General Equilibrium and factor shares

Note:   I want you all to be highly critical of my posts on factor shares – and where you can throw literature at me.  I wrote a bunch of posts in a single day based on one book (and some prior knowledge), I have no appeal to authority here and would love to have your ideas thrown in there 🙂

I was surprised that there was a chapter focused solely in general equilibrium – and not GE in general, but competitive, neo-classical, GE.  I was especially surprised as such a model isn’t really “built” for distributional analysis – economists often say we need a different framework to do distributional work!

It is a neat chapter though, so let’s pop it in here 🙂

To quote:

The quality that designates an economics as neo-classical is the derivation of agents’ supplies and demands from particular types of maximization problems.  It is assumed that each consumer’s domain of choice, preferences, and assets, and each producer’s technology, are exogenously given, as are the institutions allowing economic interaction to occur through voluntary contracts.  On this basis, every consumer maximizes utility subject only to a budget constraint, and every producer maximises profit constrained only by technology.  A set of prices that makes their choices compatible is a general equilibrium.

Hold on, you may say, those assumptions are not realistic.  This is true.  However, remember we can’t observe the types of choices people are making – in that sense we can use an idealized world that incorporates certain types of choices as a means of comparison.  The way our assumptions fail will tell us something about how our model does not fit the data.  Although even in this it is important to be careful, this is the chain of reasoning used by the author to help discuss distributional issues (and their interpretation) using a GE framework.

Eg:

Nevertheless, there are some definite conclusions on distributional matters.  For example, the theory implies that in an equilibrium pure profits will be zero.

….

[However,] it means that any observed profits over and above interest must derive from those phenomena from which Arrow-Debreu theory abstracts.

Ina similar light to last times discussion of Neo-Ricardian models, and the high level of abstraction and lack of conclusions we have the following note in the essay:

Obviously, the less abstract the assumption are, the more concrete the propositions will be that can be derived

However, it isn’t all positive – if there are institutional features we treat as exogneous, which are in fact an endogenous part of the model.  This leads to the point:

Neo-classicism provides nothing by which this problem maybe resolved; not surprisingly, the theory we have considered remains at a high level of abstraction

This mean, among other things, that Walrasian analysis cannot shed much light upon the distribution of income and wealth in any actual capitalist economy.

Nevertheless, it is also true to say that, for those who take the neo-classical perspective at all seriously, it provides an invaluable standard by which clear thinking can be enhanced and alternative theories evaluated.

Conclusion

I would note here that the discussion on GE models, and their modern use as CGE models, corresponds to my own view.  We ask small conditional questions, given a transparent set of assumptions, and a view on the inductive relationship between this idealised system and reality.

In order to answer questions about “distribution” we need to tackle specific issues relative to our analysis, asking specific question about distribution.

It is for this reason I strictly favour analysis of household level data for discussing points on distribution, rather than analysis of factor shares.  If I was to build up larger “groups” than households to discuss, I can tie them together on shared characteristics in this framework – compared to the arbitrary and loaded combinations of “parts of individuals” that occur with factor work.

This has been fun, thanks for putting up with me rattling off a bunch of points I wrote up going through this book in a single day – I will use the comments you’ve put in your posts to challenge my own priors, which no doubt have come through in my writing here 😉

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