Monday, May 25, 2015

Economics in TWO Lessons?!

Economist John Quiggin recently provided a draft of the preface of his new book "Economics in Two Lessons" on his blog, Crooked Timber. The book is a response to the classic "Economics in One Lesson" by Henry Hazlitt. It's certainly an interesting project and I plan to pick up a copy when it's published.

That said, the preface indicates the potential for some problems in terms of his criticisms of markets. Quiggin seems to think that Hazlitt has a very simplistic view of markets, to the point that he refers to the "dogmatic certainty of Hazlitt's free-market policies." Whether or not Henry Hazlitt himself simply thought "markets good, government bad" and assumed perfection in markets is immaterial. Such simplistic thinking is not required to come to Hazlitt's conclusions about the outcomes of government policy. (As Quiggin admits, this simplistic presentation may have made sense at the time Hazlitt wrote, and one can certainly expect a simplified presentation in a book for popular audiences.)

For us to conclude that markets are preferred to government policy in the direction of resources, we only need to be able to say that markets are more likely than government policy to direct resources in a way that is consistent with the preferences of individuals in society given the scarcity of those resources.

Why might someone take that view? To start, politicians and bureaucrats cannot know all the relevant factors necessary to plan an economy. Much of the information necessary for a rational economic order is tacit and can't be communicated to a central authority. If a central authority attempts to plan this or that aspect of the economy, it distorts or precludes the decentralized plans of individuals. While I'm sure Quiggin is not arguing for Soviet-style communism, he certainly seems to prefer centralized control when market outcomes do not fit the results of economic models.

If we look at the market economy as a process of plan revision and coordination rather than a static equilibrium, certain "outcomes" that appear to be inefficient might simply be the first step in improving the overall wealth of individuals in society. The incentives provided by the profit and loss system in a market economy tend to weed out firms that fail to provide value for consumers. Since bureaucrats and politicians do not benefit from this instant feedback mechanism, even those with the best of intentions are not likely to improve the economic well-being of their constituents, on net.

In fact, Public Choice theory suggests that politicians and bureaucrats will operate with just as much self interest as entrepreneurs, consumers, managers, etc. The difference is that they are able to use legislation and bureaucratic regulations to enrich themselves at others' expense. This can certainly take the form of collusion with those in industry, enriching the ostensibly "private" market participants beyond their ability to add value to consumers.

Taken together, these theoretical arguments amount to a very good reason to prefer (admittedly imperfect) market direction of resources to political or bureaucratic direction. This, of course, isn't just a bunch of words on a page; evidence suggests that the agriculture industry, many other industries, and the economy as a whole have suffered dramatically due to regulation of markets.

Quiggin seems to prefer a "mixed economy," with the government correcting perceived negative market outcomes. While I certainly don't think markets are perfect (no human institution is), they are vastly preferred to control by politicians and bureaucrats who are not subject to the important feedback provided by markets.

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