The economic crisis, the calculation debate, and stability theory
Is the financial crisis -- which is rapidly becoming the "real economy" crisis -- somehow the "dual" of the socialist calculation problem?
A'la Hayek, say the price of copper goes up. Markets will make many adjustments and the proper adjustments usually cannot be foreseen by a central planner. Nonetheless there is some iterative process by which those adjustments get made and, I am sad to say, our understanding of that process involves a good deal of hand waving. It's fine to talk about entrepreneurship but the net effect need not be equilibrating. The relationship between local adjustment, where we have decent Marshallian theories, and global adjustment, about which we know little, remains tricky.
General equilibrium stability theory used to assume gross substitutability to derive the convergence to a new equilibrium but in fact convergence did not usually come easily in the models. (I take gross substitutability as meaning that a decline in the price
of one good will, on the whole, lead to increased expenditures on other
goods, but here are some alternate specifications.) Most of the time we hope that the proper local adjustments get made and the whole pinwheel turns and mutates in the proper directions over time.
Are there conditions, however rare, under which market adjustment and convergence does not occur? If a few of the vertices get stuck, can it become impossible for the economy to fulfill its mutating pinwheel program of change and adaptation?
Today, banking, finance, and construction all need to shrink and indeed they are shrinking. Given the centrality of lending and project evaluation, is a sufficiently healthy banking sector needed for the pinwheel to properly turn? Must investors abandon their quest for liquidity to bring their information to bear on market prices?
Paul Davidson, the Post Keynesian, used to stress that gross substitutability should not be taken for granted. Was he on to something?