Thursday, May 5, 2016

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.


  1. I would add that good intentions aren't even a necessary condition for "for efficient and effective government solutions." I'm not saying they don't help, but they are not necessary.

  2. Yeah, I hesitated when I wrote that. Good point.