Alfred Marshall and Modern Economics

Equilibrium Theory and Evolutionary Economics

N. Hart

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9781349337781, 9780230302716
• eBook ISBN: 9781137029751
• Topic: Economics
• Subtopic: Econometrics
• Index: Economics

Alfred Marshall and Modern Economics re-examines Marshall's legacy and relevance to modern economic analysis with the more settled conventional wisdom concerning evolutionary processes allowing advances in economic theorising which were not possible in Marshall's life time.

1

Introduction: Equilibrium and Evolution

The Mecca of the economist lies in economic biology.

(Marshall, Principles: xiv)¹

The very notion of what constitutes an economic theory will have to change. For a century, some economists have maintained that the biological is a more appropriate paradigm for economics than equilibrium models analogous to mechanics … economic theory may well take an analogous course.

(Arrow 1995: 1618)

The prediction made by Kenneth Arrow (see the second epigraph), a leading figure amongst modern equilibrium theorists, is part of a collection of contributions from scientists judged to be at ‘the frontier’ of their disciplines. Each scientist was asked what he or she saw in the future for science. Arrow’s prediction echoes Alfred Marshall’s famous depiction of economic biology as the ‘Mecca of the economist’ made well over a century ago in the preface to his highly influential Principles. As Arrow’s account indicates, mainstream economic analysis has evolved in a direction that has largely abandoned the economic biology Mecca proclaimed by Marshall, with the ‘equilibrium models analogous to mechanics’ constituting the central organising method in the construction of economic theory. The biological paradigm is nested within what now constitutes evolutionary economics; however, despite its growing popularity, this line of inquiry continues to lurk at the fringes of mainstream economics, and has yet to significantly challenge the dominance of the traditional equilibrium-based methods of analysis. In this setting, Arrow’s prediction of a more biological approach to economic analysis appears to be rather problematical, with the economic biology Mecca instead seemingly destined to remain the unfulfilled ambition that it had largely been in Marshall’s writings.

The methodological obstacles that render the biological pathway elusive within mainstream economics parallel those that Marshall had struggled to overcome in the successive editions of his Principles, where we observe a recurrent struggle for ascendency between ‘mechanical’ and ‘biological’ theoretical perspectives. In particular, Marshall sought to reconcile an equilibrium-based theory of relative prices constructed with techniques borrowed from mechanics, with explanations of economic growth and development that was recognised as being continuous in time and evolutionary in nature. In the pursuit of his ambition to preserve a unity between value theory and explanations of growth, Marshall discovered that equilibrium and evolution were essentially incompatible bedfellows.² However, Marshall was unwilling to abandon the mechanical analogies, while holding steadfastly to his conviction that economic processes had to be interpreted as being ‘biological’ in nature.

If modern economic analysis is to attain Arrow’s prediction regarding the adoption of a ‘more biological paradigm’, the issues left largely unresolved by Marshall and disregarded in much of the subsequent mainstream literature, will have to be confronted. As outlined in Chapters 3 and 4, the equilibrium-based theories that have been constructed after Marshall have inherited many of the limitations and logical difficulties that Marshall had alluded to in his cautions regarding the hazards inherent in static analysis founded on mechanical equilibrium analogies. Most significantly, these equilibrium-based theories of value have become divorced from explanations of actual economies undergoing growth and transformation. From Marshall’s methodological perspective, this signifies a retrogressive outcome in the development of economic analysis, given Marshall’s ambition to establish a unity between explanations of economic growth and development and what he termed the general relations of demand and supply and value. Clearly, if economics is to navigate a ‘more biological pathway’, there has to be a movement away from the mechanical equilibrium models that impede such a journey. This would entail a fundamental shift in focus within mainstream economics and to borrow the words of Marshall’s most famous protégé John Maynard Keynes (1936: xxiii), a ‘struggle of escape from habitual modes of thought and expression’. The nature of this struggle, together with its possible resolution, forms the basis for discussion in this book.

1.1 Outline of the book

The discussion of the themes outlined above is organised as follows. The nature of Marshall’s proposed economic biology Mecca is examined in Chapter 2, where Marshall’s struggle to reconcile ‘mechanical’ and ‘biological’ methods of analysis is investigated. This discussion draws on a much more detailed investigation of Marshall’s struggles and related themes published earlier in Hart (2012). The misinterpretations of Marshall’s approach by his disciples and critics alike, and the implications this had for the subsequent development of mainstream economic analysis, are also considered. The following chapters consider the mechanical and biological approaches as they have evolved subsequent to Marshall’s era. For the purpose of discussion in this book, Marshall’s era will be taken to have concluded by the early 1930s, corresponding to Paul Samuelson’s (1967: 111) assertion that ‘much of the work from 1920 to 1933 was merely the negative task of getting Marshall out of the way’.

In Chapter 3, a critical assessment of the more popular variants of equilibrium analysis is developed, and it is concluded that despite the considerable advances in analytical techniques, Marshall’s ‘reservations’ as to the general limitations of equilibrium analysis were well founded. In Chapter 4, discussion is extended to examine the role of equilibrium within mainstream macroeconomic theory, where diverging interpretations of the contributions of Marshall’s favourite student John Maynard Keynes are encountered.

Chapter 5 focuses attention more directly on explanations of economic development, the domain of Marshall’s economic biology Mecca. Despite the recent appearance of ‘new’ theories of economic growth, these approaches have struggled to escape the confines of their equilibrium-based heritage, and fall well short of performing the role Marshall had reserved for his biological method. The chapter then goes on to explore the cumulative causation (and related) literature that has amongst its origins Allyn Young’s (1928) insightful contribution to the Marshallian cost controversies of the late 1920s. This approach both highlights the limitations inherent in the equilibrium method that had been identified by Marshall, and at the same time suggests an alternative to an equilibrium-based perspective when the nature of economic transformation is being investigated. Aspects of Marshall’s often neglected applied industrial analysis are considered in Chapter 6, together with the demise and possible revival of the approach to industrial economics that he had championed. The approach advocated by Marshall stands in stark contrast to the deductive theoretical approach that characterised

the ‘new’ theories of imperfect competition that emerged in the 1930s.

In Chapter 7, the nature of evolutionary economics is examined, beginning with the perspectives presented by acclaimed pioneering evolutionary economists such as Thorstein Veblen and Joseph Schumpeter that differ in some important respects from that suggested in Marshall’s proposed system of economic biology. This is followed by a general discussion of some of the key themes in modern evolutionary economics as it has developed from Nelson and Winter’s (1982) path-breaking Evolutionary Theory of Economic Growth. The nature of the linkages between themes in evolutionary biology and economic analysis is considered, together with some contrasting views on how evolutionary economics relates to the more traditional equilibrium-based approaches discussed in Chapters 3–5. Chapter 8 examines more directly how Marshall’s vision of the economic biology Mecca corresponds with contemporary evolutionary economics, and, in particular, how the issues Marshall had struggled to resolve in his Principles may be reconciled in the setting of these contemporary approaches. Central to the discussion is a re-examination of Marshall’s endeavour to preserve a unity between explanations of economic growth and development and value theory. It is concluded that the long-period equilibrium method in particular, whether in the form constructed initially by Marshall or developed by others, needs to be discarded if theories of (relative and general) prices and outputs are to be nested within an evolutionary paradigm.³ What is required is a return to Marshall’s emphasis on the insights that are to be gained directly from historically based observation of industrial organisation, together with a consideration of cognitive processes that govern human action. These conclusions lead to a consideration of the merit of non-equilibrium-based theories of output and price determination. Some central conclusions are re-stated in Chapter 9.

The following two sections in this introductory chapter present some very general observations on the nature and role of equilibrium analysis within mainstream economics, followed by some suggestions as to how the approach to thinking on economic issues may differ if a ‘more biological paradigm’ were to be adopted.

1.2 Equilibrium analogies in economic theory

The significance, along with the legitimacy of usage, of analogies and metaphors in economics has often been questioned.⁴ Reasoning by analogy is essentially a form of inductive reasoning, since there is the possibility that the similarities that are presupposed in the inference may not actually obtain (Harre 2008). Positivism, a philosophical position embedded in much of the methodology of mainstream economics, instead champions the call for a metaphor-free science, rejecting conceptualisations that cannot be objectively measured and tested directly by observation or experiment. However, as writers such as Bruce Caldwell (1982) and Geoffrey Hodgson (1997a, 1999) have convincingly argued, positivism as a philosophy has been shown to be unsustainable, particularly in light of the critiques presented by the likes of Willard Van Orman Quine, Roy Bhaskar and Paul Feyerabend. Instead, the recent trend observed in the philosophy of science has been to emphasise the central role that analogical reasoning plays in both the physical and social sciences (Harre 2008).⁵ From a historical perspective, these views can be seen to be opposed to Thomas Hobbes’s critique of the ‘deceitfulness’ of metaphors and John Locke’s denunciation of figurative speech as a ‘perfect cheat’ (Raffaelli 2007). Given the presence of complexity and given that complete reductionism is not possible, an appeal to metaphors is both necessary and inevitable as a device in ordering thought processes using the known to express the unknown. Metaphor is essential to economic thinking, even economic thinking of the most formal kind (McCloskey 1983).

The appearance of metaphors and analogies may become clouded within formal mathematical representations of logical arguments. The origins and initial significance of metaphors and analogies are also often sublimated or forgotten with casual and habitual use (Gramm 1996). Importantly, metaphors and associated analogies are not simply literary ornaments; they form the foundations of the thought processes that develop theories directed at explaining complex systems. They may be heuristic in nature, merely representing what is already known but in some useful or convenient form. More importantly, they may be explanatory, paramorphic and creative in nature, enabling the conceptualisation of new kinds of beings or unobserved processes.

As affirmed in the 1987 New Palgrave Dictionary of Economics, various notions of ‘equilibrium’ (Latin for equal forces or balance) have come to represent the dominant metaphor in economic discourse and analysis, at least within what could be termed ‘mainstream’ economics:

From what appears to have been the first use of the term in economics by James Steuart in 1769, down to the present day, equilibrium analysis (together with its derivative, disequilibrium analysis) has been the foundation upon which economic theory has been able to build up its not inconsiderable claims to ‘scientific’ status. Yet, despite the persistent use of the concept by economists for over two hundred years, its meaning and role have undergone some quite profound modifications over that period.

(Milgate 1987: 179)

The equilibrium metaphor, as adopted by economics, originates most directly from a branch of mechanics in physics known as statics, which is concerned with the calculation of forces acting on and within structures that are in equilibrium, in contrast to dynamics (including kinetics), which studies the mathematical and physical behaviour of bodies under the actions of forces that produce changes in motion in them (Giancoli 2000). The different context in which equilibrium is used in physics is interesting to observe, given some analogous applications of the concept in economic analysis and discourse:

Equilibrium in physics: an unchanging condition in which the forces acting on a particle or system of particles (a body) cancel out, or in which energy is distributed among the particles of a system in the most probable way; or the state in which a body is at rest or moving at constant velocity. A body is in thermal equilibrium with its surroundings if no heat enters or leaves it, so that all its parts are at the same temperature as the surroundings.

(Lafferty and Rowe 1993: 218)

In its simplest and most direct application in economics, equilibrium could be regarded as a ‘balance’ reached between opposing forces, such as the proverbial forces of demand and supply. Equilibrium could also denote outcomes that, if achieved, would be characterised by the absence of any tendency for change in the absence of exogenous disturbing influences. Equilibrium positions may be defined to represent economic outcomes towards which the economy tends to gravitate (‘persistent forces’) or that are perhaps achieved under ‘ideal’ or ‘normal’ (‘natural’) circumstances. Equilibrium may be defined in an intertemporal setting, suggesting that the forces at work and outcomes may take on different characteristics with the passage of logical time.

The 1987 New Palgrave entry on equilibrium places the origins of the equilibrium metaphor, and its associated system of analogies, in the ‘classical’ period of economic enquiry. In addition to James Steuart, at least indirect usage of equilibrium concepts can be found in the writings of other early contributors such as David Hume, François Quesnay and Anne-Robert-Jacques Turgot in particular. It is not uncommon to observe Adam Smith listed amongst the pioneers of equilibrium analysis, particularly in the context of his and others’ subsequent classical treatment of, the relationship between market and natural prices. In this treatment, market prices were seen to be continually gravitating towards the natural prices, and this tendency towards equilibrium was held to be operative in the actual economic system at any point in time. Irrespective of differences in the classical analysis of the determination and composition of natural prices, ‘natural conditions’ reflected the outcomes of persistent or systematic forces at work in the economy when conditions of free competition prevailed. Divergences between market and natural prices could be explained in terms of what would normally be interpreted as temporary obstacles to the operation of persistent forces:

In speaking then of exchangeable value of commodities, or the power of purchasing possessed by any one commodity, I mean that power which it would possess, if not disturbed by any temporary or accidental cause, and which is its natural price.

(Ricardo 1821: 92)

Significantly, equilibrium in this context did not reflect mechanical notions of the balancing of opposing forces, but instead outcomes associated with what may be termed ‘normal’ circumstances. Natural prices represented a point of gravitation for market prices, provided free competition (the absence of barriers to the movement of capital) prevailed. However, at any point in time, a divergence between market and natural prices was likely, and as emphasised by Adam Smith, these deviations could characterise actual economies for considerable periods of time:

But though the market price of every particular commodity is in this manner continually gravitating, if one may say so, towards the natural price, yet sometimes particular accidents, sometimes natural causes, and sometimes particular regulations of police, may, in many commodities, keep up the market price, for a long time together, a good deal above the natural price.

(Smith 1776/1976: 77)

Therefore, while notions of equilibrium may be associated with the classical theories of exchange value, care must be exercised in comparing the classical method with that of the later ‘neoclassical’ equilibrium theorists.⁶ It should be emphasised that Adam Smith, unlike some of his contemporaries, did not directly introduce the equilibrium metaphor into his theoretical structure. Indeed, the omission of reference to equilibrium analogies in Smith’s work is significant, given his intellectual background. Apart from his abiding contributions ...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• Foreword
• Preface and Acknowledgements
• 1. Introduction: Equilibrium and Evolution
• 2. Alfred Marshall’s Economic Biology Mecca and Mechanical Analogies
• 3. Equilibrium Economics after Marshall
• 4. Keynes’ Marshallian Heritage and the Walrasian Eclipse
• 5. Equilibrium Growth and Cumulative Causation
• 6. The Revitalisation of Marshall’s Industrial Economics
• 7. Themes in Evolutionary Economics
• 8. Marshall, Evolutionary Economics, and Post-Keynesian Theory
• 9. Conclusion
• Notes
• Bibliography
• Index