Is anything worth keeping in microeconomics ?
Open letter from economic students
About game theory
Who are we?
The Fitoussi Report
Everybody praise the recent US textbooks on "the principle of economics" published by leading authors such as Mankiw and Stiglitz. In fact, everybody appreciate these manuals because they are very clear and use very little formalisation. Colours, photos and abstracts from newspapers articles illustrate these lively books.
But what is their purpose? It is to convince the reader that there is a specific kind of reasoning, called "economic reasoning", which is quite simple to grasp and has general validity. All it takes is a little effort. This economic reasoning has two pillars: the "law of supply and demand", which everyday life is supposed to give evidence for, and the proposal that the market is an efficient system - i.e. a mechanism which generally allocates resources in an optimal way. This proposal is presented as a result, in its mathematical sense, not as a statement or an a priori belief. But since the textbooks considered are very simple, the proof of the result cannot be given: it is merely evocated, through lively images, among which the inescapable "invisible hand".
Of course, everybody knows that economists very often disagree with one another. But this disagreement is presented as existing on minor points only. Hence the stress that these textbooks put on the "consensus" which is said to be prevailing among economists on the core of the subject. Stiglitz provides a list of statements on which all economists are supposed to agree. The first chapter of Mankiw is based on the "Ten principles of economics", principles which are presented as obvious, and hence not subject to discussion nor disagreement. In its second chapter "Thinking like an economist", he presents "Ten proposals on which everybody agrees". It is true that both mention the existence of debates. But this is in order to precise immediately afterwards that it is also the case in other social sciences, and that these differences, especially when it comes to policy recommendations, are to be explained by different "values". For the reader, the idea of a prevailing "consensus" remains, in particular when it comes to the core idea, i.e. the "efficiency" of the market. This is, after all, the most important.
Mankiw: "the magical invisible hand"
In its first chapter, Mankiw asserts the following principle: "in general, competitive markets are an efficient way to organise efficiently economic activity". In order to justify this principle, Mankiw tells the old story of "the collapse of communism", but above all the even older one of Adam Smith’s "invisible hand": "In its book, The Wealth of Nations, the economist Smith remarked (and this is the most famous remark of all economics) that firms and individuals which participate in a market behave as if they where guided by an invisible hand which favours positive results for all. One of the aims of this textbook is to explain how this magical invisible hand works. By studying economics, you will learn that prices are the tool through which the invisible hand organises the economy."
Of course, we won’t learn anything, because, on the contrary to what he pretends, Mankiw never explains how this "invisible hand", of which the prices are supposed to be the "tools", "works". It is quite possible that Mankiw thinks of the quite visible hand of the walrasian auctioneer, but the reader will never know it. In the whole textbook, there is not a single reference to the Arrow-Debreu general equilibrium analysis, although it is generally presented by neo-classical economists as the mathematised version of the "invisible hand". Instead, the reader is to be satisfied with mere statements on "the remarkable capacity of the invisible hand to organise the economy" or on "the failure of central planners which wanted to manage the economy with one hand tied in their back - the invisible hand of the market".
The "amazement" of Samuelson and Nordhaus and Stiglitz’s "spring"
Samuelson and Nordhaus (abr. SN) also present the invisible hand, in a section of the Chapter 2 of their Economics called "what’s a market?". According to them, the "actions and goals" of individuals "are coordinated in an invisible way by a system of prices and markets". Here, the "miracle" of the market replaces the "magic" of Mankiw: "but the true miracle is that the whole system functions without coercion nor central direction by anybody". This is the source of their wonder: "most of our economic life takes place without State intervention; this is the true wonder of our society". Besides, it is supposed that the "proof" that "a perfectly competitive economy is efficient" has been given, even if this was done under "restrictive conditions". The market economy may have some "deficiencies", but it is its miraculous feature which matters.
Stiglitz is not as enthusiastic as SN, but the idea is the same. He also states that if markets are competitive, then "the economy is efficient". Of course, "all economists admit that reality does not match the perfectly competitive model", but it is nonetheless a "useful framework for them", as "it leads to satisfying results - the deduced forecasts, although not perfect, correspond to what is effectively observed." Hence a detailed study of "perfect markets" where the "law of supply and demand" can work perfectly. The image used is the one of a "weight attached to a spring", which moves progressively slow down, until they reach the equilibrium. Here, it is what could be called the "physical version" of the invisible hand which is presented. But the "economic version" is still missing…
What’s a market?
Nowhere these textbooks explain how prices are determined on "markets". Where do they come from? Who determines them? How do they fluctuate? This will never be said, although it is through this mechanism that the "invisible hand" is supposed to be operating.
In fact; when Mankiw wants to give a "concrete" example, i.e. "the ice cream market in a given city", he has obvious problems to explain where the prices come from. After having supposed that the (numerous) consumers are price takers, he faces a difficulty: he cannot do the same with firms, or the price would not be determined by anybody. Or, even worse, he would have to say WHO determines the price. This is why he surreptitiously introduces a "current price", through an apparently common sense argument: "a seller has few reasons to sell under the current price, and if he sells above, then consumers will buy their ice cream somewhere else." Isn’t it obvious? Economics is so simple… But the question of the fixation of the price, even the current one, remains unadressed.
SN do basically the same trick: they state that "in a market economy, no individual or organisation is responsible for production, consumption and the fixation of prices". They give the following definition: "a market is a mechanism through which all buyers and sellers interact in order to determine the price and quantity of a given good or service". They then precise that "on a market, prices coordinate producers and consumers decisions… Prices are the driving belt of the market mechanism." Here, the solution is the mechanic metaphor - "driving belt"; "mechanism" which permits them to avoid the question of the way prices are effectively fixed.
If these textbooks are so appreciated, it is because they are "applied" to concrete problems. But then, one realises that one can read all of these textbooks without using any of the tools of standard microeconomics. For instance, Mankiw does not present the theory of consumer choice before Chapter 21, and it is presented as an "advanced" problem (!). Its presentation is in fatc a mere graphic presentation of the substitution and revenue effects. Then, four "applications" are deduced:
1. "Do demand curves have a negative slope?"
After the inescapable presentation of Giffen-goods, the answer follows: "the law of supply and demand is nearly inviolable". Would economists have a general law, at last? Alas, as always, this result is obtained when the revenue is deemed to be fixed. And this does not make sense, as the source of the revenue is the sell of something: when this link is taken into account, the "inviolability" of the law of supply and demand disappears, and nothing can be said. The result is indeterminate, as Sonnenschein showed it thirty years ago. Mankiw cannot but knowing it, but he pretends he does not, by abusing from the apparent obviousness of the "law of supply and demand".
2. "How do wages act on the demand for labour?"
Answer: we don’t know ("economic theory cannot predict the result of this game").
3. "What’s the effect of interest rates on the households savings?"
Answer: we don’t know ("the final result is a priori indeterminate"). A precision: "consumer theory hence tell us that a raise of interest rates can stimulate or on the contrary depress savings"…
4. "Do poor people prefer transfers in cash or in kind?"
Do you need many curves to get an answer?
Conclusion: consumer theory tells nothing for three out of four "applications", and as the answer of the fourth is obvious, one understands that it is perfectly useless. It is then not by chance that its presentation is given at the end of the "microeconomic" part of the textbook.
In all this long textbooks, it is always presupposed that the market is an efficient device, guided by the invisible hand. The most important questions of the effective formation of prices and of the coordination of individual choices are not treated, because it is postulated that they are solved beforehand.
It is only when these textbooks deal with market failures (information asymmetries, externalities, public goods, etc.) that they provide (some) interesting insights. In particular, when dealing with these problems, the authors recognise that there is no obvious "solution". On the contrary, the outcome depends on the factors taken into account, their relative importance, the forces and interests at stake, as well as, very often, the norms and values endorsed by the people. Besides, it is striking that these discussions and reflections take place without using any of the famous "tools" of standard microeconomics. This is finally not so surprising, as these "tools" apply only to imaginary worlds, completely detached from the world we live in.