The GME Replacement Theory: Part I

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General market equilibrium (GME), pioneered by Walras and infused with the  genius of Arrow and Debreu, is a towering scholarly achievement that has long provided a valuable model of rational price-mediated exchange. Like the succession of beautiful theories in physics, however, it carries seeds of its own demise as a general account of actual behavior. Moreover, as in physics, the nature of its gathering inconsistencies with important evidence points toward the more powerful replacement theory to come. A tip-off with respect to the future of stabilization-relevant macroeconomics is Keynes’s shrewd rejection of his Second Classical Postulate, the equality of wages and the marginal disutilities of work. That pillar of neoclassical thought is the Achilles heel of GME analysis.

Replacement theory. Rethinking the Second Postulate has led to microfounding nonconvex Worker Exchange Relations, the keystone of generalized-exchange macroeconomics – the replacement theory for GME featured in this website.  Readers, newly acquainted with that analytic tool, may be surprised by its real-world relevance. They shouldn’t be. In commonplace LEV (large-establishment venue) circumstances, workplace supervision of on-the-job behavior is badly damaged by inherent information asymmetry. Ineffective oversight has compelled profit-seeking firms to turn to human-resource management (with its emphasis on equitable treatment) that experience indicates pushes modal OJB toward consistency with firm objectives. Scaled-up, highly specialized production aligns with that practitioner-familiar approach to motivating employees. Confining workplace analysis to economist-familiar market governance became, as the 20th century progressed, an increasingly debilitating mistake. For starters market centricity is not compatible with the downward wage rigidity (DWR) and pure wage rent (PWR) that are necessary for the rational suppression of labor-price recontracting and, more generally, the adequate explanation of the full range of macro evidence.

The Great Fact. It is worthwhile to elaborate a bit on when and how LEV workplaces seized control of a substantial share of labor pricing and use. The growth literature’s timeline of living standards (output per capita) over thousands of years provides useful context. (See for example Jones (2002).) It is known that it took some 12,000 years before the ancient Greeks (around 1000 BC) roughly doubled the productivity associated with origin hunting/gathering, with much of the gains going to a small slice of the population. We also know that near-zero, narrowly distributed annual global progress persisted for nearly all of the subsequent three millennia.

For almost the entirety of human history, near subsistence worker living standards were the salient macro problem. As late as early nineteenth-century Britain, the time of Jane Austen’s enduring stories of English manners, the typical Englishman was a farm laborer who consumed some 1500 calories a day – less than modern hunter-gatherer tribes in New Guinea and little better than earlier experienced by a Roman slave. Malthus’s model of intertwined subsistence and the urge to procreate (or, in the subtler version, the economic advantages of children) builds on the inadequate productivity growth that dominated economies up to the industrial revolutions that took hold in the 19th century. Those seismic shifts, notably requiring large, bureaucratic firms to facilitate the aggressive pursuit of scale that enabled the huge transfer of labor from agriculture to manufacturing, have broken most of humanity out of the Malthusian trap. Complex corporate forms (extended to high-productivity services and other nonmanufacturing) became home for a growing share of rational labor pricing and use, cumulatively diminishing the dominance of market exchange.

The 19th-century pick-up in living-standards growth began a significant acceleration that, in the 20th century, exploded upward. A remarkable thirty-fold increase was recorded in just five generations. Economic activity during the past century and a half, the tiny tip of human experience, became profoundly different from what it had been for thousands of years. That nearly all global progress in living standards has occurred in a single burst is named the Great Fact. The massive change becomes especially relevant to the GEM Project when coupled with Alfred Chandler’s  insightful research (1977, 1990, 1992).

In Chandler’s narrative, trend productivity growth was transformed by increasing returns associated with the spread of large, bureaucratic firms, beginning in North America and Europe and dating from the late 1800s. The now-ubiquitous hierarchical enterprises were enabled by creation of railroad, steamship, telegraph and cable systems, reducing delivery times and uncertainties for large flows of goods through national and international economies. The wave of uncomplex technological innovations exploiting the potential for high-volume, high-speed production was named the Second Industrial Revolution. From Chandler et al. (1997, pp.12-13, italics added): “Entrepreneurs and firms in these nations [U.S., Britain, Germany] pioneered the commercialization of new capital-intensive technologies by making the investments and creating the new corporate forms required to fully exploit their profit-making potential.”

That an increasing and now dominating share of global GDP is associated with large, bureaucratic firms is at the heart of the Great Fact. Unhappily, macro theorists never got the message that such establishments are home to optimizing activities that fundamentally differ from what occurs in their small, uncomplex counterparts. Production processes that intensively exploit scale and specialization, creating powerful combinations of size, high productivity, workplace information asymmetries, job routinization, market rents, and the criticality of voluntary employee cooperation, today coexist with market-centric businesses that are much more simply organized and motivated.

Chandler’s new corporate forms create an activity set (workplace exchange) that the two-venue model integrates with mainstream market-centric thinking. Macro theory has been enriched by an additional class of equilibrium, i.e., rest periods in the space of optimizing workplace decision rules, that frequently dominates market equilibrium.

Next week’s essay wraps up this brief description of the replacement-in-waiting for the long dominant but now inadequate general-market-equilibrium macroeconomics.

Blog Type: Wonkish San Miguel de Allende, Mexico

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