Whither Socialism? poses as an attack on the possibility of market socialism.footnote＊ But that pose is superficial. The central object of Stiglitz’s attack is the conventional general equilibrium model of twentieth-century economic theory, fathered by the French economist Léon Walras in the late nineteenth century, and brought to term by Kenneth Arrow and Gérard Debreu, with their proof of the existence of a ‘Walrasian equilibrium’ in an abstract mathematical model of a private-ownership economy, in 1954. The Arrow– Debreu model provides a rigorous foundation for three important views regarding capitalist economies (ones where ownership of resources and firms is private, and economic activity is market-directed): first, that it is possible for markets to engender a general economic equilibrium, a set of trades between economic actors in which every firm demands resources and labour and sells outputs in a profit-maximizing fashion, subject to its technological constraints, and every consumer purchases goods and supplies labour and other resources to firms in that way which maximizes her utility, subject to
These three claims form the theoretical basis of the view that a private-ownership market economy is an economic device sufficient to realize the goals of any rational humanitarian. There is, furthermore, an irony: in a general competitive market equilibrium, each economic actor is concerned only with itself. Firms need not try to do their best for society, they need simply behave so as to maximize the wealth of their shareholders, and no consumer need worry about what others need, he may simply act to maximize his own preferences, subject to his economic (budget) and technological (labour supply) constraints. Social efficiency, in the Paretian sense, is the consequence of the pursuit of individual self-interest.
Stiglitz’s book is a sustained attack on all three claims of the Walrasian world-view, but mainly on the second and third claims, the two welfare theorems. He argues that market equilibria of private-ownership economies are not Pareto-optimal (against the fwt), even in a ‘second-best’ sense, and that efficiency (i.e. Pareto optimality) cannot be separated from distribution, contra the claim of the swt. He does not argue that the theorems of Arrow and Debreu are false, but rather that the hypotheses of those theorems do not describe real-world capitalist economies. Hence, the theorems are inapplicable.
The essential reality which the Walrasian tradition ignores, according to Stiglitz, consists in the uncertainty which pervades economic activity: when firms hire workers, they are uncertain what kind of labour they will get; when they write contracts with other firms for the future delivery of resources and commodities, they are uncertain about how well their expectations for delivery of goods of a certain quality will be fulfilled; when firms plan large investments, they are uncertain about future states of the economy, in particular, for the demand of their output; when banks lend to borrowers, they are uncertain as to whether they will be repaid; when individuals make long-range plans, they are uncertain about the future. The reality of uncertainty, Stiglitz argues in great detail, vitiates the hypotheses of the two welfare theorems.
But why should this constitute an attack on market socialism? Because, Stiglitz says, the Lange–Lerner model of market socialism, constructed in the 1930s, was based on the Walrasian world-view. In essence, Lange and Lerner put too much faith in markets and prices—they were too ‘neoclassical’. They believed that social planners could bring about efficient and equitable allocations of resources by asking firm managers to respond to price signals, initiated by the centre. They believed, in particular, that prices carried all the information necessary to direct economic agents to a Pareto-optimal allocation of resources. But the consequence of the incompleteness and asymmetry of information in real economic environments, Stiglitz argues, is that actual economic agents must use all kinds of non-price information. The claim that actual capitalist economies can arrive at Pareto-optimal allocations when economic actors simply respond optimally to prices is wrong, and likewise is the claim that socialist firm managers can engender an efficient resource allocation by responding to price signals from Lange’s central planning bureau. Stiglitz’s criticism of the Walrasian world-view is Hayekian: what economic actors really do in a market economy is much more complex than what they are postulated to do in the Arrow–Debreu or Walrasian model. They evaluate all kinds of information which cannot conceivably be communicated to central planners about the complex specifics of their micro-environments, including their perceptions of demands or potential demands of consumers, of the quality of the available labour, and of the reputations of suppliers with whom they must deal. Planners cannot possibly capture the correct response of a firm manager to this informationally incomplete and complex environment by instructing him to maximize profits against some postulated set of prices, or more generally to choose that level of output which equates marginal cost to price.