Boetkke on Buchanan

by Levi Russell

I've enjoyed reading every bit of George Mason University economist Peter Boettke's work that I've had the time to read in the past several years. His work is very interesting in part because he addresses issues most of us don't spend a lot of time on. In this post, I reproduce some of my favorite quotes from a recent speech Boettke gave. The speech focuses on Jim Buchanan's perspective on economics generally and political economy specifically. As usual, I suggest you read the whole speech, as it is very good and very short.

The problem as Buchanan sees it is that economics as a discipline has a public purpose, but modern economists have shirked on that purpose and yet are still being rewarded as if they were earnestly working to meet their educational obligation. As he put it:“I have often argued that there is only one ‘principle’ in economics that is worth stressing, and that the economist’s didactic function is one of conveying some understanding of this principle to the public at large. Apart from this principle, there would be no general basis for general public support for economics as a legitimate academic discipline, no place for ‘economics’ as an appropriate part of a ‘liberal’ educational curriculum. I refer, of course, to the principle of the spontaneous order of the market, which was the great intellectual discovery of the eighteenth century” (1977 [2000]: 96).

Prices serve this guiding role, profits lure them, losses discipline them, and all of that is made possible due to an institutional environment of property, contract and consent. These are the basic principles from which we work in economics. Important to note, economic analysis relies neither on any notion of hyper rational actors myopically concerned with maximizing monetary rewards, nor on postulating perfectly competitive markets. It relies simply on the notion that fallible yet capable human beings are striving to better their situation, and in so doing enter into exchange relations with others. Atomistic individualism and mechanistic notions of the market is, as Buchanan has stressed, nonsensical social science.

From a Buchanan perspective, basic economics can be conveyed in 8 points.
1.Economics is a "science" but not like the physical sciences. Economics is a "philosophical" science and the strictures against scientism offered by Frank Knight and F. A. Hayek should be heeded.
2. Economics is about choice and processes of adjustment, not states of rest.Equilibrium models are only useful when we recognize their limits.
3. Economics is about exchange, not about maximizing. Exchange activity and arbitrage should be the central focus of economic analysis.
4. Economics is about individual actors, not collective entities. Only individuals choose.
5. Economics is about a game played within rules.
6. Economics cannot be studied properly outside of politics. The choices among different rules of the game cannot be ignored.
7. The most important function of economics as a discipline is its didactic role in explaining the principle of spontaneous order.
8. Economic [sic] is elementary.

A Lawyer and a Physicist Walk Into a Bar

by Levi Russell

A lawyer and a physicist walk into a bar... 

I don't have a good joke for that intro, but I do have a punchline: physicist Mark Buchanan's recent Bloomberg View column entitled "The Misunderstanding at the Core of Economics." What is this misunderstanding, you ask? Well, it's the (mistaken) belief that markets are perfect. This belief, Buchanan alleges, is widely held among professional economists. Buchanan argues that this widespread belief has had tragic consequences:

Economists routinely use the framework to form their views on everything from taxation to global trade -- portraying it as a value-free, scientific approach, when in fact it carries a hidden ideology that casts completely free markets as the ideal. Thus, when markets break down, the solution inevitably entails removing barriers to their proper functioning: privatize healthcare, education or social security, keep working to free up trade, or make labor markets more “flexible.”

Those prescriptions have all too often failed, as the 2008 financial crisis eloquently demonstrated. ...

The trouble with all of this is that none of it is true. If political party affiliation is any indication, the fact that academic economists are overwhelmingly Democrat indicates that pro-market utopianism isn't widespread. Another survey indicates that a mere 8% of academic economists can be considered supporters of free-market principles and only 3% are strong supporters. In terms of economists, Buchanan's only reference is to the late Kenneth Arrow. He provides no evidence that a massive swath of the profession are all free-market ideologues incapable of nuance. Buchanan cites one newly-popular economic commentator, an historian and lawyer, James Kwak. Kwak has been roundly criticized by economists for his simplistic analysis of economic phenomena many times, notably here, here, here, and here and many other times over the years.

So-called "free market" economists are far more nuanced in their views of market and government solutions to the problems in our imperfect world inhabited by imperfect human beings. A short but accurate summary would be something like: "In the real world, markets are, for the most part, better at dealing with externalities and other economic problems than actually-existing governments staffed by actually-existing politicians and bureaucrats." That is, no institutional arrangement is perfect, but the problems associated with voluntarily and spontaneously generated institutions are usually relatively minor when compared with those associated with institutions designed by a central authority. Examples of this nuanced position can be found in previous Farmer Hayek posts here, here, here, here, here, and here, as well as in the writings of Jim Buchanan, Gordon Tullock, Deirdre McCloskey, Pete Boettke, etc. A closer reading of these and other "free market" economists might change Buchanan's mind about the types and level of analysis that leads to "free market" conclusions.

Can Plows Create Mountain Ranges?

by Levi Russell

According to the EPA, the Clean Water Act does not require a permit for normal agricultural practices including the following:

Normal farming, silviculture, and ranching practices. Those activities include plowing, seeding, cultivating, minor drainage, and harvesting for production of food, fiber, and forest products.

Upland soil and water conservation practices.

Agricultural stormwater discharges.

Return flows from irrigated agriculture.

Construction and maintenance of farm or stock ponds or irrigation ditches on dry land.

Maintenance of drainage ditches.

Construction or maintenance of farm, forest, and temporary mining roads.

That sounds pretty comprehensive to me, but the EPA and US Army Corps of Engineers has apparently decided to circumvent their own rule. A report released by the Majority Staff of the Senate Committee on Environmental and Public Works claims that

Landowners will not be able to rely on current statutory exemptions or the new regulatory exemptions because the agencies have narrowed the exemptions in practice and simply regulate under another name.  For example, if activity takes place on land that is wet: 
- plowing to shallow depths is not exempt when the Corps calls the soil between furrows “mini mountain ranges,” “uplands,” and “dry land;”
- discing is regulated even though it is a type of plowing;
- changing from one agricultural commodity constitutes a new use that eliminates the exemption; and 
- puddles, tire ruts, sheet flow, and standing water all can be renamed “disturbed wetlands” and regulated. 

This expansion of jurisdiction is apparently not what the EPA previously claimed it would be. If farmers are required to get permits to cultivate the soil, I'd bet on a couple of things:
1) the average farm size will grow dramatically as smaller farmers go out of business very quickly;
2) food prices will rise, or will fall more slowly than they otherwise would.

I doubt the average person looking at this situation would call those outcomes "good" but they're highly likely in my opinion. As Public Choice theory indicates, the EPA is not a residual claimant with regard to its policies, so its incentives are not as well-aligned as are the owner of the typical non-monopoly firm. Further, the EPA has plenty of incentive to increase the quantity of work for its employees and lawyers. This question remains: Will the farm lobby be able to keep their exemptions?

Anti-Trust vs Regulation: The Case of Baysanto

by Levi Russell

Bayer's impending purchase of Monsanto is all over the news lately. As is typical in these situations, the conversation centers around concerns of increasing market power and monopoly profits. Regular readers might expect me to focus on the notion that industry concentration doesn't necessarily imply welfare losses, but I'm not.

It seems to me that the relationship between anti-trust legislation and regulation is an under-discussed issue in these cases. Agribusiness firms are heavily regulated by three of the most powerful regulators in the US: the FDA, the USDA, and the EPA. Many regulations function as fixed costs, implying that there are economies of scale in regulatory compliance. Thus, the greater the regulatory burden placed on firms in an industry, the greater the inducement to merge.

These regulatory economies of scale militate directly against the goals of anti-trust policy. The latter, perhaps as an unintended consequence, gives us fewer and larger firms while the latter attempts to reign in these cost-saving mergers in the name of competition. If we're going to seriously discuss regulation and anti-trust, we need to be cognizant of the interplay between them.

Of course, there are plenty of problems with the regulatory revolving door and other public choice issues to deal with as well. On this front, it seems fairly obvious that the incentive to rent-seek is positively correlated with the prize being offered. Perhaps this is an argument for less power vested in the administrative state and more power returned to the courts.

Beef Trade and the TPP

by Levi Russell

As one of my colleagues recently pointed out at an Extension meeting, both major-party candidates are (at least claiming to be) anti-international-trade. It's true that trade restrictions would be harmful to many segments of the U.S. agriculture sector, including beef. I ran across a great article in Beef Magazine last month that shows the U.S.' top trade partners. The chart below is lifted from the article.

As you can see, Australia is responsible for a substantial proportion of beef (not cattle) imports into the U.S. Our exports go primarily to Asian markets and our geographical neighbors. The article goes into some detail about the recent change in fresh beef imports from Brazil. The new policy is a tariff-rate-quota; details are available in the article and in this video.

Since I strive to tell the other side of the story as fairly as possible, I thought I'd link to what I believe is the most sophisticated argument against the Trans Pacific Partnership I've read. I recommend reading it, even if you are pro-TPP.

Mandated GMO Labels: A Regressive Tax

by Levi Russell

The predictable effects of mandatory GMO labeling will be felt very soon in Vermont and those with low incomes will be especially hard-hit. Supermarkets in the state will lose some 3,000 products from their shelves. The video on this news story is telling: people don't seem to know much about GMOs and don't really think about the negative effects of mandatory labeling. Anti-GMO organizations such as Greenpeace have been accused of running a fear campaign that isn't supported by scientific evidence. There's no evidence that GMOs are harmful to people, but a law requiring them to be labeled very likely will be.

The federal law passed in the Senate will require companies to use QR codes or dedicated websites to provide information about the presence of genetically modified organisms in their food. The compliance costs associated with this law include the addition of the QR code or website URL to the packaging, the development of the databases with the required information, and the maintenance of this database as farming practices and ingredients change. The latter two will likely be far higher than the former and will affect food prices for the foreseeable future.

Here are some of the potential indirect effects:

1) Less consumer choice - The article linked above shows that this is already becoming a reality. I suspect those 3,000 products will come back to shelves eventually, but the development of new products is now more costly due to the necessity of adding information to GMO databases.

2) Higher prices - Additional costs to food companies will effectively shift the food supply curve to the left and raise prices.

3) Less innovation - Though "very small" food companies are exempted from the rule, many startups are created with the goal of becoming mass-market products (If you don't believe me, just watch an episode of "Shark Tank."). This requirement will be another cobweb of red tape these companies have to get through to get on consumer shelves.

Maybe all these costs are worth it. Given the lack of scientific evidence of harm and the fact that humans have been modifying the genetics of food in a far more haphazard way for a very, very long time, I have my doubts. The reality is that the costs mentioned above will fall disproportionately on those with the lowest incomes. Those with moderate to high incomes will be able to pay more for the food they really want, but for those who spend a substantial portion of their income on food already will find it harder to make other ends meet.

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.

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.

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.

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.

Intentions, Faith, and the Nirvana Fallacy

I've addressed the Nirvana Fallacy several times on this blog, and keep finding new examples of it, especially in the popular press. Many economists seem to be unaware of this fallacy and Mark Thoma is no exception. I've critiqued him previously on this issue, but his most recent commission of the fallacy is especially interesting. Below I share key parts of his recent CBS News column (in block quotes) with some of my commentary.

The Nirvana Fallacy, as put forth by UCLA economist Harold Demsetz, is the comparison of real-world phenomena to unrealistic ideals. The mere fact that economic models can specify a perfect policy solution to a problem doesn't imply that real-world political and legal institutions can successfully implement that policy. More importantly, though, imperfections in markets which are the result of informational inefficiencies can't be solved readily by governments because the governments themselves lack the necessary information.

In addition to being quite confident about the ability of economic models to generate policies that "break up monopoly" and "force firms to pay the full cost of pollution they cause," Thoma seems to put a lot of stock in the intentions of regulators and politicians.

When government steps in to try to correct these market failures -- breaking up a monopoly, regulating financial markets, forcing firms to pay the full cost of the pollution they cause, ensuring that product information is accurate and so on -- it's not an attempt to interfere with markets or to serve political interests. It's an attempt to make these markets conform as closely as possible to the conditions required for competitive markets to flourish. 

The goal is to make these markets work better, to support the market system rather than undermine it.

It may very well be that all legislators and regulators have the purest of intentions. Even so, that doesn't imply that their policies will actually achieve the results they desire. Good intentions are a necessary but not sufficient condition for efficient and effective government solutions. Decades of work in public choice economics and more recent work in behavioral public choice show that the implementation of government policies is fraught with its own government failures. Why doesn't Thoma mention these?

Perhaps the clearest example of the Nirvana Fallacy in Thoma's column comes a few paragraphs down:

In other cases, it's less well understood that failure is the reason for the government to regulate a market, or even provide the goods and services itself. Social security and health care come to mind. But once again, the private sector's failure to deliver these goods at the lowest possible price, or to deliver them at all, is at the heart of the government's involvement in these markets. (emphases mine)

Here we have Thoma's standard for real world markets. They must deliver certain goods and services at the lowest possible price. What does he mean by "possible?" Possible in the abstract world of economic theory? Why is this a relevant comparison? Does Thoma also propose we hold the actual activities of politicians and regulators to such an ideal?

Further, I'm not sure what he means by "deliver them at all." We have accidental death and dismemberment insurance, life insurance, and health insurance in private markets and have had them for a long time. We've had health care for much longer than the government has been as heavily involved as it is now. In fact, the evidence suggests that political favoritism killed a very useful alternative health care system for the poor and blue-collar folks back in the 1930s. On the insurance side of things, it's at least plausible that increases in payroll taxes decades ago helped bring about employer-provided insurance and exacerbate the problem of preexisting conditions.

Finally, let's unpack the last two paragraphs in Thoma's column. He writes:

Conservatives tend to have more faith in the ability of markets to self-correct when problems exist, and less faith in government's ability to step in and fix market failures without creating even more problems. Honest differences on this point are likely, but there are certainly cases where most people would agree that some sort of action is needed to overcome significant market failures.

Where to start? From his use of the word "conservative" as the only descriptor of his intellectual opponents, it's clear that Thoma is thinking about this as a purely political issue, not as a technical economic issue. He also seems to think that mere faith is the only reason someone might disagree with his view. Conservatives, he says, have more faith in markets and less faith in governments. Again, the public choice literature documents quite well the problems actual politicians and regulators have with implementing the idealized policies derived from economic models. He goes on to say that honest differences are "likely," not "possibly justified" or "important to consider." It seems Thoma can't conceive of a reason for his opponents to doubt the ability of the government to fix the problems he sees with the world outside of pure ideology.

Thoma's final paragraph really demonstrates the problems with the static model through which he views the world:

However, when ideological or political goals (such as lower taxes for the wealthy or reduced regulation so that businesses can exploit market imperfections) lead to attacks on those who call for government to make markets work better -- often in the guise of getting government out of the way of the market system -- it undermines government's ability to promote the competitive market system the opponents claim to support.

Government regulations essentially amount to fixed costs that prevent new firms from entering markets and existing smaller firms from competing with larger firms. Maybe these regulations are still justified, but it's not plainly obvious using the static model Thoma seems to prefer. From their inception, anti-trust suits were and still are brought mostly by competitors, not consumers. A look at the data from the late 19th and early 20th centuries doesn't tell the same "Robber Baron" story we hear in 9th grade history texts. Output was expanding and prices falling in the industries accused of being dominated by monopolies.

Richard Langlois' recent testimony to the British Parliament on dynamic competition provides some important critiques of static models. Here are some excerpts:

On monopoly and barriers to entry:

There are only two ways that a platform can maintain prices above marginal costs. One is to be more efficient that one’s competitors – to have lower costs, for example. Such a situation would not be “policy relevant,” in the sense that taking regulatory or antitrust action against the more-efficient competitor would make society worse off. The other way to maintain price durably above marginal cost is to have a barrier to entry.  

The static and dynamic views are in agreement that competition requires free entry. Taking a static view often leads to intellectual confusions about the nature of barriers to entry (that they can arise from the shape of cost curves, for example); but in the dynamic view it is clear that barriers to entry are always property rights – legal rights to exclude others.(1) For example, one can have a monopoly on newly-mined diamonds if one owns all the known underground reserves of diamonds. More typically, especially in the case of platforms, the property rights involved are government-created rights of exclusion, either in the form of intellectual property or regulatory barriers.

On the abuse of market power:

What if it is customers who complain about the “abuse” of market power? To an economist, the problem with market power is the (static) inefficiency it creates. There is no such thing as the “abuse” of market power. Economists have understood for some time that a firm possessing market power cannot by its own actions increase that market power. The only way a firm can get market power (apart from being more efficient) is to possess a barrier to entry. What many see as “abuses” are usually what modern-day economists have come to call non-standard contracts: contractual practices beyond the simple calling out of prices in a market, practices that seem “restrictive.” These practices are often solutions to a much more complicated problem of production and sales than is contemplated in the simplified models of market power. They are very frequently an effort to overcome problems created by high transaction costs.(2)

The quality of discussions of the benefits of government intervention would be greatly improved if some notion of the costs of such intervention were mentioned. This would include discussions of dynamic models of competition and the explicit admission that politicians and regulators are subject to the same cognitive biases and information problems that cause real-world markets to deviate from the perfection of static economic models.

Taxes as Social Engineering

Cornell economist Robert Frank recently appeared on probably the best economics podcast on the web, EconTalk. Frank was there to discuss his recent book on the role of luck in successful folks' lives. The conversation was interesting and Frank certainly has a unique perspective. He makes some clever observations but I wasn't convinced of his conclusions. I encourage Farmer Hayek readers to listen to the podcast and check out the comments here and here for some good counterpoints to Frank's positions if you're interested.

Instead of taking Frank's comments head on, I want to discuss what seems like a background assumption he makes. Frank's overall point is that since luck (specifically good luck) plays an under-appreciated role in our success, we should favor higher taxes on the wealthy. This would provide additional funds to beleaguered governments which he asserts are low on funds for infrastructure. More importantly, though, it would ensure that the wealthy would spend less money on things that don't make "anybody any happier."

Frank provides almost nothing in terms of evidence of his claims other than his own personal experiences (see the comments linked above), but even assuming he's correct about the particular facts he lays out, there's a more fundamental problem. It might very well be that declining quality of public infrastructure has more to do with simple mismanagement of resources, rather than a lack of tax revenue. Hayek's work implies that government planners are less effective at directing resources than decentralized owners of "several property" because the former simply can't gather the necessary information to plan efficiently. (see here, page 85) Much of the information necessary for an orderly economy is tacit and ever-changing such that any amount of computing power is insufficient to create the sort of plan Frank seems to believe we need.

To be clear, it's not that markets are perfect, simply that they are more likely to be better than centralized decision makers at allocating scarce resources. The knowledge required to do so is dispersed and tacit, As Hayek puts it:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.

I can't resist a couple of final points. Though Frank disputes it, it's pretty clear that taxes on the wealthy do affect their choice of location (here and here). Frank uses a Rawlsian ethic that is quite common in business ethics courses. However, it's not altogether obvious that Rawls' ideas can be used to justify the policies Frank favors.

Potpourri

David Widmar at Agricultural Economic Insights has some interesting maps showing the run-up in ag land values from 2004-2014. Check it out!

The folks at the Pro Market Blog (a new blog associated with the Stigler Center at U Chicago) use survey data to show Americans' concerns about the influence campaign donors have on candidates. Trump and Sanders are seen as the most removed from these concerns.

Here's a short podcast interview with Bill Easterly (NYU) who works in international development. Easterly is famous for his skepticism of the benefits of foreign aid.

Don Boudreaux, in his characteristic style, criticizes Krugman for his support of trade protectionism. (here and here)

James Pethokoukis blogs about Deirdre McCloskey's work on economic history and what made the west prosperous.

Relatively Good Regulation - GMO Edition

In previous posts on food labeling I've discussed food labels and the information they provide as well as possible reasons why a private GMO label hasn't already appeared. In this post, I'll discuss the reasons commodity groups are in favor of federal GMO labeling legislation.

Senator Pat Roberts (R-Kansas) recently introduced legislation that would establish federal guidelines for GMO labeling. The law would preempt state mandates for GMO food labels and start an educational campaign for the public on the safety of GMO foods.

The question isn't whether farmers, food companies, and retailers believe the guidelines are good for them financially but whether these guidelines are better than the relevant alternative. I'd wager that food companies would, in an ideal world, prefer to label their food in a manner that maximizes their profit.

Since that world doesn't exist, and there's a credible threat that interest groups in some states will successfully pass legislation mandating GMO labels, federal preemption of such laws is preferable. For producer groups, federal preemption makes it less likely that potential discounts on conventionally-produced food will be passed on to them. Additionally, the cost of educating consumers will not be borne by food companies, retailers, and farmers but by taxpayers.

As I argued in a previous post, the tremendous cost of educating the public on the safety of GMO foods is one possible reason why we haven't seen widespread efforts by food companies or third parties to create a GMO labeling scheme.  Another possible reason is the presence of substitute labels. Many consumers who are concerned about the safety of GMO food might be content buying food labeled "organic."

The more I think about it, though, the more I'm convinced that the main reason we haven't seen a third-party, private effort to create a GMO label is that the public generally trusts only the federal government to ensure food safety. It's true we have all sorts of private labels informing consumers of the characteristics of the food they buy, but safety is a separate issue in most people's minds.

The new legislation introduced is likely to be a net benefit to farmers, food companies, and retailers. They'll be shielded from the risk of more onerous regulation at the state level and won't have to bear the cost of educating the public about GMO safety. This makes the bill, from their points of view, relatively good regulation.

Off-Topic - The Stagnation of the American Middle Class

Don Boudreaux (GMU Econ) recently gave a talk at the Economics Club meeting at my alma mater.

Since Boudreaux is such a dynamic speaker and so well informed on this topic, I thought I'd share it with FH readers even though it isn't one of the typical topics we cover.

I'd suggest starting at 3:10 and adjusting the speed (using the gear button at the bottom right) to 1.25 since it's a rather long talk.

Cooperation Between Environmentalists, Oil, and Agriculture

A recent Twitter conversation with the folks at the Property and Environment Research Center (PERC) pointed me to some interesting examples of cooperation between environmentalists and oil interests, farmers, and ranchers. Some of them involve artificial markets for conservation credits while others are simply payments to land owners to help preserve environmental amenities. I don't specialize in environmental economics but I think it's important to bring up theses issues from time to time on the Farmer Hayek blog. On a related note, I want to be clear that I don't take a position on these issues personally since I haven't studied them carefully.

One example concerns the decline of monarch butterfly habitat. A blog post last week at the Environmental Defense Fund gives the details:

Ideology, Evidence, or Approach: What Drives Economists Beliefs?

Mark Thoma's recent Fiscal Times column presents two possible explanations for the beliefs of economists: ideology and evidence. While these may be important for an individual economist, I think an important third factor is the approach we take or what Arnold Kling calls "interpretive framework." The approach you take to a question might be related to your ideology (causing some to confuse the two) and it certainly affects the way you interpret evidence. All of the facts we observe are interpreted. The approach we take in economics determines, at least to some degree, how we interpret facts.

Conveniently, Thoma's article provides some opportunities to juxtapose the influences of approach, ideology, and evidence on our beliefs. In the first paragraph of Thoma's piece he says:

Potpourri

Brent Gloy and David Widmar at Agricultural Economic Insights revisit the issue of declining farmland values and come to roughly the same conclusion they did earlier this year.

Farmland values and cash rents in the Corn belt continue to come under downward pressure. When current cash rents are compared to current farmland values, the outcome is a capitalization rate of around 3%. This value is reasonable given current longer term interest rates. However, the bigger question is whether cash rents can be sustained at current levels in this economic environment. 

When one considers the returns that would be generated by a farmland owner-operator relative to current farmland values the rate of return is very low. This means that farmland values and cash rents are likely too high to be justified given the current economics of crop production. This low rate of return can be addressed through farmland values and cash rental rates falling and/or the row crop income situation improving.

Jayson Lusk points to an interesting article that he says should be filed under "Unintended Consequences."

Researchers find that a ban on bottled water on the University of Vermont campus (presumably to cut down on waste) led to more plastic bottles being shipped to campus and to more soda consumption. 

Marian Tupy and Chelsea German at HumanProgress.org tackle Akerloff and Shiller's recent op-ed in the Washington post on the effects of markets on our well-being.

Arnold Kling provides some wisdom on proper critiques of economics. My favorite bit:

A bias toward “engineers” rather than “ecologists.” That distinction comes from Greg Ip’s new book, Foolproof. The engineer is like Adam Smith’s man of system, who ignores evolution, both as a factor that may permit markets to over come their own failures and as a factor that may cause government “solutions” to become obsolete.

Continuing this theme, Steve Forbes provides a critique of economic theory. I enjoyed reading the first page, but lost interest on the second.

Don Boudreaux points to Gene Epstein's response to some of Bill Gates' comments in an interview.

Potpourri

Food
Jayson Lusk disputes the claim that local foods are good for the environment.

Helen Viet writes "An Economic History of Leftovers"

Angus Deaton's Nobel Prize
Pete Boettke's commentary

Peter Klein points to Deaton's critique of randomized control trials.

Regulation
Jared Meyer discusses the effects of regulation on economic growth.

Bonnie Christian on regulating the gig economy

David Henderson comments on Sunstein's review of Akerloff and Shiller's book "Phishing for Phools."