Value and exchange.

• Author: Kohn, Meir
• Position: Shift away from Hicks-Samuelson Economic theory

Economics is at a crucial juncture. The research program that has guided economic theory for some six decades is at an impasse, and a new and different research program is emerging. The new program grows out of a very different vision of the economic process. This vision suggests a very different type of economic theory offering a different explanation of how the economy works and different policy advice. The implications for the future of economic research and for the conduct of economic policy could not be greater. The purpose of this article is to explain this momentous change and to explore its likely consequences.

The Impasse in Economic Theory

To understand the current difficulties of economic theory, we need to understand the goals of the research program that guides it. That program has its origins in the work of two great economists--Paul Samuelson and John Hicks--and its goals grew out of theirs.

Samuelson's goal was to reformulate economic theory in the language of mathematics (Samuelson 1947). He believed that this would promote greater clarity and precision. And he hoped that mathematization would lead to a formal unification of the whole of economic theory. He believed this possible because he thought that all of economics could be formalized using essentially the same mathematical approach.

While Samuelson's goal was formal unification, Hicks's goal was substantive unification. Hicks believed that much of economies could be understood in terms of the theory of value--the part of economies that seeks to explain the pattern of relative prices in an economy and the resulting allocation of resources (Hicks 1939). The construction and refinement of the theory of value had been the principal project of economies since Ricardo, and its major components were largely in place by the time of the marginalist revolution of the 1870s. Its most ambitious formulation was the general equilibrium theory of Walras and Pareto that addressed simultaneously all of the markets of an economy and their interconnections. It was within this Walrasian framework that Hicks hoped to unify much of economic theory. (1)

Samuelson's goal and Hicks's, while different, proved highly complementary. Samuelson's approach was to reformulate a piece of economic theory as a set of equations that jointly determined the economic variables of interest. It was essential to his method that this set of equations could be interpreted as describing an equilibrium of the system in question. The theory of value was especially amenable to this method because the concept of equilibrium was at its very core. Given the relative case of mathematizing the theory of value, it was then only natural to attempt to mathematize other parts of economic theory by reformulating them as extensions of the theory of value. It turned out that advancing Hicks's goal was a natural way to advance Samuelson's.

The connection between mathematization and the theory of value was initially purely opportunistic: Samuelson himself denied any necessary connection between the two. (2) Over time, however, substantive unification proved to be a more powerful idea than merely formal unification. The triumph of substantive unification is nicely illustrated by the history of macroeconomic theory. The original mathematization of Keynesian theory by Hicks and Modigliani--endorsed enthusiastically by Samuelson--relied on a concept of equilibrium quite different from that of the theory of value and indeed inconsistent with it (see Kohn 1986). The equilibrium assumed by the theory of value is one in which all opportunities for mutually advantageous exchange are being realized. In contrast, equilibrium in the Keynesian sense can involve widespread involuntary unemployment--hardly a situation in which all opportunities for mutually advantageous exchange are being realized. This inconsistency with the assumptions of the theory of value--described as a "lack of microfoundations"--led to increasing discomfort among theorists with the Hicks-Modigliani model. The new classical theory of Lucas, Sargent, and Barro eventually resolved the inconsistency, but it was in effect more a repudiation of Keynesian theory than a formalization of it.

Increasingly, then, adherents of the Hicks-Samuelson research program came to see the theory of value as being economics: they saw the two as identical and indistinguishable. (3) This view, which has come to dominate economic theory, goes far beyond the ideas of Hicks and Samuelson themselves. (4) I will call it the value paradigm. (5)

The Hicks-Samuelson research program today is in trouble. Of course, in terms of its dominance of economic theory, it has been an unqualified success. The "job description" of an economic theorist today is the elaboration of mathematical models. Arguments not couched in mathematical terms are dismissed as lacking in intellectual rigor. (6)

The devotion to mathematics and the adherence to the value paradigm have not been without cost. Mathematization has promoted a kind of sterile armchair theorizing. Many theorists see little need to be acquainted with the details of real-world economies: almost exclusively, they study each others' models. (7) Both mathematization and the value paradigm have induced a significant narrowing of the theoretical agenda: economic phenomena that do not lend themselves to mathematical treatment or that are impossible to reconcile with the assumptions of the theory of value have become "uninteresting."

While the costs of the Hicks-Samuelson program are clear, its benefits have been elusive. It is difficult to see the payoff to this huge intellectual effort beyond some successes in the theory of asset pricing (which really falls within the theory of value proper). In such areas as money, fluctuations, and growth, the mathematical theory of value has contributed confusion rather than illumination. (8)

Most disappointingly, the Hicks-Samuelson research program has done virtually nothing to assist in the formulation of economic policy. On the great issues of the day, it has been virtually silent. The major improvement in the management of the domestic monetary system that occurred in the 1980s was the result of trial and error on the part of practitioners: economic theory contributed virtually nothing. On transition and economic development, modern economic theory has again had nothing useful to say (see Easterly "2001). This is not to suggest that economists as individuals have made no contribution. However, their advice has relied more on economic common sense than on high theory. It is difficult to see how a 19th century economist, or even one from the 18th century, would have made a less useful policy adviser than a tooled-up modern theorist.

The failings of the Hicks-Samuelson research program have hardly gone unnoticed. The principal response of mainstream economics has been increasingly to turn away from this program in favor of an entirely different one--the application of econometric methods. While econometrics was developed originally to test or to estimate the models devised by theorists, today's applied econometrics is largely atheoretical. (9) Applied econometrics rather than mathematical theory is today the high-status field in the best graduate schools and the one that attracts many of the best minds. (10)

Because the applied econometrics program is firmly empirical it has been much more fruitful. (11) Some interesting work has focused on an area particularly refractive to the Hicks-Samuelson approach--the causes of economic growth and development. Shleifer and Levine and their respective collaborators have used cross-country comparisons to explore the significance for growth of legal and financial institutions. (12) This work is highly suggestive, but it is ultimately limited by its atheoretical nature. Yes, financial and legal institutions matter--but why? For an answer, we need a theoretical understanding of the processes at work. More generally, as this example shows, atheoretical applied econometrics avoids the problems of economic theory but it does not solve them.

This brings us to a different response to the theoretical impasse. Instead of ignoring modern economic theory, a growing body of work has sought to repair its defects or to develop alternatives. Such work includes the new institutional economics, transactions cost economies, Austrian economies, public choice theory, law and economies, and the economies of information. Important contributors include Cease, Alchian, Buchanan, Demsetz, Jensen, Kirzner, North, Olson, Williamson, Nelson, Romer, Akerlof, Stiglitz, and many others. The literature is too vast to even attempt to summarize here. (13) However, there are some important common themes that distinguish much of this work from the Hicks-Samuelson orthodoxy. Often it is concerned less with relative prices and allocation and more with information and institutions. Much of it focuses not on the outcome of the process of exchange but on the process itself.

I shall argue that these differences are fundamental and that they imply a different way of thinking about the economy. I will call this view the exchange paradigm. (14) The exchange paradigm provides a framework for economic theorizing very different from that of the value paradigm. The theory that results produces a very different positive economics, particularly when it comes to the process of economic growth. It also has very different normative implications. I will explore each of these in turn. While some of the new theoretical work explicitly repudiates the value paradigm and its assumptions, much of it does not. Rather it seeks to extend the value paradigm or to repair its defects by introducing new elements. I will argue that such "hybrid" theorizing is a mistake and that it leads only to confusion. I will conclude by exploring the implications of the exchange paradigm for the future direction of...