Commentary on Political Economy

Thursday 29 May 2014

Economic Equilibrium and Politics

B. The Extrinsication of the Mechanical Equilibrium Schema into Political Market Process: Competition, Profit, Innovation


1. Equilibrium, Mechanics and Dynamics


Walras … would have said (and, as a matter of fact, he did say it to me the only time that I had the opportunity to converse with him) that of course economic life is essentially passive and merely adapts itself to the natural and social influences which may be acting on it, so that the theory of a stationary process constitutes really the whole of theoretical economics and that as economic theorists we cannot say much about the factors that account for historical change, but must simply register them. … I felt very strongly that this was wrong….
I was trying…. to answer the question of how the economic system generates the force which incessantly transforms it…. a source of energy within the economic system which would of itself disrupt any equilibrium that might be attained. If this is so, then there must be a purely economic theory of economic change which does not merely rely on external factors propelling the economic system from one equilibrium to another. It is such a theory that I have tried to build …
It was not clear to me at the outset what to the reader will perhaps be obvious at once, namely, that this idea and this aim are exactly the same as the idea and the aim which underlie the economic teaching of Karl Marx. In fact, what distinguishes him from the economists of his own time and those who preceded him, was precisely a vision of economic evolution as a distinct process generated by the economic system itself.” (Schumpeter 1937/1989, p. 166)” (Preface to Japanese edition of “Theorie”, quoted in N. Rosenberg, ‘Endogeneity’, p.7.)

The contradiction in Schumpeter’s well-known exposition of his theory of economic development is absolutely evident: If indeed “the economic system” can be “propelled from one equilibrium to another”, then for him the notion of “economic equilibrium” must be theoretically valid. Yet if indeed there exists

“a distinct process generated by the economic system itself…[through a] force or source of energy that incessantly transforms it…, which would of itself disrupt any equilibrium that might be attained”,

then it is obvious that no such “equilibrium” exists or can exist, for the precise reason that “the economic system” is at all times – “incessantly”! – being trans-formed. It is the very trans-formation, the meta-morphosis, the trans-crescence of the economic system that precludes any “equi-librium”, any “equi-valence” of its internal values. An economic system that is able internally (“from within”) to undergo the “incessant transformation” that Schumpeter intends to theorize is quite simply conceptually incapable of being in “equilibrium” because equilibrium can be predicated only of economic systems based on “equal exchange”, that is, the exchange of equivalents. But Schumpeter’s “dynamic process” is one in which the values produced by the economic system are incessantly and qualitatively changing because of political forces that turn market prices into something entirely different from “equilibrium prices”, because they reflect a political reality rather than a reality of “pure competitive exchange” on the basis of marginal utility. This means that Schumpeter’s dynamic process, the Dynamik, is categorically different from the static economy, the Statik, intended by equilibrium theory. Schumpeter’s dynamic economy is one in which “equilibrium”, if attributed to it, is a contradictio in adjecto!

Schumpeter himself explicitly states in the Theorie that “dynamic equilibrium” is impossible because it is a contradiction in terms, an oxymoron: yet he does not seem to realize that for that very reason it is also impossible for the “distinct process” of Entwicklung to lead “from one equilibrium to another”! When speaking of Entwicklung, Schumpeter rightly treats equilibrium as a stationary state in which all “exchange values” or “market prices” are fixed in accordance with the utility schedules of market participants taken as individuals. But then, he fails to notice that for the “economic system” to move “from equilibrium to equilibrium”, those “exchange values” or “market prices” can no longer be fixed, first, in a regime of “pure competition”, and second, according to utility schedules, - because the very reality of Entwicklung, the “dynamic process”, determines values and prices not according to the pure economic laws of equilibrium theory with its axiomatic utility schedules, but rather according to the very “impure” practico-political processes that allow the economic system to be “trans-formed” and to mutate!

Schumpeter’s clear attempt here to reconcile Marx’s critique of political economy with Walras’s axiomatic schema of Neoclassical equilibrium theory by reconciling whilst maintaining the “distinct” character of the Statik and the Dynamik founders on the evident logical impossibility of the attempt – that is, of theorizing the capitalist economy on these two “distinct processes”: – that of Neoclassical stationary equilibrium which describes an economy of pure equal exchange based on marginal utility, and that of the Marxian critique of political economy based on the political antagonism of capitalist accumulation. This is so because a theory based on pure exchange leading to equilibrium views the economic system as one in which “prices” – the rate of exchange of goods, where supply meets demand – reflect the equi-valence of the determinant of prices, whether this be marginal utility or labour-power, whereas a theory based on political antagonism cannot regard prices as signifying the “equivalent values”, either objective quantities (labour-power measured by time) or rates of change of subjective estimations (marginal utilities), prescribed by the Law of Value of both Classical and Neoclassical Political Economy.

Differently put, equilibrium theory deals with equivalent values (whatever it is that is being “priced” for “exchange”) whose underlying “sub-stance” is “utility” because its “prices” are all relative to the utilities exchanged within the equilibrium system of exchange as defined, and cannot be determined until all exchanges have been completed. Furthermore, the axiomatic condition of perfect or pure competition prevents individual market participants from entering combinations or from changing production functions so as to obtain an advantage over other market participants. In complete contrast, Marxian theory treats the economic system as one in which political antagonism determines prices and therefore no independent market mechanism can fix prices as the exchange rates of equivalent values. Neoclassical equilibrium theory and the Marxian critique of political economy cannot be regarded as “distinct processes” except in the sense that they deal with subject-matters that are categorically different and therefore incommensurable and incomparable.

The all-important point that is being made here is that once we exit the axiomatic conditions of equilibrium theory and we allow market participants (a) to effect changes to production functions and (b) to co-operate selectively to the detriment of others, then market prices are no longer determinable in accordance with the given utility schedules of market participants because these no longer act as “equals” in terms of their production functions and their market power. In neoclassical equilibrium theory it is the axiomatic “goal” of equilibrium that determines “prices” – so that these “prices” are necessarily “relative” to the constraint of equilibrium axioms that ensure the formal equality of market participants. (Tony Lawson, in the essay cited above, makes this perceptive point.) But once the axioms of the “atomicity” and formal equality of market participants are removed, then the determination of market prices is no longer possible because there can no longer be an “equilibrium” in what has become an economic system whose “prices” are affected by political conditions and antagonisms that are not amenable to “measurement”.

Yet, whilst he clearly contends here that the “economic system” already contains the internal “force” or “source of energy” that will “disrupt any equilibrium that might [temporarily] be attained” and degenerate into periods of profound instability and crisis, Schumpeter is also equally adamant that it is possible to theorize positions of “equilibrium” or “tranquility” (Joan Robinson’s preferred term, in The Accumulation of Capital) during which the behavior of “the economic system” is scientifically predictable or stable and can even be said to be “in harmony”. Whilst he wishes to construct “a purely economic theory of economic change” that relies on “endogenous” rather than “external factors”, Schumpeter still insists on the need to differentiate this “purely economic theory” from the more “static” theory of economic equilibrium as a “distinct process”, even though the two “processes” are quite evidently not only “distinct” but also in fact categorically inconsistent!


Schumpeter therefore bases himself on a dual typology of “economic science”: a “Statik” science represented by orthodox Neoclassical Theory as the “scientific” attempt to systematize empirical observations about “the economic system” founded exclusively on the empirical reality of “market exchange and pricing” that must lead to a state of equilibrium – which is why he insists that the economy moves from equilibrium to equilibrium; and a “Dynamik” science capable of being “a purely economic theory of economic change” founded on the fact that the capitalist economy seems to be able to trans-form itself and, in so doing, go through a wave-like or “cyclical” motion or “evolution” that propel[s] the economic system from one equilibrium to another”, - a “propulsion” not due to “external factors” unconnected with the scientific operation of the economic system, but much rather to the fact that


the economic system [itself] generates the force which incessantly transforms it….a source of energy within the economic system which would of itself disrupt any equilibrium that might be attained


Apart from the fact that “external influences” could be hypothetically the ultimate cause of capitalist “disturbances”, it remains true for Schumpeter that


practically all the phenomena, difficulties, and problems of economic life in capitalist society… as well as the extreme sensitiveness of capitalism to disturbance, would be absent if productive resources flowed every year through substantially the same channels toward substantially the same goals, or were prevented from doing so only by external influences, [Business Cycles, p.83]


It follows therefore that any economic theory that limits itself to the task of describing or classifying or merely analyzing this “circular flow” (Kreislauf) of economic activity would not only fail to account for the “disturbances” (Storungen) and for “all the phenomena, difficulties, and problems of economic life in capitalist society”, but it would also fail to account for the actual combined “quantitative growth [Wachstum] and qualitative development [Entwicklung]” of the capitalist economy and society, that is to say, it would not account for capitalist accumulation. Both Classical and Neo-classical equilibria represent only a “circular flow” (Kreislauf) of goods exchanged, because in a state of “pure competition” (reinen Wettbewerbs) market exchange leads eventually to the exhaustion of any “profits” or “surpluses”, and therefore of any “growth” or “development” or “evolution” or indeed even “crisis”, that may exist initially when the economy is in dis-equilibrium.



Following Marx in opposition to Walras, Schumpeter maintains that the economic system is characterized by two “distinct processes” that generate opposing forces, one of which guides it toward equilibrium (what Marx called “simple reproduction”) and one that pushes it out of that position (Marx’s “expanded reproduction”). In these premises, the Law of Value shared by both Neoclassical equilibrium theory and  Classical Political Economy necessarily entails, at least theoretically, the inevitability of economic “stagnation” – the former because aggregate supply must equal demand until no further profitable exchange is possible (this is the outcome of Walrasian tatonnement), and the latter because competition among capitalists and competition for higher wages from workers will eliminate all possibility of profit arising from the exploitation of workers - as Schumpeter consistently and validly argues throughout his work. (This point is discussed at length in the next section.)



No doubt, the fact that Schumpeter is able to mention Walras and Marx without pointing out the categorical incompatibility of the two approaches (the “distinct processes”) to economic theory testifies to Schumpeter’s own lack of dialectical comprehension of the fundamental politico-philosophical and even onto-epistemological concepts involved. Even so, however, there can be little doubt that Schumpeter had some idea of the difficult issues that capitalist accumulation posed for the development of a “purely economic theory of economic change”, as his attempts at conceptualizing these issues show quite clearly. Let us look closely at how Schumpeter engages in this difficult conceptual exercise.

The first fundamental issue that Schumpeter addresses for his entire monumental theoretical effort in economic and social theory is contained in this question:

[H]ow does an economy make the transition from one level - which itself was viewed as the final point and point of equilibrium - to another level? This question takes us to the very essence of economic development.[468]

To this fundamental question, Schumpeter gives the following answer – an answer consistent with and borne out in all of his subsequent work:

[469] This [present work, the Theorie] is an attempt to present a theoretical analysis of development, of its mechanism, in the form of a scheme to which the facts of development would generally conform. We look first at a general cause for the changes in the fundamental structure, i.e. in the level of the circular flow. We locate this cause in the fact that - as we expressed it - new combinations get driven through. We saw that when new combinations are carried through this can be attributed to the actions of a particular type of economic agent whom we called an "entrepreneur".

Now, let us sift carefully through this statement and state exactly how and where Schumpeter has gone wrong in seeking to tie the two “distinct processes” in economic analysis. First, Schumpeter clearly assumes that there is such a thing as “a state or level of equilibrium”. His question then is how to account for changes in the “level” of equilibrium. And Schumpeter claims to have found the cause for this change in “levels” of equilibrium in
the actions of a particular type of economic agent whom we called an ‘entrepreneur’ [who is responsible for]… the new combinations [that] cause…the changes…in the level of [equilibrium or] circular flow.

But the difficulty with this reasoning is that the notion of equilibrium applies to a theory of the economic system in which any “changes” in “combinations”, any “new combinations”, are instantly “semaphored” or communicated to all other economic agents because these “changes” are not changes occurring in time but are rather changes in the logical structure of the equilibrium level! In equilibrium theory the “economic agents” do not make any “changes” at all because all market participants are absolutely axiomatically, formally and logico-mathematically “equal” due to the axiomatic conditions of “pure competition” in which “equilibrium prices” are fixed and determined by the theory! What Schumpeter is proposing here, instead, is a theory (one of economic change) in which prices are no longer determined by the formal, axiomatic, logico-mathematical “equality” of market participants, but rather by one specific market participant capable of causing or “carrying out new combinations” or “innovations” – Schumpeter’s entrepreneur.

But in this case the fundamental condition of equilibrium theory – the condition of “pure competition” – no longer obtains! Schumpeter has introduced into the analysis, entirely illicitly, a new condition that allows the entrepreneur to change autonomously and independently “the rules of exchange”. But if this is the case, the “prices” that now obtain in “the market” as a result of the entrepreneur’s actions can no longer be “equilibrium prices” and indeed can never be “equilibrium prices” because the economic system can never be said to be in “equilibrium” for the simple reason that “market prices” are now determined not through “pure exchange” or “pure competition” but rather by the political conditions that allow entrepreneurs to change “the rules of competition” independently of other market participants!

Please note that here we speak of “political conditions” and not, as the critics of equilibrium theory from Sraffa to Joan Robinson and beyond do, of “imperfect competition” because (a) such an expression suggests that “perfect or pure competition” is possible and indeed conceivable (!), and (b) because the “imperfection” is not due to “transaction costs or frictions” but rather to the ability of market participants to combine politically to affect prices. As we are about to show, not only is pure competition not possible – it is indeed also inconceivable because it is an aporetic or antinomic notion that contains in itself the seeds of its own destruction.

That Schumpeter was aware of these conceptual difficulties afflicting his theory of Entwicklung in its relation to Neoclassical equilibrium theory is made utterly transparent by the following revealing discussion in the Theorie in which Schumpeter comes very close (“almost”!) to identifying the incomparability of the two “distinct processes”:

Pure economic laws describe a particular behavior of economic agents, whose goal is to reach a static equilibrium and to re-establish such a state after each disturbance. Pure economic laws are similar to the laws of mechanics which tell us how bodies with mass behave under the influence of any external "forces", but which do not describe the nature of those "forces". In mechanics it is assumed that bodies [that is, objects without a “self” or” will” or “freedom”] when no force [that is, unless a force] affects them from the outside, do nothing of themselves and do not produce even a single new phenomenon of a mechanical nature. In the same way pure economics provides us with formal laws as to how the economy is [that is, economic agents are] shaped under the influence of conditions coming from the outside. It shows [471] how the economy [that is, economic agents, now only “bodies”] responds to changes in those conditions coming from the outside. Therefore, in such a conception, pure economics almost by definition [axiomatically] excludes the phenomenon of a "development of the economy from within".

No! It is not “almost by definition” that “pure economic laws” exclude “a development of the economy from within”: it is indeed “by definition” (!) that they do so! And this is because the market participants of equilibrium theory, its “self-interested in-dividuals”, are not allowed axiomatically to act as “economic agents”! Schumpeter’s confusion is shown quite clearly when he states above that

[p]ure economic laws describe a particular behavior of economic agents, whose goal is to reach a static equilibrium…


Not at all! The “self-interested in-dividuals” of economic theory do not and can never have any “economic goals” of their own and most certainly not the goal of reaching equilibrium (!) because their “economic goals” are fixed axiomatically “from outside” (Schumpeter’s own expression above!) in their “utility schedules” and cannot be changed autonomously if “equilibrium prices” are to have any meaning at all! In equilibrium theory “economic agents” are not “agents” at all because the “goal” of equilibrium is not “theirs” but is rather set “from outside” as an axiomatic condition of the analysis. It is not that economic equilibrium exists because its market participants desire it: it is rather that the desires of market participants, their utility schedules, adjust to the axiomatic condition that there be such an equilibrium! (Again, this is a point that Tony Lawson highlights genially in his work and that Frank Hahn acknowledged.) In reality, the “self-interested” nature of economic agents, hence their self-hood, contradicts their “atomicity” in the sense that an “atom” like a “body” in mechanics cannot have a “self” capable of acting but can only be acted upon because its “free-dom” (its “room to manoeuvre”, as Max Weber called it) is limited and defined by the equal and opposing “free-doms” of all other participants – which is why we have chosen to describe these “freedoms” as “free-doms”, that is, as formal “dom-ains”.


As Schumpeter comes very close to perceiving, what makes these self-interested economic agents passive “atoms” or “mechanical bodies” in equilibrium theory - rather than (self-conscious, active) “agents” -, is the fact that their self-interests, their individual “free-doms”, are limited by the equal and opposing “free-doms” of all other agents - so that they are reduced indeed to the unconscious mechanical role of “bodies” as in mechanical physics. The “economic agents” of equilibrium theory are not “agents” at all because they are restrained from inter-acting with one another as a result of the axiomatic definition of “pure competition”! Equilibrium is the state most consistent with the formal pure “equality” of these economic agents: their “free-dom” is in reality only “inertia”, that is, the power to remain in the same state unless acted upon by an external force. In “pure competition” the only state possible is one of equilibrium because the purity of competition means that no advantage can be gained by individual agents through “innovation” either singly or in concert. And therefore there cannot be any profit in the theory of equilibrium:

All the more controversial is the proposition that entrepreneurs' profits and related gains which arise in the disequilibria caused by the impact of innovation are, as far as the business process itself is concerned and apart from consumers' borrowing, the only source of interest payments and the only "cause" of the fact that positive rates of interest rule in the markets of capitalist society. This means that in perfect equilibrium interest would be zero in the sense that it would not be a necessary element of the process of production and distribution, or that pure interest tends to vanish as the system approaches perfect equilibrium. Proof of this proposition is very laborious 39, because it involves showing why all the theories which lead to a different result are logically unsatisfactory, (Business Cycles, p.125. See also CS&D, p.131 on “The Obsolescence of the Entrepreneur”.)



Equilibrium is a “frozen or stationary state” because by axiom, by definition, no single agent is allowed to act upon or co-operate with other “agents” or the economic system so as to gain an advantage over others. This makes profit and interest impossible. And yet this is exactly what Schumpeter allows his “entrepreneur” to do! But to do this is to move from the theoretical logico-mathematical framework of equilibrium theory to a new political framework of analysis in which “equilibrium prices” are no longer fixed axiomatically as in equilibrium theory but rather “politically”, that is, through the political power possessed by capitalist entrepreneurs to impose their “innovations” or “new combinations” on the rest of society or, if you like, on “the market”.


In summary, Schumpeter’s attempt to derive “a purely economic theory of economic change” has led him to refute the theoretical legitimacy of equilibrium theory, because of its axiomatic inability to change, and also of his own “pure theory of economic change”, because it shows that economic change cannot be explained by a “purely economic theory”. The Law of Value has finally been exposed for what it is – one of the biggest intellectual frauds in the history of humanity!


Both in the Statik and in the Dynamik economic agents are motivated by self-interest bounded only by the self-interests of all other economic agents. But only in the Dynamik does this profit-seeking intention become the reality of profit-making. The Statik therefore resembles a schema entirely analogous to the laws of mechanics in the sense that its atomistic “self-interested individuals” are restrained from acting upon “the laws of economics” by the equally self-interested actions of other market participants. Consequently, the economic agents of the Statik resemble entirely the “bodies” of mechanical physics in that they are “acted upon” by the axiomatic laws of economics but do not themselves act or initiate anything of their own free will (Wille) or volition (Willkur). Least of all are they allowed to act in concert or to do anything that may gain them an “advantage” over other competitors because this would infringe against the axiom of pure competition.


In other words, the economic agents of the Statik are not “agents” at all because they merely react to the “external forces” exerted by the equal self-interests of all other economic agents which must, by definition and axiomatically, result in “economic equilibrium”! Because of its “in-dividuality” or “a-tomicity”, the “self-hood” of the Statik economic agent is reduced to sheer mechanical automaticity by the equal and opposing self-interests of all other individuals. The “freedom” (of will and of choice) of the individual in the Statik is curtailed and determined or confined or limited by the equal and opposing “freedoms” of other economic agents. Thus, the individual freedom of the “self” becomes a mere mechanical “free-dom”, a mechanical inertia, that is to say, the power to move subject to the dom-ains (free-doms) of all other economic individuals. The mechanical interaction of the self-interests of economic agents in the Statik reduces each selfish individual to the status of a mere “body”, that is, to the opposite of an “agent”!

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