Tuesday, January 25, 2011

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

I would have left this comment on the blog, but comments don't seem to be open.

Regarding, Jeff Weintraub: Kenneth Arrow & Frank Hahn put Smith’s theory of the market in perspective, the post quotes Arrow and Hahn saying it is not so obvious
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.
As we found out recently, equilibrium is not quite as automatic as this suggests. In addition, I think that the emphasis on markets as an efficient way to allocate resources and to stabilize an economy overlooks an important point. One of the most significant things about market based economies is their creativity. That in my view is even more important than stability. After all, stability is easy in a top-down economy as well. It's creativity that's hard. And creativity is not always compatible with stability and equilibrium. But it's generally worth the cost of the meta-market mechanisms necessary to shield a society from the disequilibria created by creativity.

Where does the creativity come from? It results from the fact that market economies take advantage of more of the intelligence in the overall system than other economic systems. In a market economy one has many points of perception and intelligence that are continually searching the environment for opportunities. That sort of distributed intelligence is simply not possible in a centrally controlled system. It is by encouraging distributed intelligence and by enabling it to contribute its insights to the economy that market systems gain their great advantage.

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