In his Memoirs of an Unregulated Economist (1988, 61), George Stigler reports one of my favorite stories about economists interacting with one another over elementary principles. Stigler reports that he received a letter from Tjallling Koopmans asking whether he had in fact advocated the use of the price system to evacuate NYC in case of a bombing during WWII. Stigler responded that he had never even thought about the problem before, but upon reflecting on the problem that (1) upon the first bombing of NYC any system of evacuation would be chaotic and inefficient, but that (2) if the bombings were repeated, that indeed he would argue that the price system would be the most efficient way to handle the problem. Then Stigler makes my favorite statement in this very entertaining and informative book: "The first half of my answer was surely correct, and I believe now even more than I did then in the market system's flexibility, adaptability, and resourcefulness in finding new ways to make money." (emphasis added)

That George Stigler was an amazingly powerful economic mind cannot be denied. What he is talking about in that passage is the resiliency or robustness of the market economy to changing circumstances and shocks. He is alluding to the dynamic adjustment properties of the market economy, and how those adjustments are guided by relative prices. But this characteristic of the market economy is not captured in the traditional textbook model of the competitive market. In fact, as Armen Alchian and William Allen write in University Economics (1972, 111), "The facts of the world fly in the face of [the implications of the textbook model]." The problem isn't the reality of dynamic markets, the problem is in our formal depiction of them on the blackboard. Product differentiation, brand name quality, the pursuit of profit, etc. are all natural economic activities. The problem is due mainly to a "misleading" understanding of the concept of competition (see Alchian and Allen, 113, fn. 1, and also 11-14). Competition is an activity, not a state of affairs. Competition is omnipresent in a world of scarcity, the form of competition varies depending on institutional environment. As F. A. Hayek wrote in "The Meaning of Competition" (1940), "The confusion between the objective facts of the situation and the character of the human responses to it tends to conceal from us the important fact that competition is the more important the more complex or 'imperfect' are the objective conditions in which it has to operate. Indeed, far from competition being beneficial only when it is 'perfect', I am inclined to argue that the need for competition is nowhere greater than in fields in which the nature of the commodities or services makes it impossible that it ever should create a perfect market in the theoretical sense." (Individualism and Economic Order, 103-104, emphasis added) The economic argument for the benefits of competition, according to Hayek, thus do not rest on an idea of "perfect markets", but on competition as an activity and that within the right framework of property, contract and consent, an "effective use of resources" would be brought about by the rivalrous behavior of market participants even in the most imperfect of circumstances.

Alchian, Hayek and Stigler all argued that the market economy was amazingly resourceful in the wake of conditions which would in the textbook depiction lead to market failure in the form of an inefficient allocation of resources or even missing markets. In fact, I think this difference in judgement from their colleagues such as Paul Samuelson, George Akerlof, and Joe Stiglitz may in fact sum up the major evolution in economic thinking since the mid-20th century. Consider Akrlof's famous "Lemons" paper, if you read the argument closely you will see that Akerlof correctly identifies the market institutions associated with reputation, etc. that evolve to address the lemons problem, he just doesn't have much faith that they will evolve in a timely enough manner nor in every instance. So his identification of the market institutions that arise to cope with our imperfections gets de-emphasized, and his identification of the imperfections inherent in human endeavors gets highlighted. It is the exact opposite turn ones sees in Alchian, Hayek and Stigler I would argue. The resourcefulness of markets in the wake of imperfections is denied (or at least seriously questioned) by the Samuelson, Akerlof and Stiglitz crowd.

Why?

I want to suggest it is because economists have underappreciated the value of appreciative theory and overestimated the value of formal theory. For a discussion of the distinction between the two different modes of theorizing see Nelson and Winter, An Evolutionary Theory of Economic Change (1982, 46-48). But I'd go further than Nelson and Winter. They are content to argue that appreciative theory becomes the grist for the formal theory mill. Our appreciative theory captures aspects of reality that defy the current textbook model, but due to this exposure, the formal theoretical structure is augmented, and the previously somewhat informal explanations are sharpened and made more rigorous by incorporation into the model. They admit that Marshall recognized this distinction between the two styles of theorizing, but that he probably drew too start a line between them because of the limits of the mathematical tools of his time. But with the development of tools, formal tractability today is far greater than it was then. But even in their own work, the focus on tacit knowledge embedded in routines within the firm is not something formally tractable. And I would contend that the sort of resourcefulness that Alchian, Hayek and Stigler were talking about above largely remains intractable to this day with the formal tools economists use. This is why the effort to provide the formal theory of disequilibrium adjustment to equilibrium falls short, while various "simulations" either in the lab or with computers do a better job at explaining how the higgling and bargaining of the market can result in an efficient allocation of resources.

The mechanism that results in the competitive market process being able to be flexible, adaptable, and resourceful is, I would contend, entrepreneurs being alert to opportunities for pure profit. Or as Stigler put it, "finding news ways to make money". But this idea --- the alertness to hitherto unrecognized opportunities -- is not easily captured on the blackboard. So in order to communicate it to our students we usually tell stories about profit opportunities, and perhaps overconfident predictions by "experts" who though well versed in a particular market couldn't see the next profit opportunity that was lurking right around the corner. (see The Economic Way of Thinking (2010, 166-167)

We try to cultivate an appreciation in our students for markets that is far greater than the p and q space on the blackboard, or the elegance of a solution to a system of simultaneous equations. But that appreciation of the story is precisely what we are trying to theorizing about. It is the stuff that makes markets work. And if our appreciative theory outdistances our formal theory, economics is lesser as an intellectual enterprise to the extent formal theory is exalted and appreciative theory is denigrated.

So serious scholars such as Joe Stiglitz can actually claim that: "because Hayek (and his followers) failed to develop formal models of the market process, it is not possible to assess claims concering the efficiency of that process." (Whither Socialism? 1994, 24-25) I have always been struck by such claims --- can he not read and follow the argument Hayek lays out?; can he not read the empirical record of economic development in the West and the failure of state led efforts at development in the rest?

As the German sociologists Hans Albert argued in the 1980s, modern economics suffers a form of model Platonism, and it will not be able to fix these problems until it addresses not only its institutional deficiencies in theory, but its behavioral deficiencies. It might be important to note here just how important the first 100 pages of Human Action by Mises are for being able to address an economics for an open-ended universe (as Kirzner calls it). If you don't deal with human beings as capable but fallible actors located in a problem situation of uncertainty and ignorance, then you will not get the analysis of the role of competition as a procedure for discovering that which we much come to know, and how to eradicate our ignorance and cope with the uncertainty in which we are engulfed. In short, there would be no need for markets to be flexible, adaptable and resourceful.

For those who appreciate markets, the story I am telling is little more than the common-sense story they share with their students to explain how markets clear through the adjustment of supply and demand guided by relative prices. If we respect that story, then entrepreneurial decision making will be valued in our theoretical exercises. If entrepreneurial decision making is valued, then all economists (and their students) will start to better understand the economic forces at work in a market economy.