Hayek, Lindahl, Hicks and neo-Walrasian equilibria
Hayek’s attack reflects an important novelty, the birth of the belief that it is possible to maintain the supply-and-demand approach while abandoning the defective conception of capital as a single value factor, through a shift to a treatment of each capital good as a distinct factor with its given endowment.
The different notion of equilibrium is sketched by Hayek in 1928 (see Gehrke 2003), but Lindahl (1929) is the first to develop it consciously as an alternative to value capital and long-period equilibria. Differently from Walras, both Lindahl and Hayek realize that the given vectorial endowment of capital goods implies that they are determining a very-short-period equilibrium, hence equilibrium prices may well be destined to change rapidly, and therefore agents must be admitted to take expected price changes into account in determining their equilibrium choices. This is done either by assuming a simultaneous determination of present and future equilibrium prices and quantities (a complete-futures-markets or perfect-foresight intertemporal equilibrium), or by introducing subjective and non-uniform expectations (temporary equilibrium). These notions of equilibrium are called Walrasian or neo-Walrasian, but they differ from Walras owing to their acknowledged very-short-period nature and admission of non-persistence of the relative prices that the equilibrium determines.This new approach is made widely known by Hicks’s Value and Capital (1939) where the temporary equilibrium method is advocated. Importantly, the justification Hicks provides for the shift misrepresents Marshall’s static long-period equilibrium as a s ecularly stationary equilibrium (in the latter the rate of interest and the quantity of capital are endogenously determined so as to induce zero net savings and therefore no given quantity of capital appears among the data of equilibrium; in the former the quantity of capital is given and stationariness is assumed only for simplicity) and therefore too remote from actual economies; this allows Hicks to avoid a discussion of the true role and deficiencies of capital the value factor.
The misrepresentation of the traditional notion of equilibrium as secularly stationary has dire consequences on the subsequent capacity of economists to understand previous economic theorists: the notion of normal position as distinct from steady growth is no longer understood, to this day many economists appear unable to grasp that the speed of variation of the composition of capital is sufficiently higher than the speed of the changes brought about by accumulation as to allow neglecting the latter changes in order to determine normal prices. Other aspects of the book are also perplexing. Hicks admits the need for instantaneous equilibration but is unclear on how to justify (after Keynes!) a very quick adaptation of aggregate demand to full-employment output; he avoids discussing the insufficient factor substitutability associated with a given “form” of capital, admitted by him in earlier writings, or the indeterminacy due to unknowable subjective expectations he had criticized in a 1936 review of Keynes’s General Theory. (He will admit these weaknesses subsequently in what amounts to a full recantation of the temporary equilibrium method, see Petri 1991.)The shift to neo-Walrasian equilibria is not intended to alter the marginalist view of how market economies work. In Hayek, Lindahl and Hicks one finds the same certainty as in Clark, Marshall or Wicksell that decreases of the rate of interest cause switches to production methods that require capital goods of greater value per unit of labour and therefore raise the flow demand for savings, ensuring stability of the savings-investment market; and that if real wages decrease, the demand for labour will rise, if not immediately for lack of substitutability, then through changes in the physical composition of capital over a succession of periods. The traditional marginalist factor substitution mechanisms are still believed to be operative although possibly over a sequence of temporary equilibria (or of periods of an intertemporal equilibrium): the traditional conception of capital is only apparently abandoned, it no longer appears in the specification of production methods nor of the economy’s endowment of capital, but traditional capitallabour substitution is still present (although now without foundation since no solid argument makes up for the official rejection of value capital) in the assumed stability of the labour market and of the savings-investment market.
Lindahl, Hayek and Hicks open the way to an argument by Arrow and Debreu (1954) that capitalistic production can be dealt with by the acapitalistic model of general equilibrium without any need for formal modification, through a reinterpretation of goods as dated, of the model as describing an intertemporal equilibrium over a finite number of periods, of prices as discounted prices, and of some of the given factor endowments in the initial period as capital goods produced before the date when equilibrium is established. Koopmans (1957) notes the implausibility of complete futures markets, which imply the absurd assumption that future generations are present in the first period to communicate their desires, but without concluding that this notion of equilibrium must be discarded. Debreu’s Theory of Value (1959) insists on the reinterpretability. No attention is paid to the fact that Maurice Allais had already developed the intertemporal-equilibrium model in the 1940s (with overlapping generations too in it) only to reject it as lacking sufficient persistency and incapable therefore of having the role of centre of gravitation of timeconsuming disequilibrium adjustments.
The 1950s witness the coexistence of the acapitalistic general equilibrium model in textbooks, of the intertemporal model in specialist articles, and of the traditional treatment of capital as a single value factor in applications. The persuasion slowly takes hold that there is no incompatibility between the traditional and the neo-Walrasian treatments of capital. Solow is representative: in an answer to Joan Robinson’s (195354) article that starts the Cambridge controversy in capital theory by asking in what units capital is measured, he admits problems with the notion of “quantity of capital” but argues that they can be surmounted through intertemporal equilibrium theory:
[T]he real difficulty of the subject comes not from the physical diversity of capital goods. It comes from the intertwining of past, present and future, from the fact that while there is something foolish about a theory of capital built on the assumption of perfect foresight, we have no equally precise and definite assumption to take its place. (Solow 1955-56: 102)
In the same years he proposes his one-good growth model and even bases econometric estimates on it.