Economic Theory in a Dynamic Economic World

NorthDouglass C. North in Business Economics:

FORMAL ECONOMIC theory has become increasingly mathematical, elegant, and precise. It also increasingly has failed to confront the economic problems of societies. Economics, in consequence, is slowly and painfully moving away from the formal mathematical models built around a frictionless, static conceptual structure. Frank Hahn, one of the pioneers of general equilibrium theory expressed it succinctly:

“…there will be an increasing realization by theorists that radical changes in questions and methods are required if we are to deliver, not practical, but theoretically useful results.” (Hahn, 1991, 47)

It is not as clear where economics is going. But the direction is suggested by two glaring shortcomings of neoclassical theory: it is a frictionless theory inn world in which the frictions are where the action is, and it is static in a world in which dynamic change is going on at an unprecedented rate. Remedying these defects requires that economics builds on its strengths, modifies the unrealistic assumptions that made it frictionless, and incorporates time into the analysis to confront the issues of economic change.