Money, Banks and Finance in Economic Thought

Equilibrium: Coordination of what? Smith, Walras and Modern Economics

Witztum Amos Witztum, London School of Economics

There is a strange anomaly in the standard approach to economic equilibrium. On the one hand, a competitive system with the appropriate conditions will always reach equilibrium. On the other hand, the second welfare theorems allows for the possibility that such equilibrium will not be socially desirable. Now if equilibrium is a coordinated outcome of individuals’ rational plans, how can such an outcome not be socially desirable? If it were coordinated, in a system based on methodological individualism, should it not be socially desirable almost by definition? Alternatively, if it were not socially desirable could it possibly be a coordinated outcome? Perhaps the most poignant expression of this anomaly is in the form of the prisoner’s dilemma. The coordinated outcome is not the one which best serves both agents. But, claim experimental economists, if we turn the agents into social being by attributing to them social preferences, the prisoner’s dilemma disappears and there is a unity between coordinated outcome and socially desirable one. Naturally, the hidden assumption behind standard economic analysis is that the domains of economic and social interactions are mutually exclusive. This means that one can easily imagine a coordinated outcome in the economic domain which is not acceptable by the social domain. But why is it, one wonders, that the socially ‘coordinated’ outcome is derived through mechanisms of social choice rather than through a concept of equilibrium? Is the nature of social interaction different from the nature of economic interaction? If so, how can the attribution of social preferences to individuals resolve the prisoner’s dilemma problem which casts doubt about the ability of equilibrium to yield a meaningful coordinated outcome? In this paper I will examine the question of the relationship between social and economic interactions. Against the contemporary view which completely separates the two domains, I will juxtapose the positions of Walras and Smith. In the case of Walras I will make use of the ideas embedded in his Economie Sociale which could be seen as a mechanism which combines social and economic coordination. In the case of Adam Smith, I will argue that there exists only one coordinated outcome—at natural rates—which is consistent with the social objectives upon which the entire economic system had been constructed. Here, I will also focus on a Smithian take on the problems raised by the prisoner’s dilemma and the attempts to resolve it by socialising preferences.

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Keywords: Equilibrium, Economic and Social Coordination, Adam Smith, Walras

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