Efficient equilibrium in economics

The Economics for socialists series looks at the intellectual basis of the economics field.

Reading: Harvard Business Review, There is No Invisible Hand

Economics is separated from other social sciences by its use of models. Whereas other social sciences try to gather evidence from the past and present to understand what might occur in the future, economics creates mathematical models to try to show what is likely to occur in the future.

Nearly every economics model relies on the efficient equilibrium hypothesis. This hypothesis assumes that if everyone pursues their rational self interest, the economy will naturally move towards–and eventually reach–the most efficient configuration possible. In this configuration, all resources are utilized at greatest efficiency, everyone will be hard at work, all factories will be churning out goods 24 hours per day, consumers will eagerly buy and use the goods produced, etc. This is the most efficient configuration the economy can possibly have, and it is only possible when everyone is allowed to pursue their natural self interest–that is, if it is a pure free market. If there are “imperfections” to this free market ideal–this could be taxes, income support for those in poverty, single payer healthcare or other welfare programs, public sector workers who are not subject to the pressures of the free market, unions, etc–the result¬†must be¬†less efficient than a “perfect” free market without these imperfections.

But is this really true? In Economics 101, students learn how to prove that an economy with a single good in it reaches an efficient equilibrium, by balancing supply and demand. Later, they will learn how to prove that economies with two goods reach equilibrium. But the real world doesn’t have just one or two goods in it, and it’s incredibly difficult to mathematically model an economy with more than two goods.

As the article for today explains (deliberately taken from the Harvard Business Review to show that this is not a fringe idea), it took over a century for economists to solve this problem. It turns out that if everyone pursues their rational self interest–if we have a perfect free market without any imperfections–the economy lurches violently from boom to bust to boom to bust. It doesn’t tend towards an efficient configuration; it doesn’t tend towards anything, instead acting totally unstably. This, obviously, is not a world we want to live in.

Many ideas are based around the efficient equilibrium hypothesis: we cannot have a generous social welfare state because this is a step away from a perfect free market, which will lead to inefficiency and do more harm than good. But economists have shown that this is not true; a free market does not lead to an efficient outcome. Trying to strip away the “obstacles” to a perfectly free market, like the welfare state or unions, will likely lead to a less efficient outcome–simply because free markets are not efficient.

Progressives sometimes argue that the free market ideal is impossible to attain. For example, only people who have been to medical school can actually be a smart “consumer” of health care. Thus, market-based health care reforms can never work. But socialists know that–even if we could somehow solve those problems by sending all patients to medical school–market-based reforms would not work because the efficient equilibrium hypothesis has been proven wrong by economists. Free markets are not efficient.


Discussion questions:

Open discussion about this topic.

Can you think of policies that are justified based on the efficient equilibrium hypothesis?

Some notes from the discussion:

This was done together with prices and efficient allocation of goods. However, I think this was too much to cover.

Next time, this would be much stronger with concrete examples of how the efficient equilibrium hypothesis is used to justify terrible policies.