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Equilibrium Illusion, Economic Complexity and Evolutionary Foundation in Economic Analysis

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Abstract

It is widely believed that an equilibrium framework based on simple models, such as the representative agent and bilateral bargaining, in a frictionless economy provides a consistent framework in micro, macro, finance, and institutional economics. However, equilibrium believes in self-stabilizing market and institutional convergence broken down when inherent instability and non-predictable uncertainty emerge under nonlinear and social interactions. Equilibrium illusions in economics and econometrics are pretty in math modeling but dangerous in policy decision. Known examples are the Frisch model of noise-driven cycles, the Lucas model of microfoundations, and the Coasian world of zero transactions. These models not only violate basic laws in science but also lack evidence in economic history. Their common problem is associated with linear Hamiltonian economics with symmetric information without history. Economies are dissipative systems in nature, characterized by symmetry breaking, information flow, a time arrow, and history. The many-body problem is fundamentally different from the one-body and two-body problem in mathematics. Both computational and natural experiments, such as a stock market crash and a transitional depression, reveal the severe limitations of equilibrium thinking and structural changes from evolutionary dynamics. The new science of complexity offers new tools of nonlinear dynamics and non-stationary time series analysis. Existing puzzles in equilibrium economics, such as persistent cycles, interruptive crises, market resilience, social movements, and organizational diversity, can be better understood by nonlinear dynamic models. Like the paradigm shift after Einstein in physics, the evolutionary perspective provides a general framework, while equilibrium models serve as its special cases, since the equilibrium picture is an approximation of economic complexity in a short-time window taken from a long-term historical current.

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  1. Ping Chen

    Present address: Center for New Political Economy, Fudan University, Shanghai, 200433, China

Authors and Affiliations

  1. China Center for Economic Research, Peking University, Beijing, 100871, China

    Ping Chen

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Correspondence to Ping Chen.

Additional information

This paper is based on the paper “Equilibrium Illusion and Evolutionary Foundation in Economic Theory” presented at the JAFEE (Japanese Association for Evolutionary Economics) annual meeting in Kagoshima on Sept. 23, 2007. The author is grateful for the inspirational discussions in the past with Paul Samuelson, Richard Day, James Galbraith, Finn Kydland, Edward Prescott, Steven Cheung, Gregory Chow, Ulrich Witt, Joseph Stiglitz, Kurt Dopfer, Yagi Kiichiro, Yuji Aruka, and the recent participants of the Kagoshima meeting.

This work was supported by Grant No. 07BJL004 from the National Social Science Foundation of China.

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Chen, P. Equilibrium Illusion, Economic Complexity and Evolutionary Foundation in Economic Analysis. Evolut Inst Econ Rev 5, 81–127 (2008). https://doi.org/10.14441/eier.5.81

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