One Positive Result of Brexit

by Levi Russell

In the wake of the UK's referendum on its membership in the EU, there have been many positive and negative reactions. My own view is that, even with the potentially negative impact of tighter immigration restrictions, the UK will be better off without EU regulations and will likely have trade terms similar to those it had before (see Switzerland). In fact, the biggest proponents of the Leave campaign want free trade with the EU. Of course I could very well be wrong. It might have been better from a utilitarian/consequentalist point of view for the UK to remain in the EU.

I think there's one benefit of the UK's (potential) exit that is unambiguous: The UK citizenry will be better equipped to govern themselves. Specifically, the cost of monitoring their lawmakers has fallen dramatically. If and when the UK leaves the EU, Britons will only have to monitor the behavior of the 650 members of parliament (MPs). Outside of trade deals, the EU MEPs in Brussels will have no direct effect on them.

Additionally, the benefit of participating in the political process is higher as well. Each MP now controls a larger share of the laws and regulations under which Britons live. Thus, any influence Britons (whether individually or in groups) wield over MPs now carries more weight.

It's possible that, on net, the UK's (potential) exit from the EU will be very bad for the average British citizen. However, there are clear benefits from a public choice point of view.

Value of Farm Data: Proving Damages Based on Trade Secret Protections

By: Terry Griffin, Ph.D. 

Last month, Ashley Ellixson and I described potential damages that farmers may claim in the event of a data breach if farm data were considered a trade secret. We (more specifically Ashley) discussed that legal protections for trade secrets include 1) actual damages, 2) reasonable royalty, and 3) unjust enrichment.  Over the last couple weeks since posting our publication, I have been contemplating which protection will most likely be utilized in practice. When the farm data, i.e. the trade secret, is used without permission from the farmer or farm data owner, a disclosure of the data results and it is assumed that damages can be claimed. Specifically when a data breach occurs, or the data are disclosed, the farmer or group of farmers desire to seek legal action and determine which protection would return the greatest compensation to them. 

I approach the issue such that I were retained to serve as an expert witness to deliver testimony. In this scenario, I would perform forensic economics to compare the relative value that the farmer would realize under each of the three protections in the event that farm data were considered to be a trade secret of the farm (Ellixson and Griffin, 2016). Ashley defines the three damages regarding trade secret protections as:

Damages may be one of three types:

1. Actual damages may include lost profits, which are typically calculated as net profits (meaning gross profits minus overhead and expenses required to run the business).

2. Reasonable royalty rate is determined by constructing a hypothetical negotiation for licensing the trade secret, or farm data, between the parties at the time misappropriation began. The law assumes this hypothetical negotiation occurred and that the farmer, who ordinarily would not license his trade secret to the misappropriator, did so willingly for a bargained‐for price.

3. Unjust enrichment seeks to return the benefit the misappropriator gained from his actions to the farmer.

First, before addressing the three sources of damages it is important to review how the different players benefit from the big data system in agriculture. In our definition, the big data system is a network of many farms’ data combined into a community dataset. In this community, the economics of networks are important. In the short term, the aggregator(s) attempt to entice as many farmers to submit as many acres of data as they can (remember than in the short run there are many aggregators vying to become a monopoly but in the long run there will be very few or only one aggregator). In the long run, the aggregator who controls the flow of data enjoys the lion’s share of the value of the data system. The individual farmer-members of the network benefit less than the aggregator; and the other players who offer analytic services are somewhere in the middle. In the following scenarios, I make the assumption that individual farmers have already captured the vast majority of any potential farm‐level benefits from their farm data (such as communications with landowners, creation of variable rate prescriptions, compliance reporting, directed scouting, etc.); and the damages only apply to the data being disclosed to others, i.e. the farm still has access to the data. It can also be assumed that the data disclosure or breach has occurred intentionally from the farmers’ perspective. I’ve also avoided any discussion of class action and have only evaluated these damages at the individual farm level. The expert witness for the misappropriator would most likely take the opposite approach than the one taken here.

Review of network effects

When I’m presenting on farm data issues I compare the data communities to classic networks such as the telephone and modern pop culture examples like Twitter or Facebook. The value of the system depends on how many other people consume or participate in the system. The value of the telephone system was zero when there were only one telephone (who are you going to call?). The value of the system, or community, is greater than the sums of the individual benefits each member receives in the long run. Multiple farms’ data in the aggregate are more valuable than one individual farm’s data. Given this characteristic of ‘network effects’ where the value of the system is a function of the number of members of the system, the aggregator enjoys much greater benefits than any individual in the long run. However, in the short run aggregators would attempt to entice farms to join the network up to the point that a critical number of farms were in the system. Once the data community has a critical mass of farms, i.e. the long run, farmers’ bargaining power with the data aggregator is greatly reduced. That being said, it is not expected that farm data would be misappropriated until a critical mass of data were available, so I’m only evaluating the mature data system for now.

Actual damages

Actual damages may be a viable option for the expert witness to testify about especially when considering ‘data as a resource’ and ‘excludability’. Excludability no longer exists when data are shared with a third‐party, i.e. in this case a data disclosure breach. If resource‐based theory (see Griffin et al., 2016, for more farm data details) applies to disclosure of farm data such that the excludability of that data were adversely impacted, then competitive advantage with respect to local bargaining power may be lost (Griffin et al., 2016). In this case, an individual farmer may lose real or perceived local negotiating power with landowners and agricultural retailers; these losses could be quantified and are expected to be substantive. In many regions of the USA, the competition for farmland is fierce and some farmers fear that they may not successfully win a bid for rented land if their data were disclosed. Another example may be in negotiation ability with ag retailers could be diminished. Loss of farmland acreage and lack of discounts on input purchases are quantifiable. These losses are the ‘actual damages’ that the expert witness would estimate using net present value of subsequent changes in farm revenue.

Reasonable royalty

Reasonable royalty will not likely be the damages sought by individual farms because the hypothetical negotiation is expected to arrive at an impasse. In this scenario, the farmer and aggregator enter into a hypothetical negotiation where the farmers’ bargained-for price of data were determined. Again, we look to the economic theory of networks to examine how this hypothetical negotiation turned out. Economic theory suggests that, in the long run, the aggregator places very little value on data from any individual farm and therefore would not negotiate beyond $0. The farmer who values farm data as a good, i.e. positive value, would not accept the $0 offered by the aggregator. Farmers’ reservation prices, or willingness‐to‐accept for their farm data, starkly differ from the price that aggregators are willing to pay. From the perspective of the aggregator, it makes very little difference whether any given farmer participates in the network. This is where the estimation becomes tricky. We know that the value to the aggregator is greater than the summation of all the individual benefits; however we also know that any given farmer can withdraw from the network without causing the aggregator to lose value with respect to the network once a critical number of farms are in the system. Therein lies the problem of determining the bargained-for price; the aggregator can argue that the value of any given farm is $0 to the aggregator. Since the parties are not likely to converge on an agreed upon price, the ‘reasonable royalty’ would be the most difficult of the three damages to defend. As the expert witness for the farmer, I would avoid attempting to prove a ‘reasonable royalty’ since the testimony would be based on an individual farm’s losses.

Unjust enrichment

As the expert witness, ‘unjust enrichment’ is the damage that my testimony would be easiest to prove and therefore the most likely candidate for farmers to claim damages. Given that the marginal value to an individual farm is relatively small, the misappropriator has the opportunity to disproportionately benefit or enjoy some sort of “unjust enrichment.” Even for well-meaning aggregators who initially would not disclose data to others for a profit, the temptation may become too large to ignore. For these reasons, ‘unjust enrichment’ is a logical damage to seek. At the community level, farm data has value to the aggregator and other third parties for commodity marketing manipulation, supply chain management, improvement of products, and so on. Although the preceding examples are not malicious on their own, we’ll proceed assuming that the agreement between the farm and aggregator precluded these examples. In this case, the misappropriator has opportunity to disproportionately gain from the unauthorized use or sale of community farm data. However, a value to the misappropriator may be in the millions of dollars but would equate to only pennies on the acre to the farmer.    

Conclusion

Given the three potential damages of trade secret disclosure, I would avoid attempting to prove ‘reasonable royalty’ in the long run and focus on a combination of ‘actual damages’ and ‘unjust enrichment’. I expect the per farm value for ‘actual damages’ to be greater than from ‘unjust enrichment’ however will also require more effort on the part of the expert witness to prove. In the short term when there are relatively few farms in the big data system, the farmer would have a relatively better chance at ‘reasonable royalty’ although the forensic economics would still be relatively more difficult to estimate substantial damages. The largest per acre damages that a farmer could claim would come from ‘actual damages’ if data were treated as a resource. The second largest per acre damages that a farmer could claim come from unjust enrichment. As an expert witness, I would attempt to claim both ‘actual damages’ and ‘unjust enrichment’. Proving ‘reasonable royalty’ would be most difficult of the three potential damages for an expert witness to estimate.

Contact information:

Terry Griffin, Ph.D.

@SpacePlowboy

References

Ellixson, Ashley and Griffin, T.W. 2016. Ownership and Protections of Farm Data. Kansas State University Department of Agricultural Economics Extension Publication. KSU-AgEcon-AE-TG-2016.1 May 31, 2016 http://www.agmanager.info/crops/prodecon/precision/FarmData.pdf

Griffin, T.W., T.B. Mark, S. Ferrell, T. Janzen, G. Ibendahl, J.D. Bennett, J.L. Maurer, and A. Shanoyan. 2016. Big Data Considerations for Rural Property Professionals. Journal of American Society of Farm Managers and Rural Appraisers. pp 167-180 http://www.asfmra.org/wp-content/uploads/2016/06/441-Griffin.pdf

Brexit Stock Market Perspective

by Levi Russell

The financial press was abuzz before and after the recent UK referendum to leave the European Union (see here, here, here, here, here, and here). To be sure, the British Pound took a big hit and several stock market indices across the Western world were affected. I'd just chalk this up to political uncertainty, not a referendum on the referendum. After all, we don't actually know if the UK will leave the EU. Perhaps I'm biased.

Here's the perspective I promised in the title. First, a look at the 5-day charts (all taken from Yahoo Finance) of U.S. (Dow and S&P 500), British (FTSE), Spanish (IBEX), German (DAX), and French (CAC 40) stock exchange indices:

To be sure, these are some pretty serious one-day drops. However, the Dow and S&P 500 fell more modestly than the others and the FTSE (British index) has recovered somewhat. The hardest hit so far are the European indices. Interesting, to be sure.

But what does this selloff look like over a 1 year time horizon? How far back in time do we have to go to see these indices at similar levels?

The Dow and S&P 500 are right about where they were last month. If you take out the big troughs in September 2015 and early this year, both indices are pretty much flat. The FTSE looks similar, though it seems to have a bit more of a downward trend than the U.S. The Spanish, German, and French indices are down a bit more relative to the past few months but it seems they're just continuing a downward trend that's been around for the past 12 months.

I'm not saying the referendum had no effect on the markets but after looking at these charts I'm left asking "Where's the fire?" Maybe I'm missing something, or maybe my cavalier attitude to the stock market stems from the fact that I'm 29 years old.

Brexit Roundup

The UK recently passed a referendum to leave the European Union. Regardless of your view on the outcome, it certainly is a momentous occasion with potentially far-reaching implications for the future of the EU itself.

Here are some articles I found informative on the issue:

A nice summary

A cautiously optimistic take

A couple of very positive takes (here and here)

A negative take

Here's a look at the fallout in the US stock market in the wake of the vote.

Zoning Laws Past and Present

In the past I've linked to interesting material on community and regional economics that I found interesting. I'm not a community/regional economist but regulation (a subject I'm very interested in) is often discussed in regional economics analyses.

This article from the NY Times is one such example. The article discusses the various zoning regulations currently in place that would effectively prohibit the construction of 40% of the existing buildings in Manhattan, NY today. The article does a great job of explaining the various regulations and mapping out where the violations of each type exist in the city. Working on the (perhaps incorrect) assumption that agglomeration is a "good thing," it makes me wonder just how much economic growth New Yorkers are missing out on due to current regulations. We'll never know.

Specialization and Trade - A Reintroduction to Economics

That's the tile of Arnold Kling's newest book. It's published by the Cato Institute and is available in e-book format on Amazon for a mere $3.19. You can also download a PDF copy here free. Arnold Kling is an MIT trained economist who spent the bulk of his professional economic career at the Federal Reserve and Freddie Mac. Kling's blog, one of the best on the web in my opinion, is always thought-provoking. As the title of his blog suggests, he makes every effort to understand and fairly state the positions of those with whom he disagrees.

I read a couple of blurbs about the book last week and have only just finished the first chapter. So, rather than write a review, I'll reproduce a section of the Introduction that gives a short description of each chapter. Kling certainly has a unique perspective and I suspect I'll learn a lot from this relatively short book.

“Filling in Frameworks” wrestles with the misconception that economics is a science. This section looks at the difficulties that economists face in trying to adopt scientific methods. I suggest that economics differs from the natural sciences in that we have to rely much less on verifiable hypotheses and much more on hard-to-verify interpretative frameworks. Economic analysis is a challenge, because judging interpretive frameworks is actually harder than verifying scientific hypotheses. 

“Machine as Metaphor” attacks the misconception held by many economists and embodied in many textbooks that the economy can be analyzed like a machine. This section looks at a widely used but misguided approach to economic analysis, treating it as if it were engineering. The economic engineers are stuck in a mindset that grew out of the Second World War, a conflict that was dominated by airplanes, tanks, and other machines. Their approach fails to take account of the many nonmechanistic aspects of the economy. 

“Instructions and Incentives” deals with the misconception that economic activity is directed by planners. This section explains that although people within a firm are guided to tasks through instruction from managers, the economy as a whole is not coordinated that way. Instead, the price system functions as the coordination mechanism. 

“Choices and Commands” is concerned with the misconceptions held by socialists and others who disparage the market system. This section explains why a decentralized price system can work better than a centralized command system. Central planning faces an information problem, an incentive problem, and an innovation problem. 

“Specialization and Sustainability” exposes the misconception that we must undertake extraordinary efforts in order to conserve specific resources. This section explains how the price system guides the economy toward sustainable use of resources. In contrast, individuals who attempt to override the price system through their individual choices or by imposing government regulations can easily miscalculate the costs of their actions. 

“Trade and Trust” addresses the misconception among some libertarians that the institutional infrastructure needed to support specialization and trade is minimal. Instead, this section suggests that for specialization to thrive, societies must reward and punish people according to whether they play by rules that facilitate specialization and trade. A variety of cultural norms, civic organizations, and government institutions serve this purpose, but each of those institutions has its drawbacks. 

“Finance and Fluctuations” deals with the misconceptions about finance that are common among economists, who often fail to appreciate the process of financial intermediation. This section looks at the special role played by financial intermediaries in enabling specialization. Intermediation is particularly dependent on trust, and as that trust ebbs and flows, the financial sector can amplify fluctuations in the economy’s ability to create patterns of sustainable specialization and trade. 

“Policy in Practice” corrects the misconception that diagnosis and treatment of “market failure” is straightforward. This section looks at challenges facing economists and policymakers trying to use the theory of market failure. The example I use is housing finance policy during the run-up to the financial crisis of 2008. The policy process was overwhelmed by the complexity of the specialization that emerged in housing finance. Moreover, the basic thrust of policy was determined by interest-group influence. The lesson is that a very large gap exists between the economic theory of public goods and the practical execution of policy. 

“Macroeconomics and Misgivings” argues that it is a misconception, albeit one that is well entrenched in the minds of both professional economists and the general public, to think of the economy as an engine with spending as its gas pedal. This section presents an alternative to the mainstream Keynesian and monetarist traditions. I argue that fluctuations in employment arise from changes in the patterns of specialization and trade. Discovering new patterns of sustainable specialization and trade is more complex and subtle and less mechanical than what is assumed by the Keynesian and monetarist traditions.

Potpourri

There's much ado about Bt traits lately.

Caroline Baum comments on Larry Summers' regulation epiphany. Sometimes a mundane personal event can have more impact that reams of data.

Arnold Kling looks at housing policy through the lens of supply and demand.

Speaking of housing, how high are house prices really?

Kevin Dowd tells a tale of mistakes, corrections, apologies, and disdain for the facts.

We're All Utilitarians Now?

by Levi Russell

As an avid EconTalk listener, I often hear Russ Roberts, the host, talk about his skepticism of many aspects of modern economics. I'm usually at least a little sympathetic with Russ's point of view, but a recent Wall Street Journal interview featuring Roberts threw me off:

Economics fancies itself a science, and Mr. Roberts used to believe, as many of his peers do, that practitioners could draw dispassionate conclusions. But he has in recent years undergone something of a crisis of economic faith. "The problem is, you can't look at the data objectively most of the time," he says. "You have prior beliefs that are methodological or ideological about the impact of things, and that inevitably color the assumptions you make." 

A recent survey of 131 economists by Anthony Randazzo and Jonathan Haidt found that their answers to moral questions predicted their answers to empirical ones. An economist who defines "fairness" as equality of outcome might be more likely to say that austerity hurts growth, or that single-payer health care would bend the cost curve. The paper's authors quote Milton Friedman's brief for "value-free economics" and reply that such a thing "is no more likely to exist than is the frictionless world of high school physics problems."

I certainly think our interests and ideology can steer us into asking certain questions, but I'm not sure I agree that it affects the results of our analyses as much as Roberts seems to think. The deeper issue just might be the following: our cost/benefit analyses implicitly assume a utilitarian worldview. Thus, when asked about our policy views, we are more likely to narrow our own morality to fit within the confines of utilitarianism. If a cost/benefit analysis comes out in favor of Policy X, are we not expected to favor Policy X even if our analysis didn't include other moral goods such as freedom or justice? Are we, as economists, all utilitarians?

The other day I happened to run across an article by philosopher Rutger Claassen in the Journal of Institutional Economics entitled "Externalities as a Basis for Regulation: A Philosophical View" that addresses this deeper issue. Here's an excerpt from the introduction:

Thus, the main question of the paper simply is: when should an externality be reason for state intervention? Which externalities deserve internalization? The aim of the paper is to show that the utilitarian criterion for answering this question which is embedded in economic analyses is implausible. Instead, I will argue that we need to follow those philosophers who have argued in the line of John Stuart Mill, in favor of the harm principle. Externalities are structurally analogous to harms in political philosophy. Work on the harm principle, however, points to the need for a theory of basic human interests to operationalize the concept of harm/externalities. In the end, therefore we need to fill in judgments about externalities with judgments about basic human interests. If my analysis  is convincing, then one overarching point of importance for the whole tradition of market failure theories emerges. This is what the customary attitude to the issue, to juxtapose economic theories and philosophical grounds for regulation, is highly problematic. It is telling that most handbooks on regulation start with an overview of market failures, and then add to these efficiency-based rationales some philosophical reasons for regulating: usually social justice (equity) reasons and moralistic/paternalist reasons. Instead we need to integrate both frameworks, by showing how philosophical pre-suppositions are at work within economic categories of market failure.

The author begins by discussing Pigovian and Coasean perspectives on externalities and how to deal with them. Claassen does a good job explaining both perspectives and mentions that transactions costs are a problem for both market participants and for government regulators.

The bulk of the article is dedicated to Claassen's criticism of the utilitarian perspective taken by the bulk of economic policy analysis, and discussing the harm principle as a better basis for normative analysis in economics. Specifically, he discusses 1) moral externalities which arise "from preferences about other people's behavior," 2) pecuniary externalities which are losses/gains due to changes in consumer preferences, technological innovation, or competition, and 3) positional externalities which "arise where consumers lose welfare because they compare themselves to others."

He concludes the section:

These cases point to different problems with a purely utilitarian calculus: it ignores issues of individual freedom (moralistic externalities) and justice (pecuniary externalities); and the calculus itself is highly indeterminate (positional externalities). However, philosophers thus far have been stronger at criticizing economic externality analyses than at providing an alternative. Can we find a more solid ground for a normative analysis of externalities?

The rest of the article develops his theory of "basic interests" and applies the theory to the Supreme Court's June 2012 verdict on the "individual mandate" found in the Affordable Care Act (Obamacare). I leave these to the interested reader.

Here's Claassen's conclusion:

This paper has aimed to establish three conclusions. First, economic externalities analyses are probelmatic because they ignore important normative considerations about individual freedom and justice, largely due to their utilitarian grounding (section 3). Second, some philosophers have proposed to exploit the analogy with the harm principle in liberal political philosophy. however, if we follow up on this suggestion and explore representative theories of harm (such as those by Joel Feinberg or Joseph Raz), this points to the need for a theory of basic human interests that does the real normative work in diagnosing harms. Such a theory is needed to evaluate which externalities call for state regulation (section 4). Third, what these basic interests are, in the end, is a matter of political dispute. Economists who have complained about the politicization of externality analyses have simply failed to accept the inherently political nature of questions about the organization of social and economic life. [emphasis mine]

Claassen's paper raises some important issues with the current moral underpinnings of economic analysis and challenges us to think more deeply about the assumptions we make about morality in normative analysis. As policymakers rely more and more on economic analysis, it's good to see these issues being addressed.

More Mercatus Center Research on State Tax Reform

by Levi Russell

In a previous post I shared a comparison of the results of tax reform in Utah and Kansas. That comparison was part of a broader analysis of reform efforts in 5 states: Kansas, Michigan, North Carolina, Rhode Island, and Utah. The report provides a detailed analysis of reform efforts and draws some general conclusions about how reform should be implemented.

The  authors generally report good news for the states in terms of government fiscal health. Kansas is an exception. Here's one of the "common trends" identified in the report:

The most effective tax reforms seem to be those that both lower the rates of taxation and simultaneously broaden the scope of activities that are taxed. Such reforms improve the efficiency, convenience, and transparency of a tax system.

 This is the opposite of what Kansas has done. Unlike North Carolina, Kansas politicians failed to couple the tax reform effort with orderly spending cuts. Further, as the report notes, Kansas narrowed its tax base in a distortionary way:

Kansas also made the decision to exempt “pass-through” profits from corporate taxation; that is, business income that is taxed on individual business owners’ tax returns. While this lowers the tax burden on businesses, it creates distortions in the way business owners choose to classify their operations. Moreover, it is inequitable because it disproportionately benefits high earners and creates an unfair playing field among businesses.

There has certainly been a lot of media coverage of Kansas' state government budget information. Another Mercatus paper compares state government fiscal situation data from all 50 states and Puerto Rico in 2014. Kansas is 27th of the 51 states/territories examined. This doesn't sound consistent with the dominant narrative in the media.

How has the reform effort affected the private economies in these states? Below is a graph of private GDP indices for the five states listed above, the US as a whole, and two other states that are, to put it mildly, in big trouble fiscally: California and Illinois. It's tough to draw any general conclusions. Michigan, Utah and California are all doing quite well relative to the US as a whole. Michigan and Utah have had significant tax and spending reductions; California hasn't. Illinois, Kansas, North Carolina, and Rhode Island are all lagging relative to the US as a whole. Kansas and Illinois had pretty flat growth from 2012 to early 2014, but have picked up recently. Kansas in particular seems to be catching up to the US as a whole. North Carolina has been catching up at a feverish pace.


Quantity Index for Real Private State GDP - BEA

click image to enlarge

Yet another Mercatus paper provides a short review of the literature on the relationship between state tax policy and the economic health of the state. Here's the relevant paragraph:

Research finds that higher state taxes are generally associated with lower economic performance. There is somewhat weaker evidence that state and local taxes can significantly reduce income growth within a state, particularly when the revenues raised are devoted to transfer payments. More recent research corroborates this finding in relation to net investment and employment. However, when additional tax revenue is used to improve the quality of public goods and services, economic growth may increase. When looking at business activity more broadly, more comprehensive reviews of the literature find higher taxes to be associated with less economic growth. They also find this relationship to be stronger within metropolitan areas than across metropolitan areas, which means that local taxes have a larger effect on economic growth when it is less costly for firms and taxpayers to relocate to avoid the tax.

Legal and Economic Implications of Farm Data

by Ashley Ellixson

Discussions of farm data are a hot topic not only in today’s agricultural industry but also across the legal field.  I recently authored an article that describes the legal and economic concerns surrounding data ownership, privacy rights, and possible recourse in event of intentional data breach.  The publication aims to answer the questions around “who owns farm data?”, “what happens when farm data is misappropriated?” and “what can I do to protect my farm’s data?”  These questions and many more are swirling around industry, legislatures, and farm organizations.  

Until the law defines farm data or a court speaks to the protections of such data, experts in the field can only suggest best management practices (both at the farm-level and the legal liability level). From the farm perspective, not only the law but the relative value of farm data will direct the optimal choice for damages, if any. Damages may be realized as loss of local bargaining power or a direct cost to the farmer; however, only time will tell. This collaborative effort between Kansas State University and University of Maryland can be found on the AgManager.info website.  

Ashley Ellixson, J.D., LL.M. 

Guest Contributor

@Legally_Ashley

E-mail

I Can't Put Enough Scare Quotes Around "Free Market"

by Levi Russell

Earlier this month I read a couple of fantastic posts over at the Coordination Problem blog. The common thread between the two posts is that the "free market" moniker given to many individual economists and schools of thought is really about the conclusions reached through rigorous analysis of real-world institutions, not about any sort of ideological assumption.

The first is a lengthy post by Peter Boettke. Boettke lays out his perspective of the "economic way of thinking" and describes how it's used to analyze the real world:

From my perspective there is a core of the economic way of thinking that can be traced from Adam Smith to Vernon Smith and that deals with basic ideas about human rationality, human sociability, and the coordination of activity through time.  Incentives, Information, and Innovation are part of this core as they derive from the even more primordial ideas of property, prices, and profit/loss accounting.  We live in a world of scarcity, scarcity implies that we face trade-offs, that means we must negotiate those trade-offs and we hope to do so in the most effective way possible, to achieve that we need aids to the human mind, those aids come in the form of high powered incentives and clear signals so we may engaged in the economic calculus.  One of the many implications that follows is that demand curves will slope downward and supply curves will slope upward.  The shape and the magnitude of the effects that follows are empirical matters and is largely determined by the array of substitutes available to economic decision makers.  But the essential logic holds from a style of reasoning that attempts to derive the invisible hand theorem from the rational choice postulate via institutional analysis.  Hume's principles of stability of possession, transference by consent, and the keeping of promises -- in other words, property, contract and consent -- provides that institutional infrastructure within which the human pursuit of individual betterment is channeled in commercial life into publicly desirable outcomes (e.g., wealth creation and generalized prosperity; the least advantaged are made better off).  Again, property, prices and profit/loss gives economic actors high powered incentives and informational signals to allocate resources, time and effort to the most highly valued use, and the constant feedback on whether those decisions are the right ones and the incentives and information to constantly adapt and adjust to improve in the decision calculus. 

This basic economic calculus applies to all human endeavors, and when we find ourselves outside of the realm of the market sphere of monetary calculation, the question for the analyst is what institutions will serve the same function in terms of incentives, information and innovation that property, prices and profit/loss served in the marketplace.  Does electoral politics possess those institutional proxies?  Does the bureaucratic organization of public administration? How about the philanthropic entities in the non-profit sector?  This would be an implication of the economic way of thinking -- how do people weigh the marginal costs/marginal benefits of decisions in the different contexts of human interaction? 

Nothing about what I have said is "libertarian" or "free market", but it is economics.  Consider, for example, a report that was on NPR this morning as part of a series that is being developed on Politics in Real Life as the campaign season moves from primaries to the main event in 2016 -- it was on Paid Family Leave.  Again, the economist in me kicks in while hearing the story -- not the libertarian or free market, but economists.  Thus, I want to think about Means-Ends and the logical consequences of the various proposed means to obtain the desired end, and I want to learn from as much empirically as one can from historically analogous policy experience.  I empathize with the Ends sought and do not question them in the least, my concern is solely with whether the proposed means would achieve the ends sought and at what cost.  This requires recognizing that Paid Family Leave will have its impact on the labor market, and also one must think about the impact on the least advantaged in the labor market -- not the most advantaged, because the tragedy that motivates our initial concern is not the impact on the most privileged in the work force, but the least advantaged -- in economic jargon, the marginal employee.

 Boettke concludes:

But what if, I ask, the very social ills we see before us are due not to malfeasance but due to the logic of individual decision making within the institutional context so reorganized.  The same style of reasoning that explains why individuals pursuing their self-interest can produce publicly desirable outcomes such as productive specialization and peaceful social cooperation within a specific institutional context also explains why that pursuit of self-interest in other institutional contexts results in social tragedies and social tensions. 

That is ECONOMICS, not "libertarian" nor even "free market", but just ECONOMICS pursued persistently and consistently.  And unless we get away from the habit of labeling folks and arguments in order to pigeon hole and disregard our intellectual cultural will continue to fail to understand what is causing the social ills that plague us, let alone encourage creative thinking about how to address these social ills.  That would be tragic on so many dimensions.

The whole post is certainly worth a read.

Another much shorter post by Steve Horwitz also fits into this same theme.

I have been thinking a lot about the misunderstandings of Hayek's "The Use of Knowledge in Society" essay. Below I offer what I think is a quick summary of his argument that stresses both the importance of private property and the price system as jointly necessary for economic coordination.

1. Knowledge IS decentralized in that each of us has our own personal knowledge of time and place (and that is often tacit).

2. Therefore, planning and control over resources SHOULD BE decentralized so that people can take advantage of those forms of knowledge.

3. HOWEVER, decentralization of control over resources (what Hayek calls "several property") is necessary BUT NOT SUFFICIENT for social coordination.

4. Effective decentralized planning also requires that people have access, in some form, to the bits of knowledge that other people have so that they can form better plans and have better feedback as to the success and failure of those plans.

5. Providing that knowledge is the primary function of the price system. Prices serve as knowledge surrogates to enable people's individual knowledge and "fields of vision" to sufficiently overlap so that our plans get COORDINATED. 

6. In other words: decentralized control over resources is NECESSARY BUT NOT SUFFICIENT for a functioning economy. Such decentralization requires some process that actually ensures that separately made decisions are, to a significant degree, based on as much knowledge as possible so that economic coordination can be achieved. That is what the price system enables us to do. [EDIT: and the prices in question are not, and need not be, equilibrium prices.]

Decentralized decision making without a price system will produce very little coordination and prosperity. Centralized decision making will render a price system useless for economic coordination.

The fact of decentralized knowledge requires that an economy capable of producing increased prosperity for all has both decentralized decision-making (private/several property) and a price system to coordinate those decisions.