Reviews, Socialist Review, No.196, April 1996.
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Joseph E. Stiglitz
MIT Press £27.50
‘Competitive markets are the most efficient means of anticipating and supplying consumers’ wants.’
‘There is no reason to believe that markets themselves will be efficient.’
The first of these quotations comes from Labour’s arch-spindoctor, Peter Mandelson. He is repeating a view so widespread among mainstream politicians and media commentators that it is repeated as a self evident truth.
The second quote is from this new book by the well-known, pro-capitalist, economist Joseph Stiglitz. And, despite its title, most of the book is devoted to attacking the premises of established ‘neo-classical’ market theory.
This theory, he argues, fails either to produce an ideal model of an efficient economy or to depict the real organisation of capitalist economies.
The conventional model – most fully elaborated by Arrow and Debreu a quarter of a century ago – claims that if firms and individuals are free to set prices, then supply and demand will equate with each other at the most efficient level of output. But, Stiglitz points out, there is no way anyone can tell in advance what future supply and demand will be. And so for the model to work ‘there must exist markets not only for periods in the immediate future, but for all periods extending indefinitely into the future.’
This clearly cannot happen. ‘if there were markets for each of the millions of commodities, each of the billions of contingencies, each of the infinity of future dates, then so much of society’s resources would be absorbed in organising these transactions that there would be little left over to be bought and sold on each of these markets!’
As a result ‘even under the best of conditions, with business managers engaging in the most rational analyses ... there is no assurance that markets lead to efficient outcomes’. Nor will the market automatically correct itself so as to follow the ‘unique path converging to the steady state’ that involves full employment of labour and resources.
Instead of proving that such a ‘steady state’ was bound to come about, defenders of the neo-classical orthodoxy have simply ‘ignored’ the problem.
But this was also to ignore reality. ‘if the economy was well described by the Arrow-Debreu model ... then coordinating failures’ – where ‘there are no jobs because there is no demand for the output of firms and there is no demand for the output of firms because people do not have jobs’ – presumably would not occur. The slumps of the 1980s and 1990s, crudely, prove ‘there is something fundamentally wrong with the Arrow-Debreu model’.
That is not all. The orthodox model’s own assumptions are contradictory. It assumes perfect knowledge and perfect competition. But if these existed, then firms would never have an incentive to innovate, because the moment they did so their rivals would do the same and prevent them increasing their profits. In that case ‘there will be underinvestment in research and development in a market economy ... Market processes do not automatically ensure fierce competition or rapid research and development’.
Yet if perfect knowledge and perfect competition do not exist, then the model’s own reasoning shows that the economy is not producing as much as it could, as efficiently as it could.
Stiglitz argues that the reality of capitalism is, in fact, very different from the model. There is ‘imperfect’, not perfect, competition and there are enormous gaps in firms’ knowledge of what each other are doing. This leads to all sorts of problems. Thus it is not true that stock exchange valuations tell how well managed a company is – ‘much of the behaviour of the stock market cannot really be explained by any rational behaviour’ – and, most significantly, ‘equilibrium might not exist, prices may not be set at competitive levels ... markets may not clear.’
Stiglitz’s book has problems of its own. It is titled Whither Socialism? But for him ‘socialism’ means either the old order that used to exist in the USSR and Eastern Europe or schemes for market socialism – which fail, he argues, because they rest on the same basic model of the economy as the neo-classical orthodoxy.
He himself opts for a version of capitalism as it presently exists, but with some recognition of the need for the state to intervene to correct ‘deficiencies’ in the market. This involves him vastly underestimating the amount of waste and misery inbuilt into the present system. It also prevents him asking why interventions by states have failed to ward off three recessions in the last 22 years.
Despite these failings, however, the book will be a revelation for anyone who has been forced to swallow whole the message preached in school and college textbooks like those by Lipsey and Samuelson – or, for that matter, anyone who has been taken in by the ‘modernising’ ideas of New Labour.
Last updated on 21 December 2009