The instability of a capitalist market economy: macroeconomic failures

In chapter 2, we examined traditional market failures in the light of microeconomic theory.

However, a more complete assessment of the ability of real-life markets to act as an ‘invisible hand’ cannot neglect numerous recurring ‘crisis’ situations of unemployment, inflation, external payments imbalances or underdevelopment, which do not appear to be immediately explainable in terms of the classic microeconomic market failures. These situations are manifestations of the ‘instability’ of capitalist market economies. ‘Instability’ here does not simply mean the failure of the economy to converge towards equilibrium but also the possibility that the economy may evolve along a non-optimal path from the point of view of efficiency and/or equity and may remain in such a non-optimal state.

These aspects of reality are difficult to model using general equilibrium theory – and, often, even with other existing microeconomic theories. Let us examine some of the reasons for this conclusion, focusing on general equilibrium theory.

It is difficult to believe that persistent mass unemployment, often experienced by market economies, is a voluntary phenomenon. Involuntary unemployment, however, cannot arise in models of general competitive equilibrium: if all markets are in equilibrium, the labour market will also be in equilibrium and any unemployment must be voluntary.

Microeconomic theories explain relative prices, not the absolute price level; they have never succeeded in modelling a monetary economy in a satisfactory way. For these reasons, they cannot take account of inflation.