doubtful how the complex system economics can explain basic and important economic phenomena. Economic psychology, chaos economics, and evolutionary economics interpret almost all special phenomena, but they are not common phenomena. Even the specific phenomena that they explain are not so important. This is the biggest problem of the complex system economics. Let's take one of the most prominent example.
What is the most serious and important economic issue we have faced in recent years? It would not be objectionable to consider the global financial crisis that began in 2008 as a serious and important issue. How can the complex system economics explain this miserable incident? Can economic psychology, chaos economics or evolutionary economics explain the global financial crisis logically? Even the economists who believe and pursue the economics would have no choice but to bear their heads. What is the problem? They have ignored the fundamental problem of economics. If static or general equilibrium is a fundamental problem, then the solution should have been found there, so that fundamental solutions to the basic and important problems are possible. On the contrary, Choe’s Economics makes it the starting point for solving these fundamental problems.
If we examine one of the most serious problem of the static balancing theory, it is easy to see what economics should be pursued. Such a representative example is the realistic abuses of Keynesian economics. Keynesian economics teaches that the expansion of fiscal spending or fiscal deficits will produce a multiplier effect that will save the economy from sluggishness. In other words, increasing fiscal deficit or fiscal expanding will increase consumption, increasing in consumption will increase production, increasing in production will increase employment and investment, increasing in employment and investment will increase income and consumption and increasing in income and consumption leads to a recurring cycle of increased income and consumption.
However, it is difficult to find a historical example that fiscal expansion or fiscal deficit saved the economy. Although the policy of New Deal just after the Great Depression was known as successful, however it was only politically successful. If it was economically successful, the Great Depression did not last for more than 10 years. Of course, until the 1960s after World War II, many countries including United States enjoyed a long-term boom of so-called ‘golden age of capitalism’ which seemed to have succeeded in the policy based on Keynesian economics. But it was not because of the Keynesian economic policy that the global economy boomed at the time. The establishment of General Agreement on Tariffs and Trade(GATT) and International Monetary Fund (GATT) have made the international economic order stable, leading to activation of economic activity and international trade. Especially the expansion of international trade has played a decisive role in driving the world economy to prosperity.
In fact, United States and England, which had been relatively more enthusiastic about Keynesian economic policy, gradually lost their growth potential and international competitiveness after the economic revivals of their competitors and lagged behind Japan and Germany which defeated them in 1970s and 1980s. United States and England enjoyed economic prosperity only while other countries were not recovered from the devastation of World War II. What is the reason? It is because Keynesian economics which teaches the fiscal deficit or fiscal expansion saves the economy is wrong. Why is Keynesian economics so wrong, and why did it fail in reality?
The reason for this is that Keynesian economics is also faithful to follow the proposition of the neoclassical economics, that is, ‘equilibrium is accomplished swiftly’. If the balance is ‘swiftly’ accomplished, it often overlooks the fact that it is not necessary to consider the time and the fact that fiscal expanding or fiscal deficits is not sustainable for long time. However, fiscal spending can not exceed the gross domestic product and fiscal growth can not increase indefinitely, so its expansion is not sustainable. How is it sustainable? In order to maintain the growth rate of the economy the increasing rate of fiscal expenditure or the size of budget deficit should be maintained. However, in reality, the increasing rate of fiscal expenditure should be lowered or the fiscal deficit should be reduced soon. As a result, economic growth should be bound to retreat.
In addition, the mainstream economics is based on the theory of equilibrium, so it is believed enough for the economist to examine either supply or demand. This belief is the same whether Keynesian economist or the neoclassical economist. Keynesian economist places emphasis on demand, while the neoclassical economist focuses on supply like Seey's Law. However, it is difficult to see that supply and demand are always balanced. For instances, stocks are increasing and decreasing, prices are rising and falling, and unemployment is rising and falling. Since demand and supply are not always balanced in this way, fiscal expenditure should be grasped from demand side as well as supply side.
In reality, the effect of fiscal deficit or fiscal expanding is double-faced. In terms of demand it plays a role of raising the growth rate, but in terms of supply it plays a role of lowering the growth rate. First, in terms of demand it is not necessary to say that fiscal expansion plays a role in increasing the growth rate, since fiscal expenditure is included in the aggregate demand of national accounts to estimate the growth rate. On the other hand, in terms of supply fiscal expanding plays a role in lowering the growth rate as follows.
Public expenditure is usually put into the fields where the private sector has neglected because the productivity is low. This means that limited national resources are invested in the low-productivity fields and the fiscal expanding decreases the average productivity of the national economy. Fiscal expanding lowers not only the average productivity but also the marginal productivity. If marginal productivity determines income just as marginal utility determines price, fiscal expanding or deficits plays a role in reducing income of the national economy. Moreover, the law of diminishing returns works in the demand side, on the contrary the law of increasing returns works in the supply side. This issue will be discussed in detail later in the ‘Income Decision Theory’.
Keynesian economics that teaches fiscal expanding or fiscal deficit to revive the economy has emerged only from the perspective of demand. Keynes emphasized the demand perspective by criticizing that the neoclassical economics maintains the supply perspective, but his argument is also a loss of balance. His viewpoint of demand came from the preconditions of neoclassical economics that demand and supply are always in balance. Keynesian economics recognizes that if it is looked once at the demand perspective it is not needed to look further at the supply perspective, since demand and supply are believed always in balance. However, in reality, the phenomenon that demand and supply are always in balance is hardly found. In reality there happens frequent rise and fall of the economy and fluctuations in inventories, so the problems of economics should be found here in order for economics to be evolved.
In fact, each of demand and supply works by a totally different driver. Demand is driven by the driver of utility and supply by the driver of profit. So their response to specific phenomena is different or opposite. For example, if a price rises the consumer dislikes it but the supplier likes it. Therefore, demand and supply can not always be balanced. Such as demand and supply are different from each other in preference, how are supply and supply always balanced? Demand and supply are just forward to be balanced. Of course, the price plays a role in balancing supply and demand, but the sensitivity and speed that consumers and suppliers respond to price are different. This is why all economic phenomena should be looked at separately in terms of both supply and demand.
Now, let's look briefly at the cause of the global financial crisis. If such a serious incident occurred in the other area than the economy, how did the academic community cope? Obviously, the cause is first traced, and then the development process of it which bring on the current situation is researched. If you want to grasp the current situation accurately, it is needed for you to know the cause and development process. Knowing the current situation accurately will tell you what measures are effective to solve the problem, and you can figure out where the situation will go. But this is rarely happening in economics because the mainstream economics is tied up with the big battle of ‘the economy is balanced swiftly’ which makes it unnecessary to investigate the cause and development process. If balance is accomplished quickly, why does it needed to investigate the cause and development process?
Of course, the academic world of economics has analyzed the causes of the global financial crisis. Most well-known causes are financial derivatives, excessively high investment ratio, Greenspan bubble, deregulation of financial market or neoliberalism, rapid development of financial market, excessive national debt, immoral financiers, and so on. But these are not the root causes. Only the outcome of the global financial crisis has focused on the post-mortem that seems likely to be a cause. If the above causes are the underlying causes, it should be identified the developmental process which devastates the consequences right after the global financial crisis is broken out, but such traces are hard to find. The mainstream economics, which makes the equilibrium as a battleground of its theories, makes it unnecessary to examine the development process. In reality, they are not the root causes because it is possible to present disproportionate case to them. This issue will be discussed in detail in the ‘Economic Pathology’.