de vroey the base camp paradox

7/27/2019 De Vroey the Base Camp Paradox

1/20

Economics and Philosophyhttp://journals.cambridge.org/EAP

Additional services for Economics and Philosophy:

Email alerts: Click hereSubscriptions: Click hereCommercial reprints: Click hereTerms of use : Click here

The Base Camp Paradox: A Reection on thePlace of Ttonnement in General EquilibriumTheory

Michel De Vroey

Economics and Philosophy / Volume 6 / Issue 02 / October 1990, pp 235 - 253DOI: 10.1017/S0266267100001231, Published online: 05 December 2008

Link to this article: http://journals.cambridge.org/abstract_S0266267100001231

How to cite this article:Michel De Vroey (1990). The Base Camp Paradox: A Reection on the Place of Ttonnement in General Equilibrium Theory . Economics and Philosophy, 6, pp235-253 doi:10.1017/S0266267100001231

Request Permissions : Click here

Downloaded from http://journals.cambridge.org/EAP, IP address: 144.173.6.37 on 25 Jul 2013


2/20

http://journals.cambridge.org Downloaded: 25 Jul 2013 IP address: 144.173.6.37

Economics and Philosophy, 6 (1990), 235-253. Printed in the United States of America.

THE BASE CAMP PARADOX

A Reflection on the Place ofTatonnement in GeneralEquilibrium Theory

MICHEL DE VROEY

Universite Catholique de Louvain

A basic issue in political economy is the question of how a decentralizedeconomy is possible: How can a system survive and, moreover, be ef-ficient, if all decisions are taken independently, that is, without anyexplicit coordination?1 The issue has two sides to it. On the one hand,it is a "tho ug ht experiment," falsifiable only on logical grou nd s, an objectof debate for the sake of pure intellectual interest, even for people whomight not live in a market economy. On the other hand, for those whodo or might live in such an economy, a thought experiment of this kindcontains a critical political dimension, for the conclusions derived from

it will usually be appealed to in arguing about the ideal organization ofthe economy.According to Hahn, the aim of general equilibrium theory (hence-

forth, GET) is to address this issue: "Smith not only posed a obviouslyimportant question, but also started us off on the road to answering it.

An earlier and qu ite different version of this article was published in theRevue Economique,July 1987, under the title "La possibility d'une economie d^centralisee: Esquisse d'unealternative a la thorie de l'equilibre general." I am grateful to the following for theirhelpful comments: C. Arnsperger, J. Cartelier, L. d'Ursel, D. Foley, D. Hausman, S.Marglin, C. M6nard, P. Mongin, P. Salmon, M. Sawyer, P. Solar, W. Samuels, and twoanonymous referees.

1. While Adam Smith has often and rightly been credited for first havin g raised this issue,its Hobbesian u nderpinn ing should not be forgotten, for what is at stake is the coun ter-intuitive possibility that social harmony can result from human rivalry.

1990 Cambridge University Press 0266-2671/90 $5.00 + .00. 2 3 5
http://journals.cambridge.org/http://journals.cambridge.org/


3/20


236 MIC HE L DE VROEY

GET as classically stated by Arrow and Debreu is near the end of thatroad" (H ahn , 1981; reprinted in 1984, p .72)}

Comparing Adam Smith's question to a peak to be scaled by eco-nomic theory, Hahn asserts that Walrasian equilibrium, in its Arrow-Debreu formulation, is the indispensable base camp for such a climbing(1984,p . 10). Th is view has become the object ofa large consensus withinthe economic profession and, indeed, it has going for it quite impressivetheoretical developments. Still, one may wonder whether the concep-tualization ofa market economy on which it rests is adeq uate an d, hence,whether Walrasian equilibrium is really the best place to set up the basecamp.

The aim of my article is to address this adequacy issue. The basicintuition is that to deal with it one has to investigate the role of thetatonnem ent (henceforth, TAT) assum ption within GET.I argue that thisrole is far more important than is usually admitted, and that adoptingthis assumption leads to a paradoxical result, w hichI call the "base campparadox," that what is allegedly a decentralized economy turns out tobe a planned economy. Thus, the Walrasian base camp appears to beoddly located. Rather than being at the foot of the summit that has tobe climbed - a really decentralized economy - it is located at anothersummit - a centralized economy. And, although such a paradoxical

location is defensible as a useful methodological detour, this situationnevertheless calls for reflection about an alternative starting point, inwhich the premise of the analysis would more closely correspond to itsexplanandum.

While the claim that GET has a centralized economy as its object ofanalysis is not n ew ,3 it is striking that it has not had much impact. Such"benign neglect" must be explained. It is due, I will submit, to a lackof in-depth reflection on the definition of a market or decentralizedeconom y. The view that a TAT econom y (as I will call an economy basedon the TAT assumption) is centralized follows from such a reflection,which furthermore suggests a close resemblance between a TAT econ-omy and "market socialism," as this notion was used in the debate onsocialist calculation. So the Walrasian economy ends up being a specialtype of socialist economy! This in turn paves the way for carrying overto the Walrasian approach those criticisms voiced by neo-Austrians, inparticular Hayek, against socialists such as Lange.

The article has six sections. The first five deal with the critical analysis

of GET. In the first section, I recall a basic distinction between price2. Hahn's position concerning the success of GET cannot be gleaned from such a state-

ment. Other statements come closer to the views developed in this article, for example:"GE is strong on equilibrium and very weak on how it comes about"(1973; reprintedin 1984, p. 140).

3. See for example, Clower (in Walker, 1984), Fisher (1983), Hahn (1984), Howitt (1973),Leijonhufvud (1968, 1981), Ostro y and Starr (1974), and Weintraub (1979).


4/20


THE BASE CAMP PARADOX 237

determination and price formation. The second section describes theTAT institution in its more extreme version. The third section discussesthe definition of a decentralized economy and shows the resemblancebetween the TAT economy and market socialism. The fourth section

deals with some weaker versions ofTAT. The fifth section is concernedwith the way in which GE theoreticians interpret the notion ofTAT andits theoretical role. This section also briefly discusses the New Classicalview. The central defect of the view of Lucas and his followers consists,I will claim, in their unawareness of the base camp paradox and theirunquestioned acceptance of the TAT assum ption. The last section of thisarticle is of a very different nature. It discusses some theoretical con-sequences that follow from radically abandoning the TAT assumptionand outlines some features of what a theory starting from an alternativebase camp could be.

THE DISTINCTION BETWEEN EXISTENCE AND PROCESS

The question to be answered is whether a market economy is viable.Since the notion of viability is rather vague, a more operational objectof analysis is chosen - namely, under what conditions is an equilibriumpossible in a decentralized economy? The query about equilibrium mu stthus be seen as a more tractable rephrasing of the viability question.4

The "conditions of possibility" can be unders tood in two ways, sinceone can distinguish between logical and real possibilities. Consequently,two lines of research can be distinguished. In the first one, the inves-tigation aims at asserting the logical conceivability of states of equilib-rium, a problem referred to as determination of equilibrium prices. Thispart of the theory amounts to building up rigorous existence theorems,which in turn open the way to further exploration of the properties ofequilibrium (efficiency, uniqueness, etc.). All this can be done withouttaking into account the way in which states of equilibrium are attained,which is the second line of research, usually referred to as price for-mation. Here the social process, the interaction amo ng agents by whichequilibrium states are achieved, is under examination: How will theeconomy reach the equilibrium magnitudes, given that economic actorsdo not have the same information as the omniscient model-builder?

The GET viewpoint concerning this distinction has three aspects.First, the theoretical legitimacy and usefulness of making an analyticalseparation between existence and process is asserted. Second, the ex-

istence aspect receives a logical and practical priority over the processdim ension . This prog ram has show n its fruitfulness, since it has led toa series of results about both existence and efficiency. Such achievements

4. However, it should be understood that equilibrium clearly is much too strong a proxyfor viability, since disequilibrium, initself, is not in contradiction to viability.


5/20


238 MIC HE L DE VROEY

do no t mean, however, that the existence aspect of the research prog ramhas been completed, since the results pertain only to the most heroicmodels. The third feature concerns the way to approach the problem ofprocesses. Here there is no consensus among GET authors, beyond the

view that it should be treated in a second stage. I will return to thispoint later on. In Walrasian theoryitself, however, the process dimen-sion is entirely dealt with through the TAT assumption.

PERFECT TATONNEMENT

As shown by Jaffe, Walras' views about the meaning ofTAT were ratherembryonic and evolved over time from a realistic and would-be dynamicconception to a "theory of virtually timeless, simultaneous and me-

chanical adjustment operations" (Jaffe in Walker, 1983, p. 252). It willbe shown that nowadays this interpretative ambiguity is still present.But first I must delve into the content of the notion.5

I define (perfect) TAT as the set of behavioral and institutional as-sumptions, insuring that equilibrium prices obtain or, in other words,that exchanges at "false prices" are excluded. Several comments are inorder. First, despite a semantic analogy, the notion of TAT should notbe confused with that of gravitation, p ut forward by classical econ om ists,for the latter is perfectly consistent and ev en implies exchanges at "falseprices." Second, adopting this definition and considering a Walrasianeconomy as based on TAT gives the notion of Walrasian equilibrium anaxiomatic character. Third, the equilibrium price vector may obtain inseveral ways. In other w ord s, TAT may take several forms. The standardone is the "auctioneer scenario." After describing it, I will turn to analternative form that is probably more app ealing, "th e omniscient agen tsscenario," and show that it amounts to the same thing. Fourth, imperfectTAT refers to cases in which the TAT setting, while globally maintained,

is altered in some specific respects, allowing for different results.To describe an auctioneer-led TAT, two issues are to be considered.First, what type of social organization should one conceive of in orderto ensu re the attainmen t of equilibrium mag nitudes? Second, once theseare reached, how is trade organized? The first four of the followingpoints answer the first question; the fifth point deals with the second.

(a) Agents must convene. It is often supposed that they meet in a"big hall " or, at least, participate in a communication network that allowsthem to exchange information (through the exclusive intermediation ofthe auctioneer) before exchanges take place.

(b) There exists an auctioneer (a person, possibly a computer) toserve as the coordinator of private decisions. His role is to implement

5. For other assessments see Walker (1972, 1987a, 1987b). The reader is also referred toThe New Palgrave Dictionary entries by Fisher (1987, "Adjustm ent Process and Stability"),Hahn (1987, "Auctioneer"), and Negishi (1987, "Tatonnement and Recontracting").


6/20



price adjustment by announ cing and changing prices6 and holding trans-actions still until adjustment is completed,7 thereby forbidding ex-changes at "false prices." He is external to the economy: he is not anexchanger an d he performs his role at no cost to the traders. Thanks to

him, all signaling problems are avoided. His function is to establishequilibrium, thereby mak ing private intentions compatible. On the otherhand, the auctioneer must not be likened to a central authority, as in acommand economy, for he has no power to limit the agents' freedom.Note also that his presence makes money unnecessary.

(c) Economic agents are price-takers. Price-setting may be describedas impersonal in the sense that the only agent who is able to set and tochange prices is the auctioneer, an outsider. Exchangers act as free andrational optimizers. They are isolated from each other, in that theirpreferences are defined independently of those of other agents. Mimeticbehavior, for example, is absent. The quality of goods and services isfully known to them, so that prices are the unique and sufficient meansof information. Agents are presumed not to display manipulative be-havior. Information is symmetric.

(d) The complete description of TAT implies the specification of thetime-structure wherein the price-formation process takes place. In thisrespect, despite its irrealism, instantaneity or logical time seems theeasiest assumption to make. Thus, everything supposedly takes placesimultaneously. TAT must be completed before consumption and pro-duction take place; otherwise the con tent of the equilibrium vector wo uldbecome different. Asserting that exchanges take place only when equi-librium prices are reached in all markets amounts to seeing decision-making as a unanim ous phen om enon involving all the members of theexchange community. Bilateral transactions are excluded. All contractsstand together and are interdependent.

(e) Once equilibrium prices have been determined, goods and ser-

vices still have to circulate. Different devices may be imagined, as, forexample, a central warehouse where all suppliers deliver their com-modities or the direct organization by the auctioneer of meetings be-tween trading partners. In any case, it is assumed that the search forpartners and the circulation of goods are costless. Transaction costs arethu s excluded. Co ncern ing the fulfillment of contracts, the informationaland behavioral assumptions make it possible to rule out moral hazard

6. Samuelson's standard formulation(1941, p. 102) is as follows:dp/dt = H[D(p,a) -S(p)], where H(0) = 0, H' > 0 and a is a parameter.

7. Assuming stability. A sufficient but not necessary condition for the latter is grosssubstitutability, i.e., an increase (decrease) in the price of thejth commodity will in-crease (decrease) the excess demand for the ith commodity for alli # ;'.


7/20


240 MICHEL DE VROEY

and shirking phenomena. Thereforethe implementation of contractssupposedly raises no problems.

The auctioneer version has the drawbackof making adjustmentsdepend on the interventionof an outside actor. One possible way of

avoiding this is the "omniscient economic ag en ts" assum ption , a versionwhich definitely looks more modern. While the auctioneeris thrownoverbo ard, it is still assum ed that agen ts convene or com municate beforetrade. But, it is now assumed that they havea full knowledgeof theeconomy, including all utility and production functions and all demandand supply schedules. Hence they are hardly indistinguishable from theomniscient theo rist. What is ascribed to them is much m ore than rationalexpectations an d know ledge of economic theo ry. It is also supp osed thatthey know the economic data needed for applying the theory.In par-ticular, objects of knowledge, which should be seen as purely private(such as utility functions), are assum ed to be common kn ow ledge. Oncethis assumption is made, the rest follows. Economic agents are abletodo themselves the task performed earlier by the auctioneer and calculateequilibrium magn itudes. Since they all share the same information, theonly price vector (assuming unicity)at which transactions will occuristhat one which would have been establishedby the auctioneer.Ex-changes at false prices are again excluded. Thus the new assumption

amounts to the more traditional assumption. Under the latter, the auc-tioneer is present in flesh; under the former, agents have an auctioneer-like computer in their minds.8

In such a TAT framework, whenever exchanges take place, agentsknow for sure that the prices and quantities they observe are equilibriummagnitudes. Leftto themselves, they would be unableto discriminatebetween "false" and "equilibrium" prices. Thus,in a TAT economy,equilibrium necessarily occurs and is an observable, indisputable reality,for economic agents themselves.9 There is no room at all for disequilib-rium or for "out of equilibrium" situations, since reaching equilibriumis a precondition for transactions.

There is, however, one crucial snag.It crops up when one realizesthat TAT is a very paradoxical institution. On the one hand,in a TATframework, agents remain entirely free. On the other han d, aTAT frame-work requires tremendous social discipline,as this story makes clear.So the beau ty of TAT - that it provides a story describing ho w equilibrium

8. In the sequel,I will continue to refer to the traditional form.9. Underlying this notion is a threefold ranking of levels of knowled ge about equilibrium,according to the identityof the subjectof knowledge. First, themodel builder or theo-retician knows equilibriumat once, for he is able to calculate equilibrium ma gnitud essince he knows all agents' functions. Second, theauctioneer knows that equilibriumisreached as soon as he observes that all excess demand functions equal zero. Third,economic agents know that equilibrium is attained, once they see that the auctioneer isallowing trade. They know that magnitudes then observed are equilibrium magnitudes.


8/20


9/20


242 M I C H E L D E VROEY

the category of a private ownership economy also appears too general.A private, planned economy (without public ownership of means ofproduction and central authority, but with a priori coordination of de-cisions) is perfectly conceivable. This is indeed precisely what is con-veyed by the TAT construction.

Once it is perceived that these two criteria are important, one canno longer be content with u sing just one of them . It then becomes quitenatural to see a market economy as characterized by the doub le absenceof central authority and of a priori coordination or, in other words, byprivate propertyand a posteriori coordination. The flaw of the TAT as-sumption in terms of its relevance for its alleged object of explanationis then obvious. As an institutional setting, it ensures full a priori co-ordination of decisions. But for this very reason it is an inadequaterepresentation of a market economy. What it describes is a special sortof planned economy - special because plan ning is usually (but wrongly)exclusively associated with the absence of private property. Thus, theobject of analysis of GET is not a decentralized economy. This is the"Walrasian base camp paradox." As long as the other criterion of defi-nition is not taken into account, this paradox remains hidden.

Ironically, if one stresses coordination or the organization of tradewhile leaving ownership in the backgrou nd, the TAT economy and mar-

ket socialism look like twins. Hence, one may assert that TAT amountsto a socialist way of organizing the economy - the auctioneer and thecentral planning agency play exactly the same role.

At this stage, it is difficult to resist the temptation to play on theopposition between two branches of neoclassical theory, the neo-Aus-trian and the Walrasian, and throw back to GET the criticisms addressedby Hayek (1947) to Lange and Dickinson. Take, for example, the viewsadvanced by a contemporary interpreter of Hayek, Karen Vaughn, w hilejust changing the words "socialist" and "socialism" into "GE theoreti-cian" and "TAT":

Thus Hayek argued specifically that while the model the 'GE theo-reticians' ['socialists' in the original] were using to arrive at theirsolution to the pricing problem were not logically contradictoryand 'TAT' ['socialism' in the original] was not therefore impossiblein the sense of being theoretically inconceivable, it was neverthelesspractically impossible, since the 'TAT' ['socialist' in the original]model bore no relationship to the manner in which prices wereformed in the real world. (Vaughn, 1980, p. 53)

10

10. As cogently argued by Lavoie (1985), one may reinterpret the "socialist calculationdebate" as opposing neoclassical (or in my terms, GET) economists, focusing on theexistence dimension and Austrians, emphasizing the process aspect of the price-system. The oddity is that the neoclassical viewpoint was represented by the "so-cialists." This taking-over is described by Lavoie in the following terms: "There is no


10/20



The reader should, however, not infer that I am definitely againstthe use of the TAT assum ptio n. For me, the perception of its paradoxicalnature is not a reason for rejectingit. If I have a quarrel, it rather concernsits interpretation.

IMPERFECT TATONNEMENT AND CONTEMPORARYDEVELOPMENTS OF GET

Modern dev elopm ents in GET have gone far beyond Walrasian equilib-rium. To give even the most superficial survey of them clearly fallsou tside th e scope of this article. A few remarks will, however, sufficeto make my point. First, it should be noticed that most new develop-ments are still essentially concerned with the issue of existence. Their

aim is to prove existence in a less heroic context, by relaxing some ofthe Walrasian assum ptions about information, transactions costs, search,moral hazard etc. Process analysis, including the problem of the orga-nization of trade , has rem ained a strikingly neglected terrain, w ith a fewexceptions (Clower and Friedm an, 1986; Fisher,1983;Hah n and Negishi,1962). Second, whereas it is true that not many economists would out-spokenly defend and stick to the pure Walrasian TAT process, this ismisleading. For, in most cases, if there is indeed a departure from perfectTAT, it is only a homeopathic change.11 Even in the so-called non-tatonnement theories, with which I fully sympathize, the label is amisnomer. These theories should be more appropriately renamed"quasi-tatonnement" or "slightly imperfect tatonnement" processes be-cause, while removing one or the other of the elements of WalrasianTAT, they keep all the others in their extreme form. Strictly speaking,the expression "non-tatonnement" should be reserved for social pro-cesses that diverge completely from the Walrasian world, such as de-veloped in the neo-Austrian approach or in the alternative model I will

way, Mises claimed, in which this knowledge (about the more effective ways of com-bining the factors of production) can be generated without rivalry - that is, if allproduction plans are constrained in advance by being precoordinated under a singleplan. Market prices are seen as both the consequence of this entrepreneurial rivalryand as the guid es, thro ugh economic calculation in profit/loss accounting, for decisionsthat are made to achieve a more rational use of scarce resources. The neoclassicalparadigm, represented by the market socialists in the debate, has recognized andelaborated upo n this latter guiding role of prices, but h as largely ignored their rivalrousunderpinning. Models of static competitive equilibrium banish economic rivalry fromthe scene and employ the construct of a (centralized) Walrasian auctioneer to adjustthe prices that the actual participants passively accept as "parametric." Within thisessentially static framework, it seems quite plausible to imagine a central planningbureau fulfilling the auctioneer's duties" (Lavoie, 1985, p. 24).

11. A typical procedure is to assume the five first points of perfect TAT, which allow forthe attainment of equilibrium magnitudes, while introducing some decentralizationin trade organization. See, for example, Lucas (1987, p. 73).


11/20


244 MICHEL DE VROEY

present later. Thus, to come back to my initial metaphor, not muchprogress has been made in escaping the base camp paradox. Despitecontrary assertions, GET, explicitly or implicitly, remains largely tied tothe TAT framework. Again, this in and of itself is not a defect, since the

odd location of the base camp, and the fact that departures from it areonly gradual, are defensible on methodological grounds.12 What mustbe criticized, however, is both the generalized unawareness of the ex-istence of the paradox, and the subsequent tendency to misrepresentthe object of discourse by continuing to call decentralized a social pro-cedure that is actually centralized. An example of this is the well-known"islands" metaphor, advanced by Phelps (1970, p. 6). My target is notso much theoretical as its semantic con tent. The island image sug gests,it seems to me, a context of strong decentralization and a posterioricoordination. But this is not at all the case in Phelps' example. Thetheoretical shift that the image introduces is only a small variation onthe TAT theme. Within it, all prices are formed in a centralized way,except for some lack in real wage adjustment. Thus, the island storybelongs, let us say at a 99% level, to the TAT framework. Contrary toits semantics, Phelps' islands universe remains much akin to the bigauction hall, referred to in the TAT story.

INTERPRETATIONS OF TATONNEMENTTo classify GET au thor s' conceptions ab out the role and place of TAT intheir theory , three different positions can be disting uished, wh ich I labelthe "rejectionist view," the "unconditional acceptance view," and the"conditional acceptance view," respectively.

The Rejectionist View

The "rejectionist view" considers TAT simply as an anecdote or an il-lustrative story that does not belong to the theory in any essential way.According to it, the analysis of existence and efficiency is the exclusiveobject of GET, which should thus remain mute about processes. Sucha view is surely legitimate, but one must be aware of the consequenceof adop ting it: connections m ay no longer be claimed betw een the resultsof economic theory and real-world markets. If this view is held, GETcannot be seen as aiming at answering Adam Smith's basic question,for this implies that both dimensions of the conditions of possibility

problem must be tackled.13

12. Such slight departures may indeed lead to rather unorthodox results, in particularmultiplicity of equilibrium. See Diamond (1982) and Howitt (1985).

13. For an opposite viewpoint, see Hausman (1984).


12/20



The Uncondi t iona l Acceptance View

This view is at the other end of the spectrum. It consists in reaffirmingWalras' initial position (abandoned by him later on, as shown by Jaffe),

that TAT is a "stylized" representation of real market forces. It is con-sidered a good assumption, not at a descriptive level but at an instru-mental one, an "as if" construction in the spirit of Friedman. While thisis obscu red by their reference to the "om niscient a gents" version of TATrather than to the auctioneer version, New Classical economists aredefinitely to be counted among the defenders of this view.

These authors seem to think that a principle like the following onecan be taken as axiomatic: economic agents will always find any unex-ploited satisfaction or profit opportunities and proceed to exploit them.14

Such a proposition, it seems to me, rests on two conditions. A first one(and also the most stressed one) is the assumption of rationality andmaximizing behavior. A second and more neglected one is that, for alladvantageous trade possibilities to be exploited, there must exist anadequate ins titutional setting. In what could it consist? I can see no otheranswer than TAT. Hence, we fall back on the problem of adequacyanalyzed earlier.

The heart of the matter is whethe r TAT, desp ite its radical descriptiveinadequacy with respect to a real decentralized economy, may never-theless be seen as the stylized figure of market forces or competition.In other words, is one allowed to think that the notions of TAT andgravitation, as used by classical economists, are synonymous or havethe same object? For sure, such an assertion cannot be accepted at itsface value. It has to be proven, which precisely is not done. As long asit is not elaborated on and remains at the intuitive level, no theoreticalconclusion may be drawn. Hence, my dissatisfaction with such an inter-pretation of TAT: it begs the question by taking for granted what has tobe explained, namely, the concrete process by which equilibrium pricesare formed.15 As forcefully stated by Hahn: "to leave [the question of

14. This formulation was suggested to me by a referee commenting on an earlier versionof this article.

15. New Classicals would probably object to such a criticism in terms of a Friedmanianor instrumentalist methodology. It does not matter, they would probably argue, thata decentralized econom y is modeled unde r the picture of a centralized econ omy. Whatdoes matter, ho wever, a re the pred ictions m ade on the basis of this explicitly unrealisticmod el. This debate is, of course, too broad to be dealt with h ere. Hence ,1 limit myselfto two remarks. First, as often argued, one may be skeptical about the capacity ofeconometric studies to bring to a close such theoretical debates. Second, it has beenargued that the "irrealism of assumption thesis" is either a trivial one, in which caseit does not serve its immu nizing purp ose, or a grossly unacceptable one (see Mongin[1988], where this is argued by showing that this thesis is a distortion of the standardphilosophical thinking on theoretical terms).


13/20


246 MICHEL D E VROEY

the coordinating power of the price mechanism] unstudied, is to leavevery important matters in darkn ess. The auctioneer is a coordinatorDEUSEX MACHINA and hides what is central" (1987, p. 137).

To conclude, the unconditional acceptance of the TAT assumption,

as exemplified by the New Classical school, suffers from a surfeit ofambition, in contrast with the rejectionist view. This position amountsto holding a very optimistic valuation of GET and its scientific success.Trumpeting the success of GET and at the same time accepting TAT asa theoretical blackbox seems an unacceptable position to me.

The Conditional Acceptance View

In this view, which may be associated with authors like Arrow and

Hahn, among several others, TAT is seen as an assumption usefully tobe made at an elementary stage of theory, because it permits concen-trating attention on the equilibrium price determination problem, whilenot exclud ing, at least formally, the price formation aspect. But, intrins-ically, the assumption is deemed to be unsatisfactory and in need of agradual rem oval, along the lines of non-Walrasian existence and stabilitytheories. Since this interpretation accepts the view that the overall suc-cess of GET depends on progress in the removal of Walrasian TAT,adopting it, however, obliges one to hold reserve judgment about thissuccess. And such a position, of course, implies that no inferences aboutthe real world are allowed to be drawn from results obtained in the TATframework. As the reader will easily guess, this is the view that I, per-sonally, would endorse.

AN ALTERNATIVE BASE CAMP:THE SEPARATION AS SU MP TION

The foregoing analysis should not be interpreted as recom mending writ-ing off GET as a research program. Such a suggestion would be pre-sumptuous; moreover, it would be wrong. Despite its flaws, GET haswitnessed impressive developments and has revealed itself much moreflexible than expected. On the other hand, alternative research pro-grams, such as the neo-Austrian, the post-Keynesian, or the Marxianones, have not been able to develop in a similar, cumulative way, sothat one of the strengths of GET lies in the weakness of rival theories.

Still, I believe that it is worthwhile to look for alternative research

directions. In particular, I find it important to investigate the conse-quences of totally rejecting the TAT assumption and to address thequestion of how to conceptualize a "really" decentralized economy.Earlier, I have characterized a planned economy by an a priori coordi-nation of decisions. The latter is precisely what is absent in a reallydecentralized economy. Here, decisions are taken privately in a contextof deep uncertainty about their outcomes. Agents commit themselves


14/20



by spending money in an irreversible way without knowing, when thedecision is made, whether it will prove well-founded or not. Such asystem can be called aseparated economy, the term "separation" referringto the fact that decision-makers are isolated and have no possibility of

a priori communication.The problem is to analyze its functioning. What new or specificconcep ts are needed ? Taking TAT as a negative reference, the followingfour lines of research can be po inted out. F irst, whileTAT is characterizedby simultaneous decision-making, a posteriori coordination makes senseonly if some sequentialism is introduced , obviously a more realistic view-point. Second, these assertions made about equilibrium, especially theproposition that it is a prerequisite for transactions, are no longer validin the new context. The way in which the notion of equilibrium mayplay a role in explanation is thu s bo un d to chan ge. Third, in TAT moneyhas no place. Would it not be the case that abandoning this frameworkwill result in giving money a central role? Fourth, Walrasian theory,originally at least, treats all markets as formally identical and does notgive a particular treatment to the labor market. Again, would it not bethe case that in a separated economy this principle would no longerhold, thus paving the way for the view that the labor market is radicallydifferent from others? For lack of space, I will limit myself to the firsttwo questions.16

The Sequential or Overlapping Monetary Circuits Framework

To conceptualize a sequential economy is undoubtedly a difficult task.One possible approach consists in emphasizing the role of traders, assuggested by Clower and Friedman (1986). Here I suggest another lineof research centered on the notion of circuit, as modernized by Foley.Such an approach "views the circular flow of commodities and moneyfrom the perspective of the income statements and balance sheets ofcapitalist firms" (Foley, 1986, p. 1). The separated economy may thenbe conceptualized as a web of interconnected and overlapping "mone-tary circuits."17 The no tion of circuit traces the different stages of a givenproduction and trade process. An initial inflow of money serves to pur-chase factors of produ ction (this is the opening of the circuit); goo ds are

16. The reader might ask what exactly is the status of the subsequent analysis? It is nota manifesto for a new paradigm but a more modest exercise in theoretical scenarioconstructing. My main reason for engaging in such an exercise is that, for reasonswhich cannot be explained here, I, like several others, while critical of GET, also feeldissatisfied with the existing established alternatives, be it the Marxian, the post-Keynesian, or the neo-Austrian theory.

17. Contrary to some other uses of the circuit notion, where it refers to the economy asa whole, here it receives only a micro-interpretation.


15/20


248 MIC HEL DE VROEY

produced, and then they are sold, with their sale involving a flowingback of money and the closure of the circuit. When credit-money isinvolved, two further surrounding stages are added: money-creationand money-destruction, the latter being debt repayment. The flowing

back of sufficient earnings may be seen as validating the earlier circuitopening. The contrast with TAT is that in TAT, decision-making andvalidation cannot but go along, while here they take place sequentiallyand may be dissociated: it may well be the case that validation does notoccur. The magnitude of a particular circuit depends on the importanceof the project it finances. In principle, there are as many circuits as thereare business ventures, which immediately reveals that in practice itwould be quite difficult to separate one circuit from another within agiven firm.

A notion of monetary circuit provides several insights, leading to aconceptualization of the market economy very different from what isconveyed by GET.

Overlapping circuits. The different operations take place in a def-inite order. Even if, for the sake of the argument, each operation wereseen as taking place instantaneously, the circuit cannot be reduced toone poin t in time. It must refer to a succession of such po ints . M oreover,individual circuits necessarily overlap. Consider the opening of a circuit.

It consists in a purchase that obviously represents a sale for anotheragent. Consequently, in the simplest possible case, the opening of onecircuit coincides with the closure of another. Hence, the notion of anabsolute beginn ing of the economy does not make sense: were all circuitsto start at the same point in time, there would be nothing to purchaseand so the start could not occur! Consider now the other end of theprocess. If at timet, a given entrepreneurial unit opens a circuit, therebymore or less irreversibly engaging in a specific production process, thisis based on the assumption that other units, both at the same time andlater on, are making decisions the eventual outcome of which, att + x,will be to validate its own decision. Decisions are thus interconnected,the earnings of one agent necessarily consisting in expenditures of oth-ers. But this interdependency is a diachronic one, as opposed to thesynchronic one in GET. The starting of new circuits validates the pre-vious openings of others and brings the latter to a close. Their ownvalidation in turn depends on the future occurrence of new flows ofexpenditures. Failures result from the lack of such new flows, from asequential rupture or disproportionality.

Micro-crises. I call "micro-crisis" a failure in circuit closure or alack of validation. This appears as a deficit in the income account of theeconomic unit that made what ex post appears to have been a wrongop ening decision. In the context of separation , a priori there is no correctbehavior, so that errors and losses are normal outcom es. In other wo rds ,circuit closure is never guaranteed in advance. The notion of crisis is


16/20



thus applied to particular producers - hence, the name "micro-crisis" -rather than, as usual, to the global economy, where the term "macro-crisis" could be used.18 A micro-crisis is like an identity crisis in psy-chology. What is at stake is the viability or survival of private p rod ucers,

be they self-employed workers or capitalist firms, the extreme outcomebeing their disappearance as autonomous entities, for example, th rou ghbankruptcy. Of course, micro-crises can also be corrected through ad-justments, such as improvements in efficiency, changes in products, etc.But, contrary to the TAT case, where adjustments always take place apriori, correcting potentially incompatible decisions, here they occur expost and pertain to incompatible outcomes.

Crucial decisions. An important theoretical consequence of thesequential time-framework concerns the relationship among differenttypes of economic decisions. In GET, decisions are not only interdepen-dent, but simultaneous. In such a framework, reasoning in terms ofprerequisites does no t make sense. All decisions are on the sam e footing.Here, by contrast, a hierarchy am ong decisions emerges. Some decisionsmust be regarded as crucial (Davidson, 1982-83), because they conditionothers , which m ay be seen as "derived decisions." Crucial decisions are,in fact, concerned with the starting of circuits, that is, investment andlabor-hiring decisions. The latter are in turn dependent either on thepossession of money-capital or on access to credit. If, moreover, onewere to assume a very specialized distribution of endowments amongagents, one would arrive at the result that not all of the agents are ableto make the crucial decisions. Hence, an analysis in terms of social classeswould become appropriate.

Disequilibrium

The adoption of the separation assumption impinges on the theoreticalrole of the notion of equilibrium. My claim here is not that one couldor should get rid of the notion of equilibrium, broadly understood, butrather that a radical shift in emphasis must take place. Now the notionof disequilibrium (defined as an out-of-equilibrium state), which canfind no place in a TAT framework, comes to the forefront. Moreover,the specific spelling out of an equilibriating process (i.e., a process forcorrecting disequilibria) becomes a crucial task.

To make my point, I proceed in three steps. First, I reflect on thenature of the indicator to be used in the description of the states of the

economy, whether in equilibrium or disequilibrium, and argue for a shiftfrom prices to financial accounts. Second, I explain why in a sequentialframework the notion of an observable (I am speaking of models, not,

18. Both phenomena are not necessarily concomitant: while a macro-crisis implies ex-tended micro-crises, the latter may also occur in a context of global prosperity.


17/20


250 MIC HEL DE VROEY

of course, of reality) general equilibrium fails to make sense. This leadsme to conclude that in a separated economy disequilibria, as expressedby financial deficits, are the only objective or observable social realityfor the agents in the model - the exact opposite of a TAT economy.

A new indicator. What are the signals or indicators thro ugh wh ichagents could recognize states of equilibrium or disequilibrium? In GET,equilibrium can be perceived in two equivalent ways, by looking eitherat prices or at agents' budgets. The first way is the more common.Equilibrium consists of a specific vector of prices at which all excessdemands are eliminated. Seen from the agents' viewpoint, itis a situationin which every agen t maximizes his utility w ithin the limits of his budgetconstraint, all opportunities of advantageous, mutual trade having beenexhausted. In this perspective, general equilibrium is noth ing but a gen-eralization of individual equilibria, pertaining both to markets and toagents. In my alternative framework, such a double assessment of equi-librium is no longer permitted, for the price indicator ceases to work assoon as the TAT assum ption is discarded. Agents no longer have a wayto assess the existence or the absence of equilibrium by observing prices,since they do not know the equilibrium magnitudes with which actualprices ought to be compared and since there is no auctioneer to guaranteean identity between observed and equilibrium prices. Hence, only the

other indicator remains available, the financial situation of agents, asreflected in income statements, balance sheets, etc., for which I shallhenceforth use the general term of "accou nt." All agen ts in the economyare seen as account holders. One must, however, focus one's attentionon firms' or individual producers' accounts.

The elusive character of the notion of balanced account. How arethe notions of equilibrium and disequilibrium to be understoo d in term sof this financial indicator?19 At first hand, one is tempted to define as ageneral equilibrium any situation in which all accounts are (sponta-neously) balanced, establishing thereby a correspon dence b etween equi-librium, balanced accounts, and circuit closure. Undoubtedly, a GETequilibrium could be expressed in this way. However, in my alternativecontext this is not the case. A host of issues arise, whose consequenceis that equ ilibrium can no longer be positively g rasped. A first one relatesto the relevant time structure within which equilibrium could be as-sessed. In this respect, it must be realized that the adoption of asequential framework makes the occurrence of equilibrium at one givenpoint in time (and thu s its apprehension ) inconceivable. For the econom yas a wh ole, exp enditures and incomes are necessarily equal at each po intin time. For particular agen ts, how ever , even in the most abstract setting,

19. There is an obvious definitional sense in which accounts are always balanced but thismust be discarded, for what we are concerned with is the "spontaneous" situationof the account, taking place before its "conventional" closure.


18/20



establishing whether or not there is a balance between these two mag-nitudes implies that at least two dates be taken into account, that of theinitial expenditure and that of the return flow of money. Moreover,different accounts are never balanced at the same time, since circuits are

overlapping. Therefore, one may assert that, contrary to GET, in theseparation framework no assessment about the existence of a generalequilibrium at a given point in time may be made. O ne m ight, h owever,imagine a more complicated way of recognizing equilibrium, by observ-ing that particular accounts are in a balanced state over a given timespan.But this raises at least two other issues, linked to the precise definitionof a balanced account. The first, which I will have to neglect here, hasto do with the integration of profits into the analysis. The second flowsfrom the ongoing character of economic activities. Suppose that, quiterealistically, circuits of different length are evolving at the same timewithin firms or that fixed capital is introduced. Circuits then overlapwithin firms themselves, and there is no longer a unique point in timeat which operations come to an end , so that a clear delineation of circuitsceases to be possible. In such a framework, the generic concept of ac-count should be divided into flow and stock subcategories. Some mightwant to look at the balance sheet as the appropriate indicator for ourproblem. However, as is well known, the information that it providesis only partially reliable: while some of the figures it contains may beinterpreted as objective ind icators, because they relate to closed circuits,others are only subjective evaluations of future results, which, strictlyspeak ing, cannot be given the statu s of an objective piece of information,pertaining to achieved outcomes.

The existence of disequilibrium. I subm it that in a separated econ-omy disequilibria (i.e., deficits or negatively unbalanced accounts) arethe only and truly objective (i.e., a possible object of unanimity) realityfor economic agents. Moreover, these disequilibria can be observed by

them only if they reach a certain threshold, beyond which hiding be-comes impossible. Thus in a separated economy the only indisputableinformation is negative. Firms are encountering losses and can no longerhon or their commitments; hence, bankrup tcy is the epitome of objectiveinformation! More generally, in this framework a judgment about theviability of the economy can be made only in a negative way, based onthe importance of deficits and bankruptcies. The more serious and fre-quent are micro-crises, the more unstable the economy and the moretroubled its reproduction.

CONCLUSION

Two claims were made in this article. The first and main one is that GET,while purportedly seeking to resolve the question of the functioning ofa decentralized economy, in fact takes for its object of analysis a cen-


19/20


252 M I C H E L D E VROEY

tralized economy. This is what I called the base camp paradox. Whilethis idea, itself, is not new, I have tried to formulate it more explicitly.New aspects have been em phasized : the institutional con tent of tatonn e-ment, the link between the uhawareness of the paradox and lack ofinterest in an in-depth discussion of the definition of a market economy,and the close resemblance between the tatonnement economy and thenotion of "market socialism." I have also discussed the possible inter-pretations of the place and role of tatonnement in GET and advancedsome criticisms against interpre tations like the New Classical on e, whichseem unacceptable to me.

My second claim w as to show that it is at least conceivable to deviseano ther base camp and ano ther itinerary for climbing the "Ad am Smith'sQuestion peak." Clearly, there is a huge gap between drawing a blue-print for a possible paradigm and actually starting the latter. The diffi-culties that existing alternative paradigms encounter for taking off arethere to warn us. So, neither of my two claims should be interpreted asa recommendation for rejecting GET. Yet the question remains open:Will GET be able to tackle fruitfully the process dimension hith ertoneglected and put at the forefront in my alternative approach? Whileacknow ledging GET's amazing and rather dialectic capacity to develop ,I remain, however, skeptical enough to hope for the parallel develop-

ment of alternative theories.REFERENCES

Clower, Robert, and Friedman , Daniel. 1986. "Trade Specialists and Money in an Ongo ingExchange Economy."journal of Economic Behaviour and Organization, February:115-23.

Davidson, Paul. 1982-83. "Rational Expectations. A Fallacious Foundation for StudyingCrucial Decision-Making Process."journal of Post-Keynesion Economics 5:182-98.

De Vroey, Michel. 1987. "La possibility d'une economie d6centralise. Esquisse d'unealternative a la th^orie de 1' equilibre g6ne>al."Revue Economique, July.

Diamond, Peter. 1982. "Aggregate Demand Management in Search Equilibrium,"journalof Political Economy 51:881-94.

Dickinson, H. D. 1933. "Price Formation in a Socialist Economy."Economic journal43:237-50.

Fisher, Franklin. 1983.Disequilibrium Foundations of Equilibrium Economics. Cambridge: Cam-bridge University Press.

. 1987. "Adjustment Process and Stability."The New Palgrave. A Dictionary of Eco-nomics, Vol. 1, pp. 26-29. London: Macmillan.

Foley, Duncan K. 1986.Money, Accumulation and Crisis. London: Harwoad Academic Pub-lisher.

Hahn, Frank. 1984.Equilibrium and Macroeconomics. Oxford: Basil Blackwell.

. 1987. "Au ctione er."The Nezv Palgrave. A Dictionary of Economics, Vol. 1, pp . 136-38.London: Macmillan.

Hahn, Frank, and Negishi, Takashi. 1962. "A Theorem of Non-tatonnement Stability."Econometrica 30:463-69.

Hausman, Daniel. 1984. "Are General Equilibrium Theories Explanatory?" InThe Philos-ophy of Economics. An Anthology,edited by Daniel Hausman, pp. 344-54. Cambridge:Cambridge University Press.


20/20

de vroey the base camp paradox

Documents