Tuesday, January 25, 2011

Kenneth Arrow & Frank Hahn put Smith’s theory of the market in perspective

This was sent to the students in a seminar on the history of modern economic thought, "Economic Liberalism and Its Critics", that I'm teaching this semester. Right now we're reading & discussing (portions of) Adam Smith's Wealth of Nations. This little item is relevant to that, and it may also be of more general interest. —Jeff Weintraub

To: Members of PPE 475-302 (Economic Liberalism & Its Critics)
From: Jeff Weintraub
Re: Kenneth Arrow & Frank Hahn put Smith’s theory of the market in perspective

Nowadays, more than two centuries after Adam Smith published The Wealth of Nations and after so many of his ideas have been absorbed and elaborated by academic disciplines, ideologies, and everyday public discourse, it can sometimes be too easy to take his theory of the market for granted. And doing that can have at least two different kinds of effects, both unfortunate. On the one hand, it may incline people to swallow these ideas too easily and uncritically, as though they were simply common sense, without realizing how controversial and paradoxical many of them are. And on the other hand, it may lead people to underestimate the powerful and startling originality of Smith’s theoretical achievement in WN. To reiterate a point that I've already emphasized, what the core theory of WN offers is not simply a set of technical economic analyses, but a coherent and comprehensive vision of social order.

The following passage from the Preface to Kenneth Arrow & Frank Hahn’s General Competitive Analysis (1971), which was long one of the most prominent texts in general equilibrium theory, captures something important about the point and significance of Smith’s theory of the market and makes it clear why the central thrust of his theory should remain startling, as well as illuminating, to anyone who takes it seriously.
There is by now a long and fairly imposing line of economists from Adam Smith to the present who have sought to show that a decentralized economy motivated by self-interest and guided by price signals would be compatible with a coherent disposition of economic resources that could be regarded, in a well-defined sense, as superior to a large class of possible alternative dispositions. Moreover, the price signals would operate in a way to establish this degree of coherence. It is important to understand how surprising this claim must be to anyone not exposed to the tradition. The immediate "common sense" answer to the question "What will an economy motivated by individual greed and controlled by a very large number of different agents look like?" is probably: There will be chaos. That quite a different answer has long been claimed true and has indeed permeated the economic thinking of a large number of people who are in no way economists is itself sufficient ground for investigating it seriously. The proposition having been put forward and very seriously entertained, it is important to know not only whether it is true, but whether it could be true. A good deal of what follows is concerned with this last question, which seems to us to have considerable claims on the attention of economists. (pp. vi-vii)
(You will come across this passage again later in the course, since it is quoted by Amartya Sen in his essay “Rational Fools”. But in the meantime it’s worth pondering while you’re still in the midst of reading Smith.)

—Jeff Weintraub