6 – EQUILIBRIUM IN ECONOMICS
A benevolent market, with goods and services exchanging between willing buyers and sellers, with prices and wages finding their own levels, including everybody with no one left out, is a nice model. But I’ve always thought it couldn’t really work, not because of people’s natural cussedness but because something didn’t seem to add up. It didn’t seem possible there could be a balance with the multiple actors of labor, resources and money, even in a simple economy, without creating unwilling buyers or sellers or squeezing some people out. I thought this, but I couldn’t prove it. Economic theorists assume equilibrium as a starting point and avoid nasty things like proofs of existence.
I really couldn’t imagine a simple system that would provide for sustainable economic growth, which appeared to be a non-equilibrium state. Something extra, outside the system, seemed to be needed. Some economists attribute growth to class exploitation, others to technical innovation or to cheap energy sources like coal and oil. Anthropologists point to culture – status, emulation, self-regard – as being the important factors for economic growth. All of these are entirely outside of the usual theory of simple economic systems.
It was agreed, though, that ‘balance’ is the first concept of equilibrium. The Scales of Justice balance when arguments are weighed. Forces are balanced if neither team can win a tug-of-war. All agreed, too, that many forces can be balanced all at once. The Eiffel tower would collapse if they couldn’t. This kind of constant, balanced situation is called a “static equilibrium.” Two additional ideas were needed to describe equilibrium processes. One is where an overall situation is unchanging while some variables are not static but proceeding at constant rates. The other covers time-dependent processes where some variables do vary with time while the overall situation remains the same. They are called “stationary-state” and “steady-state” equilibria, respectively, and are often confused with each other.
An example of a stationary state equilibrium is a stream running into a pond, passing over a dam, and flowing away downstream. Water flows in and out at a constant rate, continuing day after day, and the pond’s level doesn’t change. Other familiar processes, such as a steadily rotating wheel, are in stationary states. Some need inputs of energy to continue. A candle flame is a stationary process. An empirical definition of a stationary state is that it isn’t possible to tell by two observations which of them came first.
In a steady state equilibrium, things change with time. A swinging pendulum speeds up, slows down, and reverses. However, it’s in some kind of special state because it always repeats its motion. There are other examples. A group of flying geese is in a steady state. The overall V-formation doesn’t change and the group continuously moves ahead. Such steady but non-static, non-stationary conditions are called “steady-state equilibria.”
All of these equilibrium states may or may not persist if disturbed. Some are stable, some are not. A marble resting at the bottom of a bowl is in a static, stable equilibrium. If moved slightly, it will roll back toward the bottom. However, if the bowl is turned upside down and the ball is balanced on top, it’s at a static, unstable equilibrium. A boulder can balance, unstably, on a mountain top or can roll down and settle stably somewhere below. Its resting place will depend on the path it takes. Both the starting and ending points are at equilibrium; the downhill plunge is not.
So what does all of this have to do with economics? It means a lot, unfortunately. The French economist Leon Walras introduced equilibrium to economics in 1871. It has been part of it ever since in spite of the doubts of some. He chose, without naming it, a stationary state. Thereafter, in economics, his kind of equilibrium has meant the condition where production and consumption are constant, buying and selling are steady, and prices are unchanging. Walras and others knew that such conditions were unusual but were often approximately true. When they did occur his analysis should apply. If the economy was out of equilibrium it was simply moving to different equilibrium. A curtain was drawn over the in-between moments; minor perturbations, ripples on the pond. Economic variables would be stationary with time. The price of any item would be such that the goods sought by buyers would equal the amounts produced by sellers.
Walras formulated his Law of Markets, stating: “The sum of excess demand of all markets (for food, furniture, etc.) will equal zero, whether or not the economy is in equilibrium.” It implied that if there was excess demand in one market, there would be insufficient demand in another. From this he could show that by looking at all markets except one and find them in equilibrium, then the last market must also be in equilibrium. His “law” dominated economic policy development for fifty years, so that economists spent much time seeking to make it work and wringing their hands when it didn’t. The major problems with Walras’s argument were that it assumed (a) perfect knowledge of markets and prices by all participants, (b) instantaneous, costless transactions between them, and (c) perfect competition, so that no factors of production could be manipulated, no prices could be fixed, and no supplies restricted by anyone.
During the late 1800s Walras’s Law was criticized by economists but without any alternative proposals. It didn’t seem to work in practice so they tried to locate market imperfections as explanations. But they all made a critical assumption, namely, that a national economy was the sum total of all marketplace activities and transactions. Thus Walras’s Law represented an extension of Say’s Law. For 120 years they were taken together to mean, though it was not proved, that there was a tendency toward a Walrasian equilibrium even if it didn’t exist at a given moment. Then in the mid-20th century an unrelated mathematics paper unintentionally demolished that idea. When its result was applied to Walras’s Law of Markets it proved that, even if all markets were in equilibrium, the situation was unstable. If changes occurred in one market then the others must change as well, thus disrupting equilibrium in all markets. It proved mathematically that there was no tendency toward Walras-equilibrium in economic markets. No wonder his Law didn’t seem to work in practice. It did work in theory, though. The term ‘Walrasian equilibrium’ still appears in economic discussions today. It serves economists as a very simple model. They might as well be modeling a pin balanced on its point.
These are seemingly simple questions that any theory of economic equilibrium ought to have taken care of long ago, but they are extremely difficult to answer. After a hundred years only the first problem, that of existence, has been solved, but only for some ideal circumstances not resembling a real economy. There has been no real progress on uniqueness and stability. Even so, the Walrasian approach remains the basis of equilibrium theory in economics.
“Equilibrium” normally means balance and steadiness; on an even keel. But specialists give ordinary words restricted meanings so they can be discussed without confusion. This is baffling to laymen, who see such nit-picking as a lack of real-world experience. Every field has its own usages. All the sciences have shaped the word ‘equilibrium’ for their own purposes. Their experts are exasperated when other experts don’t seem to get it. Economists appropriated ‘equilibrium’ to their particular needs and have also created more subspecies: Walrasian equilibrium, General equilibrium, Dynamic equilibrium, Dynamic Stochastic General equilibrium, GDP equilibrium, Partial equilibrium, and Price equilibrium. As expected, confusion results.
In the early days of the industrial revolution, factories and mines were filled with individuals ready to work for a pittance because they worked on farms for nothing. If they wouldn’t take industrial jobs at subsistence wages, others would. This is even today presented in economics textbooks as a good example of supply and demand at work. A huge demand for jobs will drive wages down to an equilibrium level where workers will accept them, as predicted by theory. The process is logical, I suppose, as long as the supply of poor and desperate workers lasts. In the U.S. it has pretty much run out. Farmhands have long since left the farms. The poor whites of Appalachia and poor blacks across the South have gone north, gotten better jobs, and won’t go back. It took a few generations and two world wars, and it’s now finished. However, today’s laid-off unemployed workers can’t go back to the farm: the jobs aren’t there anymore. It’s not like the old days. Also, we now speak of jobs that “American workers won’t do,” meaning that they won’t take dirty jobs even at decent wages. Those are for desperate uneducated immigrants, not for regular Americans. One ought to be able to recruit Americans for farm labor by paying them enough but it doesn’t seem to work that way. Equilibrium seems to be out of reach. These facts about the labor market are widely known and are failures of standard market theory.
Workers with differing skills supposedly don’t compete to drive down each other’s wages. A job market with separate compartments doesn’t fit economic theory. But today there is not a single ‘labor market’ but many. There are different markets for skilled and unskilled workers, and special markets for special skills. Actors and welders don’t answer the same ads. Yet, skilled workers often take unskilled jobs. Everyone’s heard of the PhD driving a taxi. Better to work at McDonald’s than not at all.
The first economist to publish a solid critique of economic equilibrium was John Maynard Keynes. His 1936 book, The General Theory of Employment, Interest, and Money, gave a formal basis for persistent unemployment in the labor market even while other markets were in equilibrium. Markets were supposed to set the proper price for labor but high unemployment during the Great Depression proved that they obviously did not. Keynes showed how a modern economy could operate indefinitely without full employment. He proposed that the government spend money to provide jobs, which was very contentious. Full employment didn’t return until World War II with immense deficit spending by the government.