







































Asian Themes in Social Sciences Research 
ISSN: 2578-5516 

Vol. 9, No. 1, pp. 1-8 
2025 

DOI: 10.33094/atssr.v9i1.2356 
© 2025 by the authors; licensee Online Academic Press, USA 

 
Accepted: 10 November 2025 | Published: 28 November 2025 

1 
© 2025 by the author; licensee Online Academic Press, USA 

  

 
 
 
 

Economic system efficiency in the history of economic 
thoughts: Tracing ideas from A. Smith to J. Stiglitz 
 
 

Amira Hakim1,2 

1LPS, FS, University of Sfax, Tunisia. 
2ISIGK, University of Kairouan, Tunisia. 
1,2Email: hkmamira@gmail.com  
 
 

Abstract 
The economic system is a set of institutional arrangements used for the repartition of 
Resources. The economic systems are identified in function of their characteristics such as law 
of ownership, informational mechanisms, levels of responsibilities, authority of taking decision, 
and the incentive arrangements. The economic systems are considered as spectrum of 
arrangements for the types of economic systems such as decentralized, capitalist, incentive, 
social planned. The dichotomies within these systems bring us to the question to understand 
the differences between these types of systems and modelling the phases of transition towards 
an efficient system. We are using within this synthesis the historical economic thoughts 
analysis to diagnosis the transition towards an efficient economic system. 

 
 
Keywords: Coordination, Economic system, Efficiency, History of economic thoughts, crisis, Transition. 
Licensed:  This work is licensed under a Creative Commons Attribution 4.0 License.  
Funding: This study received no specific financial support. 
Institutional Review Board Statement:  Not applicable. 
Transparency: The author declares that the manuscript is honest, truthful and transparent, that no important 
aspects of the study have been omitted and that all deviations from the planned study have been made clear. 
This study followed all rules of writing ethics. 
Competing Interests: The author declares that there are no conflicts of interests regarding the publication of 
this paper. 

 
 
1. Introduction 

In Stiglitz (2003) addresses in his book « Globalization and Its Discontents » the dilemma of the 
importance of the neoclassical model in the new contemporary economy, writing the following: « …Behind the 
free-market ideology there is a model, often attributed to Adam Smith, which argues that market forces—the 
profit motive—drive the economy to efficient outcomes as if by an invisible hand. One of the great 
achievements of modern economics is to show the sense in which, and the conditions under which, Smith’s 
conclusion is correct. It turns out that these conditions are highly restrictive. Indeed, more recent advances in 
economic theory—ironically occurring precisely during the period of the most relentless pursuit of the 
Washington Consensus policies—have shown that whenever information is imperfect and markets incomplete, 
which is to say always, and especially in developing countries, then the invisible hand works most imperfectly. 
Significantly, there are desirable government interventions which, in principle, can improve upon the 
efficiency of the market. These restrictions on the conditions under which markets result in efficiency are 
important—many of the key activities of government can be understood as responses to the resulting market 
failures (Stiglitz, 2003). 

Such an assertion pushes back against the contradictory troubles of modern economics with the new 
theory, previous theories, and the standard theory on the one hand, but also highlights the similarity between 
traditional theory and those that followed. 

https://www.doi.org/10.33094/atssr.v9i1.2356
mailto:hkmamira@gmail.com


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The purpose of this article is to explore some lines of reflection to interpret Adam Smith’s statement when 
he declares the idealism of the neoclassical theory for the efficiency of the economic system, and to critique the 
theories that came after him up to Stiglitz: how can the efficiency of an economic system be achieved and how 
do the mechanisms of transition toward an efficient economic system for emerging countries operate according 
to theories? The ambition of this article is also to limit itself to some working hypotheses or interpretations. 
Furthermore, we will restrict ourselves to treating the analyses of Smith and classical theory itself, and not the 
new classical theories in their entirety. 

We will propose five complementary lines of reflection. Starting from the theory of the firm, which 
considers the firm as an organization and the economic system as a set of institutional arrangements where 
internalized coordination has become the major tool according to Coase for the transition toward an efficient 
system. The economics of information as the management and manipulation of market conditions to achieve 
an efficient system, in which Laffont (1984) was involved, treating information problems as a policy to attain 
system efficiency. Continuing toward the general equilibrium Pareto-Walrasian theory and the major problem 
of state intervention to calibrate the market toward an optimum to reach efficiency. And finally, approaching 
the Kuznets curve with real cases of transition toward an efficient system in which the classical theory was 
applied differently. Throughout these lines of reflection, we have maintained Stiglitz’s analysis for each line. 

 

2. Classical Theory Targeting the Idealism of the Economic System 
In our era, the theory of the firm opens the most progressive horizon of research as an object of study. To 

justify and specify the existence of the firm and its internal organization, economic theory studies the firm. 
Initially, the firm was considered a black box. With the consideration of actor behavior, the firm becomes an 
organization. Thus, economic analysis develops transaction cost theory and agency theory and assimilates the 
firm to a nexus of contracts. 

To begin, I would like to invite you to emphasize the basic assumptions of neoclassical thought. Since time 
immemorial, we have been taught that neoclassical theory rests on a set of assumptions such as: market 
atomicity, product homogeneity, freedom of entry, perfect transparency, and mobility of production factors. 
Therefore, traditional theory considers the firm as a black box, one “that was long refused to be opened” 
(Rosenberg, 1982) a profit-maximizing agent by assuming its internal conditions. It supposes that transaction 
costs are zero, technological opportunities are known, forecasts are perfect, and information is complete, free, 
and perfect (you did not pay a price to obtain information about relevant market prices). Once these 
assumptions are verified, full employment, price stability, economic growth, etc., are ensured. Stiglitz (2012) 
advocates that the efficiency of a system depends on market functioning, and any market intervention alters 
equilibrium; in other words, the efficiency of a system can be altered by other organizations. Citing the 
example of unions, the neoclassical model tells us that social divergences are resolved by the market through 
Exit-Entry mechanisms, and thus an efficiency regime is attained. Others say that to resolve the problem of 
divergence, recourse to unions is necessary. However, for the classical economists, unions are imperfections, 
distortions... So how can one make the union a collective body expressing individual preferences? The solution 
is the following: since for the classicals the union is a monopolistic entity opposing efficiency and an 
exogenous intervention that prevents efficiency, if we consider the union as a collective body expressing 
individual preferences and therefore a source of efficiency under certain assumptions, we come to solve the 
problem of externalities and Free-Riding and lead to efficiency under certain assumptions. Thus, the 
neoclassical model leads to efficiency if I inscribe it in another theoretical universe. So, with reference to 
Arrow, the conclusions of neoclassical models are obviously valid only under particular assumptions, and may 
well be far too simplistic regarding the economic world and individual preferences. So, the neoclassical 
assumptions are overly simplistic; must we still take this into consideration? According to the reference model, 
economic efficiency means that the invisible hand works; that is to say, referring to the invisible hand, the 
market represents a regulatory model spontaneously leading to optimal efficiency based on market 
coordination. Moreover, market coordination is realized through the conflict of individual interests (egoisms) 
which result in the general interest from a system of prices: in the neoclassical market, there are thousands of 
sellers who do not know each other’s existence; what attracts entry to this market is the price system (Price-
Signal) through the game of supply and demand. In fact, Smith tells us in his major work The Wealth of Nations 
that «.. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but 
from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and 
never talk to them of our own necessities but of their advantages» Thus, for Smith, the invisible hand is a sine 
qua non condition for the efficiency of the economic system. However, for the invisible hand to function, the 
underlying assumptions must be verified. But do the underlying assumptions of the invisible hand hold? 
Nevertheless, this model has limits, including that some transaction costs are positive and the degree of 
uncertainty is significant. As long as the assumptions are unrealistic, then why consider it as a referential 
framework for the analysis of an economic system? There is no better theoretical model and scientific 
approach in the 20th century infallible than the neoclassical model. However, it is disconnected from its object 
of study. When the neoclassical model talks to us about resource allocation, theoretical assumptions are 
required although it is unclear what optimal resource allocation means; it is independent of its object. 
 



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3. The General Equilibrium Theory and the Efficiency of the Economic System 
General equilibrium theory is based on normative analysis. More precisely, it concerns specifying the 

behavior that consumers must adopt to maximize their utility under budget constraints, and producers to 
maximize their superprofit. But is this distribution good or bad, efficient or not? Pareto’s contribution was to 
provide an answer to this question after defining an evaluative criterion. This criterion allows multiple optima 
to be identified but cannot decide between them. We use the Edgeworth diagram which allows choosing which 
optimum among all Pareto optima is preferable, meaning it allows selecting the best among better states. 
Pareto optimum1 is analyzed by welfare economics and is defined as the state in which one cannot improve the 
situation of one individual without simultaneously deteriorating the situation of another. Pareto (1917) states 
his criterion as follows: When a community is at a point Q from which it can move to increase the well-being 
of all individuals, it is clear that, from an economic perspective, one should continue to move in that direction 
as long as everyone benefits. Only upon reaching a point P, where further improvement for all is impossible, 
must other, non-economic considerations be taken into account». Point P corresponds, for Pareto, only to the 
social state ensuring the maximum welfare for the community. More precisely, provided certain conditions are 
met, the mere play of market mechanisms animated by agents who only have their self-interest in mind leads 
to a situation satisfying this efficiency criterion, meaning that the market equilibrium without the state 
constitutes a Pareto optimum, so the state appears as the one disturbing the ideal order of the market. 

The Pareto optimum changes depending on the initial feasible state, but this initial feasible state is a 
certain distribution of resources. It should be emphasized that the question of resource allocation is intimately 
linked to the question of resource distribution. This means that efficiency and justice are connected. However, 
the question of justice and equity is not taken into account by the reference model: productions are 
remunerated at their marginal productivity, which is the marginal calculation principle. More precisely, 
according to Simonet (2006) for Pareto, it is appropriate to separate questions related to the efficiency of the 
system, which can be studied subjectively according to him, from questions concerning equity or social justice, 
which require value judgments that the economist should not impose. 

The theory of correspondence between general equilibrium and the Pareto optimum tells us that there 
exists an equilibrium price system that renders the behaviors of all agents compatible. This is based on the two 
welfare theorems which constitute the foundation of liberal thought. The first theorem states that a 
competitive equilibrium of private property, if it exists, is a Pareto optimum. J.J. Laffont explains this theorem 
as follows:  It is sufficient that the signals represented by equilibrium prices coordinate decentralized economic 
activities in a manner that is satisfactory according to the Pareto criterion. Each economic agent, through 
their individual maximization behavior, adjusts to the price system by equating the marginal rates of 
substitution and transformation with the corresponding price ratios. Since all agents face the same price 
system, at equilibrium all marginal rates are equal to one another. These equalities, together with market 
equilibrium, effectively characterize the Pareto optima within a convex framework. More precisely, prices are 
sufficient signals to coordinate decentralized economic activities satisfactorily according to the Pareto 
criterion. The second theorem states that if the usual convexity assumptions are verified, and if Q is a Pareto 
optimum, then there exists a price vector P such that Q is an equilibrium at price P. This theorem is explained 
by Laffont (1984) as follows: Regardless of which Pareto optimum corresponds to a given criterion of justice, it 
can be decentralized as a competitive equilibrium, provided that agents’ incomes are appropriately assigned; 
that is, in a private-property economy, conditional on the implementation of suitable lump-sum transfers 
among the agents. The optimum can be decentralized; we can find a price system p and incomes R such that 
each consumer maximizes utility choosing respectively the vectors X corresponding to the optimum. So, if 
there is correspondence, this system leads to an equilibrium price system characterized by uniqueness, 
stability, and existence, and this point corresponds to a situation that society collectively optimizes. Therefore, 
the welfare theorems are proof that Adam Smith’s invisible hand indeed exists and that the market is the most 
efficient way to allocate goods among individuals. This is the formal and rigorous proof that neoclassical 
authors have provided to justify the non-need for the state in the economic sphere of the neoclassical model. It 
is the foundation of liberal ideology and the incontestable superiority of the neoclassical model. So, what 
justifies the intervention of the State in economic decisions? Nothing—if there is no longer this 
correspondence, there is no longer justification for sidelining the State. When we consider a group of 
individuals, each optimizes by maximizing their individual interest; if there is no maximization, then there is 
room for the State. 

However, the neoclassicals did not completely close the door to the State. This is what economists have 
acknowledged—that the State must intervene under certain conditions. 

What are the situations identified by the neoclassicals in which they break this correspondence? 
When a hypothesis is not verified. These hypotheses lead to insufficiencies. Moreover, these lead to the short-
sightedness of agents in their ability to foresee the future (Pigou). 

 
1 Vilfredo Pareto did not introduce the concept of Pareto Optimum under this name in his own writings. However, in his work Manuale di Economia Politica 
published in 1906, he developed the foundations of what would later become the concept of Pareto efficiency. Pareto was interested in the manner of 
optimizing the allocation of resources and in maximizing social welfare. “Si una parte degli uomini trae da un dato cambiamento un utile, mentre nessun’altra 
ne riceve danno, c’é un aumento della funzione colletriva del benessere”. 
 



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In fact, all decisions made by economic agents are projected into the future—yet the future is uncertain. 
Situations of indivisibility of goods and externalities (positive or negative) are cases in which the market fails. 
In other words, we accept to see that there is a part ignored by the Walraso-Paretian model, such as 
indivisibility of goods and externality. In the presence of these two situations, there is a divergence between 
the private TMST and the social TMST, and between the private TMST and the social TMST; and the 
general equilibrium does not correspond to the Pareto optimum. Moreover, external effects—defined as « any 
indirect effect of a production activity or a consumption activity on a utility function, a set of consumption, or a 
set of production » (Laffont, 1984)—do not pass through the market. Similarly, indivisible goods do not 
correspond to the principle of marginal calculation, whereas the model prevents non-marginal calculation. 

There is no contradiction among the hypotheses forming the axiom of construction of the neoclassical 
model. Let us take returns as an example; if returns are increasing, we cannot define a single equilibrium. So, 
the model is coherent—but to what extent does the model capture the entire economy today? If the model 
captures only part of the real world, then the model is not relevant. In fact, the hypotheses are unrealistic: 
Rationality is limited, information is imperfect, capacities are heterogeneous… So why this model? Why 
construct this model as long as it ignores a real part of the economy? There is no more flawless theoretical 
model or scientific approach in the 20th century than the neoclassical model. Economists have understood that 
neoclassical theory produces an elastic neoclassical model. Samuelson (1955) state that we can make an 
extension of the neoclassical model». Marxism is a critique of the neoclassical model and not a school of 
thought. In fact, from these critiques they created the regulation school. The Keynesian widened the capitalist 
economy and exposed the shortcomings of the neoclassical model and justified exogenous state intervention. 
Neoclassical theory represents 99.99% of today’s economic theory. Let us return to the notion of 
correspondence. Market mechanisms are failing because they only take into account the monetary dimension, 
leaving aside everything that escapes the logic of profit—this characteristic of the market, in addition to the 
already mentioned market failures, would justify State intervention. The State can intervene to restore this 
correspondence, to compensate for market failures—everything that causes general equilibrium to deviate 
from the Pareto optimum. As a consequence, there is no correspondence between GE (general equilibrium) 
and the Pareto optimum. Everything that deviates from the Walraso-Paretian norm is an imperfection and 
causes a break between collective optimum and the Pareto optimum. 

The State intervenes to correct this correspondence or to bring general equilibrium back. 
It will intervene according to the Walraso-Paretian logic. Its instruments must be Walraso-Paretian 

instruments and coherent with the microeconomic instruments of the reference model. 
What type of intervention is consistent with the Walraso-Paretian model? 
The price must equal marginal cost. If the price is not equal to the marginal cost, its intervention will not 

be coherent with the Walraso-Paretian rules and will further deviate general equilibrium from economic 
optimum. In fact, it is enough that one agent does not apply the rule for us not to reach general equilibrium 
and, as a result, the correspondence between general equilibrium and the Pareto optimum is broken. Let us 
pause on the example of public goods. 

The State will produce the goods that are not marketable; it will price these goods using the same rule P 
= MC. If we do not apply this rule, this will deviate from the correspondence. 

Faced with this failure, the State will intervene by introducing a tax intended to finance this good. 
General equilibrium is normative—this is how the State intervenes without necessarily asking whether it can 
actually achieve that in practice. Some economists tell us that the costs generated by public intervention to 
compensate for market failures may sometimes exceed those arising from the free functioning of the market. 
Thus, both the State and the market constitute imperfect organs for regulating economic activity. 
 

4. Coase: The Theory of the Firm and the Efficiency of the Economic System 
Stiglitz (2012) stipulates that public authority, like markets, is subject to a range of imperfections, 

resulting in state failures that are as significant as market failures. This underscores the necessity for the state 
and markets to cooperate and complement one another, with each offsetting the weaknesses of the other while 
leveraging its respective strengths. Others say that a failing state, instead of correcting market failures, adds 
to them, and consequently disrupts market efficiency. 

When we define efficiency, is it the totality of macroeconomic objectives? Is it the total utility? Assuming 
that efficiency is the sum of utility, then humans and animals are endowed with the same utility. In fact, it is 
generally accepted that « Economics is the science which studies human behaviour as a relationship between 
ends and scarce means which have alternative uses» (Robbins, 1935). However, according to Coase (1937) in 
reality, since humans are not the only animals capable of choice, it should not be surprising that this approach 
can also be applied to rats, cats, or octopuses, all of which, without a doubt, are engaged in maximizing their 
utility, just like humans. The fact that it has been shown that price theory is applicable to animal behavior is 
therefore not accidental. Thus, the neoclassical model resides more in its epistemological approach than in its 
object. It is enough to relax a single hypothesis for individual interest to no longer lead to the social optimum. 
In this logic, individual interest runs counter to the general interest, as demonstrated by the prisoner’s 



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dilemma in game theory. Coase2 tells us: “You are not dealing with the real world; you are dealing with a 
blackboard model.” Substantive rationality, one of the foundations of the classical model, is too disconnected 
from reality. Coase wanted to inject some realism into the neoclassical model. More precisely, Coase sought to 
minimize the distance between the blackboard economics and the real world by highlighting the operating 
cost of a general price system and the social cost. 

If we relax the hypothesis that the firm is a black box, we enter the box. According to Samuelson, “It takes 
a theory to kill a theory”; another conceptual theory was needed to open the box. Coase introduced 
“transaction costs” — the key to opening and entering the box. To do this, we must consider that information 
is not perfect, technological opportunities are unknown, the level of uncertainty is high, and agents’ capacities 
are heterogeneous. 

According to Coase, transaction costs are the costs that allow mutually beneficial exchanges between two 
or more individuals. These transaction costs generated by coordination can be classified into three categories: 
information search costs, negotiation and decision-making costs, and monitoring costs, which he supports by 
stating: When one wishes to carry out a transaction in a market, it is necessary to search for one’s 
counterpart(s), to provide them with certain necessary information, to set the conditions of the contract, to 
conduct negotiations thereby establishing a genuine market for concluding the contract, and to put in place a 
structure to monitor the respective fulfillment of obligations, etc.. This approach assimilates the firm to “a 
nexus of contracts.” It is analyzed as a form of organization to substitute for transaction costs. Azariadis and 
Stiglitz (1983) tells us: earlier theories simply assumed that redirecting and enforcing contracts incurred no 
costs. All of this is far from the real world: contracts are often ambiguous, they give rise to countless disputes, 
legal procedures are extremely costly, and most economic transactions are not governed by any formal 
contract. Under these conditions, it is often implicit contracts, tacit agreements, or social norms that allow 
society to function properly. Coase wanted the firm to evolve while being based on his well-known theorem, 
which advocates: « … a firm tends to grow until the costs of organizing an additional transaction within the 
firm become equal to the costs of carrying out the same transaction through a market exchange or to the 
organizational costs in another firm.» (Coase, 1937). This means that replacing the market with an 
organization is only relevant when transaction cost savings exceed organizational costs. Therefore, the theory 
of transaction costs strengthens the neoclassical model and corrects market coordination because market 
coordination is costly. It relies on a central idea: the chosen institutional arrangement will be the one that 
minimizes both transaction and production costs. Hence, « Markets appear as institutions designed to facilitate 
exchange, that is, their function consists in generating savings on the costs of carrying out transactions. » 
(Coase, 1937).  For Coase, efficiency is not just about the price mechanism. He emphasized positive and 
negative externalities. One cannot imagine an economic reasoning that assumes the absence of externalities. In 
fact, by considering these externalities, what was once a flaw in the neoclassical model becomes a factor. Let us 
return to the example of trade unions. Because unions become a collective organ for expressing individual 
preferences, the free-rider problem — which is costly to the economy in terms of efficiency — can be resolved. 
Thus, Coase’s contribution regarding social cost is to integrate law into the functioning of an economic 
system, meaning that what is exchanged on the market is not physical entities, but property rights. 

Coase also spoke about the role of the entrepreneur in the efficiency of the economic system. This idea is 
not new. Schumpeter3 discussed the entrepreneur’s role in efficiency, stipulating the following idea: for a firm 
to survive, it must manage intangible resources internally. As our knowledge becomes obsolete, it must be 
adaptable to an unpredictable economic environment, requiring responsiveness to generate competencies — in 
which the entrepreneur plays a major role in the process of innovation and competence creation. According to 
standard theory, system efficiency involves the existence of two Siamese twins: Privatization and competition. 
If I privatize in the textbook sense, we simply move from a public black box to a private black box — as if 
nothing has changed. So, where is the efficiency? If I privatize on the assumption that efficiency is the 
archetype of the market, I give no role or existence to the firm in coordination. In fact, the neoclassical model 
does not theoretically imply the existence of the firm. 

According to Stiglitz: “Standard neoclassical theory argues that for a market economy to work well (to be 
Pareto efficient), there must be both competition and private property (the 'Siamese twins' of efficient wealth 
creation). Both are required, and clearly, if one could wave a magic wand and instantaneously institute both, 
one would presumably do that. The issue, however, concerns choices: if one cannot have both, should one 
proceed with privatization alone?”. So, Stiglitz aimed to explain that, to achieve Pareto efficiency, the system 
must include both Siamese twins. And if one is missing, can the system reach efficiency on its own? 
Looking closely, privatization is not about transferring assets — it is about transferring wealth. Where wealth 
is involved, profit is involved, and the state may lead to “Regulatory Capture” — a corruption mechanism. 
According to Coase, if we consider privatization through the neoclassical lens, it does not lead to efficiency. 

 
2 "It can, I think, be assumed that the distinguishing mark of the firm is the supersession of the price mechanism. Instead of the allocation of resources being 
determined by the price mechanism, it is the entrepreneur who directs production. [...] The fact of direction consists in deciding the movements of the 
resources concerned and in deciding the terms on which this is done. The operation of a market costs something and by forming an organisation and allowing 
some authority (an entrepreneur) to direct the resources, certain marketing costs are saved." 

 
3 "Innovation is the key to economic efficiency. It is not limited to the introduction of new products but also encompasses new methods of production, new 
markets, and new forms of organization. [...] It is through innovation that companies increase their productivity and improve their competitiveness." 



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Thus, we need an institutional architecture supported by legal rules; otherwise, we face corruption, and thus a 
loss of efficiency. Therefore, the argument that privatization inherently leads to efficiency falls apart. 
Privatization should lead the firm toward the economy of organizations. Hence, the economic system would 
be, by definition, a set of institutional arrangements (contracts, relationships, firms). If we stop at this 
definition, we step outside the neoclassical framework. We cannot use it because institutions have no place in 
the neoclassical model — and because the model itself poses an analytical problem. But that does not mean 
rejecting the neoclassical model altogether, because efficiency requires coordination. But is it market 
coordination? We will graft another type of coordination onto market coordination — internalized 
coordination: Contracts between workers and executives, between hierarchy and employees. However, with 
internalized coordination comes problems of observability, supervision, control, and authority — hence the 
need for agency theory and incentive theory. According to these theories, for a firm to be efficient, it must 
manage issues of supervision, adverse selection, moral hazard, opportunism, and hold-up. Let us consider two 
types of problems. Akerlof4 tells us that information asymmetry is a source of blockage and generates two 
major problems in economics: adverse selection and moral hazard. In general, these informational problems 
prevent the optimal allocation of resources unless all information is common knowledge. Thus, to allocate 
resources optimally, the contract must make the agent reveal private information, and consequently, the agent 
must receive informational rents, which are generally costly for the principal. Stiglitz (2012) tells us: « The 
Smithian logic seemed to suggest that morality had no role to play, that virtues such as loyalty and good faith 
carried no weight. Adam Smith, aware of the limits of markets, knew that this was not the case. Modern 
economics has shown why economic systems in which these virtues prevail function better in the real world 
than those in which they are absent».  Thus, agency theory emerged as an application of the neoclassical 
analytical framework in which information asymmetries appear between agents, while retaining the 
assumption of substantive rationality. In fact, this theory is needed within the firm because Coase’s individual 
is endowed with bounded rationality. This theory is based on the principal–Agent principle, in which the 
relationship is defined as follows: There is an agency relationship when one person, called the agent, acts on 
behalf of another person, called the principal, who is imperfectly informed. The theory of the firm is central to 
this relational approach. In practice, since managers are better informed than shareholders about the firm’s 
quality, a transmission mechanism must be established to allow risk-takers to engage in various business 
projects. How can we ensure proper transmission of this information? By formulating incentive mechanisms 
that lead to the truthful revelation of project quality. The agent must be incentivized to send an informative 
signal about the value of their firm. According to Maskin and Laffont, for an incentive mechanism to be 
effective, it must also include rewards and penalties to discourage the agent from sending unfavorable signals 
(e.g., unemployment as a threat for workers). 
 

5. The Contemporary Process of Transition Toward an Efficient System According to the 
Standard Model 

In general, it is admitted that the neoclassical model is a weak tool for analyzing economic systems. 
However, in theoretical terms, the neoclassical model is infallible if all its underlying assumptions are verified. 
What are the empirical conditions of efficiency? One must still ask: does the real world conform to theoretical 
assumptions? To answer these questions, Stiglitz provides us with two examples of successful and failed 
economic systems: Russia and China. 

To understand these two experiences, we will first present a brief summary of the main economic crises 
since 1975, alongside the nature of these systems. Since that date, the socialist regime, either Soviet-style or 
Chinese, was the most dominant worldwide. During the same period, the Western world experienced two oil 
shocks, recession, and stagflation. The rest of the world tried to generate economic growth and then 
development. Latin America, Africa, and Asia did not achieve the expected growth rates. However, Japan 
stood out during that period in terms of growth and development. 

In 1995, the Soviet empire disintegrated, the two Germanies reunified, the communist bloc no longer 
existed as an external control organization, China became a growth champion, and markets in Asia and Latin 
America turned into global investment hubs. 

To understand the two examples presented by Stiglitz, China and Russia, we will make a comparison of 
how both economies attempted to use the neoclassical "recipe" to transition toward an emerging economy. In 
fact, in the Chinese experience, one must refer back to comparative systems to grasp the system change. The 
disparity between failure and success is so large: here are two systems that attempt to apply the neoclassical 
recipe at the same time—one manages to make the invisible hand work, and the other does not. 

China and Russia were characterized by centrally planned economies. These countries moved toward the 
market to decentralize their economies, following recommendations from the neoclassical framework. China 
succeeded in its transition. In fact, there was a significant increase in its GDP, from 300 billion USD to 700 
billion USD between 1989 and 1997. Meanwhile, Russia experienced a dramatic decrease in wealth during the 

 
4 " Information asymmetry is a fundamental problem in principal–agent relationships, where the principal cannot observe the efforts or actions of the agent. 
This creates an imbalance that can lead to adverse selection, where the principal struggles to distinguish high-quality agents from low-quality ones. 
Furthermore, moral hazard arises when the agent, due to the absence of effective monitoring, may take excessive risks, knowing that they will not bear the 
full consequences of their actions. To address these issues, it is essential to design incentive-compatible contracts that align the interests of the parties, while 
accounting for information costs and the necessary incentives to ensure that the agent acts in the best interest of the principal." 



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same period. Russia managed to privatize most of its economy. However, Coase tells us that privatization does 
not mean self-regulation, but rather transaction costs and organization. Therefore, an efficiency indicator is 
absent. 

(Stiglitz, 1999) tells us in Whither Reform that gross investment is a key and crucial indicator of an 
emerging market economy, and it is the State that provides the necessary investment conditions, such as a 
sound legal system. In fact, without a legal system, the economic system collapses, as clearly shown during the 
subprime financial crisis. 

Referring to Russia, the volume of investment dropped dramatically, and Russia became a late-developing 
economy. The failure in Russia was so significant that the Kuznets model5 was reversed. It is generally 
accepted that income distribution during economic development follows the inverted U-shaped (Kuznets, 
1955) according to which inequality increases in the early stages of development and then declines. Therefore, 
the key to Russia's efficiency lies in improving living standards and establishing a foundation for sustainable 
and inclusive development with fewer social disparities. Coase (1937) states that « These formerly communist 
countries are encouraged to adopt a market economy, and this is what their leaders desire; however, in the 
absence of appropriate institutions, even a minimally functional market economy is impossible. ». The results 
of these transitions are mixed. The neoclassical model does not apply universally. Its universal character is not 
confirmed—it is essential to consider geopolitical positions, ethnic compositions, and natural resource 
endowments. The neoclassical model cannot be used as an intellectual framework for evaluating the efficiency 
of economic systems in countries with different physical capital endowments. It is a weak tool for analyzing 
efficient economic systems. "A failure arising in part from the neoclassical model itself" (Stiglitz)—this 
sentence alone shows that the inefficiency of an economic system is partly attributable to the neoclassical 
model itself. Stiglitz raises the following questions :« What type of market economy do they wish to create? 
American-style capitalism or a more humane, softer Swedish-style capitalism? On a globalized planet, must we 
all march in step? What room is there for diversity?».  Drèze (1985) responds to almost all of Stiglitz's 
questions. In fact, Drèze (1985) tells us that a market model does not imply a market economy, meaning that a 
market economy is not the absence of the State—but rather, what kind of State? It is a regulatory State. If the 
neoclassical model’s precepts were the recipe for efficiency, one would wonder how an economic system in 
which the State’s share of GDP exceeds 70%—namely Sweden—could be considered the most efficient market 
economy. 

Drèze (1985) affirms that the State plays an essential positive role in development, stating: We cannot 
expect the market to provide social security, ensure universal education, manage urban planning, protect the 
environment, reduce social inequalities, guarantee children’s vaccination, preserve the integrity of the legal 
system, or even ensure effective regulation of private enterprises. I am tempted to add that we also cannot 
expect the market to ensure the transition to a market economy ». Stiglitz (2012) argues that « A battle of 
ideas is underway: some wish to reduce the state to a minimal role, while others recognize its important 
function, even with its limitations, in correcting market failures and advancing social justice. I count myself 
among the latter, and I intend here to show that markets, even if they are at the heart of our economic success, 
do not always function properly on their own, that they do not solve all problems, and that the state will 
always be an important partner for them ». He adds that in the context of globalization, economic conditions 
evolve, and the State must abandon old tasks and take on new ones. However, Pigou asserts that public 
intervention only appears as a corrective and regulatory action if—and only if—the economic system is 
marked by dysfunctions. He adds: « We cannot indeed hope that any public authority will achieve, or even 
sincerely strive for, this ideal. Such authorities are equally subject to ignorance, to pressure from a class, and 
to corruption of individuals by private interests ». In Whither Reform: Ten Years Later, Stiglitz asserts that if 
the AD (Aggregate Demand) model were correct, we would expect the market to self-regulate (provide social 
security, ensure universal education, engage in urban planning, protect the environment, effectively regulate 
private firms, etc.). Thus, all countries transitioning to market economies would have succeeded and should, 
for instance, have reduced poverty. However, looking at a system like Russia’s, we observe that the market did 
not guarantee the transition to a market economy—just the indicator of market economy performance 
decreased. This means that without State intervention, one cannot successfully transition to a market 
economy. 

Nevertheless, I firmly believe that the neoclassical model remains a valid and infallible reference point—if 
there is a failure, it is because of an externality that distorts equilibrium. It is not the neoclassical recipe itself 
but the circumstances of transition. 
 

References 
Azariadis, C., & Stiglitz, J. E. (1983). Implicit contracts and fixed price equilibriaa. The Quarterly Journal of Economics, 98, 

1-22. https://doi.org/10.2307/1885373 

 
5 "The relationship between the level of economic development and income inequality can be understood by considering that, in the early stages of 
development, investments and economic opportunities are concentrated in specific sectors, leading to increased inequality. However, as the economy 
diversifies and education improves, broader segments of the population begin to benefit from growth opportunities. This ultimately leads to a reduction in 
income inequality, thereby illustrating a cycle of economic transformation." 
 

https://doi.org/10.2307/1885373


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