Download Abstract

Loosing sight of the classics.
How classical economics became a static approach
Christian Schmidt
Abstract:
It has become commonly accepted to claim that Walras had laid the foundations of the
Intertemporal General Equilibrium Theory with his system of interdependent equations.
Garegnani argues in his well known article of 1976 that the theory of value and distribution
underwent a fundamental change while maintaining the classical long-period analysis in the socalled Neoclassical Revolution of the late 19th century. Elder hypotheses regarding employment
and the distribution of wages and profits were abandoned in favour of a neoclassical theory of
distribution.
Early neoclassical economists presumed the equilibrium determined by the forces of supply and
demand on the markets for labour and capital. Later, with the work of Hicks, also the notion of
equilibrium changed; for neoclassical theorists realised the incoherencies brought about by the
maintenance of the long-period method, which was characterised by a uniform rate of profits on
the selling price of all capital goods. This second shift can be called 'Second Neoclassical
Revolution' (Schefold 2008), for researchers’ efforts to decompose the classical equilibrating
process into dated periods.
But the introduction of temporary and intertemporal equilibria has not just had the purpose of
eliminating inconsistencies emerging from the combination of a marginalists’ supply and demand
approach on the one and a long-period position on the other hand. Its function has been to model
interest rates as intertemporal phenomena just as well. This, however, would head for a
generalisation of Böhm-Bawerk’s theory of interest, in which the basic idea of an equalising
tendency among own rates of interest already shows up.
In my talk it will be shown that there are passages in the writings of Böhm-Bawerk, which might
confirm Garegnani's thesis that early neoclassical authors have had the concept of a capital stock
as a magnitude able to change its content while presuming its value. Especially Böhm-Bawerk
points out the path, on which intertemporal general equilibrium theory will pursue decades later
with Lindahl and Hicks. But what has been lost with the works of Hicks was a fundamental
understanding of the classical approach to economic theorising, and it can be shown that for Hicks
took over a mathematical perspective on elder theories, and particularly for his interpretation of
concepts like 'static', 'stationary' and 'dynamic' has become standard in economics, the viewpoint
of classical economists got out of sight.
That the Hicksian confusion has been prepared by the works of early neoclassical economists is
implicitly shown by Garegnani‘s critique (1960, 2008) of the original Walrasian system of equations
of production and capital formation on the ground of which Eatwell (1975, 1990) has formulated
his critique of Morishima‘s proof of existence later on. Neither Marshall, nor Böhm-Bawerk, nor
Walras felt the need to get rid of the classic approach to equilibrium, and accepted that at the end
it is the overall capacities of an economy together with the forces of competition that renders
economic reasoning analytically powerful. Even Lindahl adopted the Walrasian and Marshallian
'classical' perspective that it is the long-period position that defines the capabilities of production
and growth of an economy, in which the forces of change and therefore the forces of competition
have come to rest, and thereby a position has been reached that permits ongoing reproduction.
For this reason he seemed to be forced to assume perfect foresight in order to assure that his
model economy reaches a final state of reproduction.
It should be clear that turning away from a long-period notion of equilibrium renders it analytically
impossible not to introduce a time element in the form of dated variables, as Lindahl, Hicks and
later on Morishima did. For the assumption of perfect competition will head for considerable
alterations in the system of relative prices. Thus, given the technique, the forces of competition
lead the system towards a long-period position characterised by a uniform rate of profits on all
necessary capital goods.
This, in general – i.e. for an arbitrarily given capital stock that is not perfectly adapted to the given
production possibilities – will alter the physical composition of the initially given capital stock
wherefore relative prices are going to change from one period to the other. To explicitly picture
the path an economy follows while tending or groping towards a long-period position by means of
general equilibrium methods one is therefore bound to model multiple or, more general, infinitely
many short-period equilibria. While the long-period position is still a point of reference and
therefore effective in intertemporal models of capital formation like Lindahl‘s it is thrown away in
pure production models as we do find them in modern textbooks presenting Arrow/Debreu
economies. What is generously overseen or tacitly accepted by modern theorists is that the
assumption of perfect foresight was still a necessity in an intertemporal general equilibrium model
of capital formation, but it wastes away to an elegant assumption supplementing mathematical
proofs of existence of pure production equilibria.
Thus what might be seen as an advantage of modern general equilibrium, i.e. the possibility of
giving up the idea of a centre of gravitation and therewith the definition of a uniform rate of
profits over all sectors of production, turns out to be no less than giving up the interest in an
economy‘s reproduction capabilities. Temporary equilibrium analysis of capital formation
reasonably went a step further by abandoning both, the crutch of perfect foresight as well as the
interest in a position of rest. That this might lead to a total breakdown of a model economy within
several periods might be seen as a central feature not yet fully worked out.
To a modern economist it might now seem less clear why such an approach received such a wide
acceptance among his fellows. Part of the explanation could be given by restating the
misinterpretation of the classical approach, for with the eyes of the classics the original Walrasian
model becomes overdetermined, whereas an intertemporal theorist cannot do otherwise than see
it as underdetermined.
For an intertemporal economist Walras was wearing his monocle on one and Böhm-Bawerk on the
other eye, both trying to see an intertemporal general equilibrium, while the one did not want to
accept the necessity of an intertemporal framework the other could not see the advantage of a
general system of equations. What this perspective cannot grasp is that both theorists never lost
sight of the classical conviction that (re)production matters for economic analysis at least as much
as the 'revolutionary' idea of utility maximising. What Hicks introduced could be called
Neoclassical Dichotomy of Statics and Dynamics, for he took statics as nothing more than a dated
point in time supposing the classics to having assumed a stationary state. A dynamic process,
however, turns out to be a depiction of dated variables through several periods. As remote as
Hicks‘s 'static classics' stood from what classical analysis aimed at, one might render him respect,
not for having solved the knot of the early 20th century when a whole bunch of economists
discussed what dynamic or static analysis really meant but for having it cut.
Unfortunately what he cut off is barely understood by today‘s economists.