In the revised edition of The Company of Strangers, Paul Seabright writes (p. 26),
One of the great intellectual achievements of modern economics has been to work out very precisely the circumstances under which decentralized systems of market exchange can produce results that are efficient, in the sense of improving the condition of every individual as far as possible whenever this can be done without harming someone else…as we shall see, all real-life systems of market exchange fail to live up to these demanding conditions
These sorts of statements are often the start of an intellectual swindle, which goes.
1. Markets are great, under some conditions (no externalities, perfect information, commodity-like products).
2. Those conditions often fail in practice.
3. Therefore, in practice we often need government.
The swindle is that (3) implicitly assumes that whenever markets fail, government is the solution. But no theory of government is used to back this assumption. On the one hand, it is a great achievement to have worked out the precise conditions under which decentralized, competitive markets are optimal. On the other hand, mainstream economists do not seem to care about working out the conditions under which government will succeed where markets fail.
Consider the following matrix:
| noncoercive | coercive | |
|---|---|---|
| centralized | large private organizations | government |
| decentralized | markets | criminal groups (?) |
I am not really interested in the bottom right quadrant, hence the question mark.
I am interested in the conditions that make it better to be in the top right quadrant than in the top left quadrant. That is, when do you need to move from central planning by private organizations, from which an individual may opt out, to central planning by a government?
For example, I have argued that the government is needed to ensure that disputes are resolved without resorting to violence. That does not mean that government must resolve every dispute. But people should know that the government will help enforce private dispute resolution mechanisms. For example, the U.S. government supports the ICANN mechanism for assigning domain names on the Internet. If you want to claim ownership of an Internet domain, and ICANN rules against you, then if you cannot fight the ruling without going up against the U.S. government.
One thing I have never understood about the “nudge” idea of libertarian paternalism is why the nudges should come from government. There are private organizations that nudge–think of Weight Watchers.
Nor do I understand how “happiness research” became an excuse for government policy. To me, it is at best an excuse for economists to write self-help books.
I do not understand why consumer protection requires coercion. Why is it not enough for me to be informed about the research about a particular drug? Why do drugs have to be banned?
I think I can come up with an argument for why pharmaceutical companies would have to be forced to put drugs through clinical trials. A lot of consumers might want drugs to go through clinical trials, but it is difficult for us to solve the free-rider problem and other organizational difficulties in putting together a coalition that creates incentives for pharma companies to test drugs properly.
Environmental issues represent another area in which assembling the coalition necessary to bring to bear people’s preferences may involve free-rider problems that are difficult to solve.
In short, I think there are conditions under which one can argue for moving from the top left quadrant to the top right quadrant. However, those conditions are likely to be very stringent. And it is quite striking that the level of interest among mainstream economists for working out those conditions is much lower than their level of interest in working out the conditions under which the bottom left quadrant is perfect.
READER COMMENTS
Matthew Gunn
Jun 21 2010 at 7:05pm
There are numerous powerful examples in the field of computers and the Internet. There is no government mandated e-mail standard, no government mandated HTML standard, and so on. Rather, numerous processes (eg. FTP, POP e-mail, DHCP etc…) are handled through RFCs: http://en.wikipedia.org/wiki/Request_for_Comments
The way I see it, for centrally setting Internet standards, communication costs are low and the Coase Theorem appears to apply. Voluntary agreements work.
Noah Yetter
Jun 21 2010 at 7:08pm
The Law of Second Best comes to mind.
So Mr. Seabright can show us that markets are not optimal. So what? That doesn’t even give us a hint at what is optimal, or if optimality is even attainable.
Yancey Ward
Jun 21 2010 at 9:56pm
Defining what constitutes a market failure is where the corruption begins.
I can’t buy a Ferrari. Market failure right there, if you ask me.
Bob Murphy
Jun 21 2010 at 10:00pm
Great post, Arnold. That “swindle” always annoyed me, too. If you want to sound high-falutin you could call it the Fallacy of Denying the Antecedent.
dWj
Jun 21 2010 at 10:11pm
My impression was that some of the nudges were expected of employers. Maybe they expected government to force employers to nudge their employees. I may have misunderstood.
Ben Kalafut
Jun 21 2010 at 10:33pm
I understand that their original paper had a slightly different focus, but most of the “nudges” in Thaler and Sunnstein’s Nudge are indeed nongovernmental. Perhaps Mr Kling missed that during a quick reading.
Yancey Ward
Jun 21 2010 at 10:48pm
Ben,
I have not read the book, so I can’t speak to all of their ideas, but I have seen some of the specific ideas discussed, and they pretty much all involved either government nudges or government nudges to prod private nudgers.
another bob
Jun 21 2010 at 11:00pm
A conundrum…
In my town there is a parcel tax on the ballot ($650/parcel) to raise money for public schools. Many people seem to support this measure.
I’ve raised money for local schools for years, or, at least I’ve tried, with some minimal success.
Where were all these parcel tax supporters when I asked them to write a check voluntarily?
When I ask, they say something like, “Well, my $650 wouldn’t have helped, but if everyone puts in $650…” Is this some kind of signaling mechanism?
There are many causes deserving of voluntary contributions but people don’t see that any cause will garner enough money to make a difference.
What’s going on here?
Steve S.
Jun 21 2010 at 11:18pm
Arnold: What about entities like homeowner’s associations / condo boards for the bottom right? Most of these entities impose coercive restrictions – which, granted, are enforceable due to government backing (although the same could be said for transactions in the left quadrant).
Arguably, one maintains a nominal right of exit by not buying into a HOA, etc. – but the fact is that they do promulgate coercive and binding rules upon members; arguably, I think there would be room for fruitful analysis here.
Your take?
Ben Kalafut
Jun 22 2010 at 12:44am
The “nudges” discussed include a “save more tomorrow” plan and other approaches to voluntary withholding from paychecks, trayless cafeterias, bets and contracts for quitting smoking and numerous other private-sector solutions in addition to applications of the idea to e.g. privatizing Social Security. Kling’s characterization is incorrect. The nudges are governmental when what is in question is governmental. There’s plenty of “Weight Watchers”-esque stuff in the book.
Henry
Jun 22 2010 at 12:47am
An important question is what really is the difference between a “private” centralised organisation and a “public” one?
A particularly large private centralised organisation may function effectively as a government. You may say that the private organisations are non-coercive and the governments are coercive, but defining coercion is more difficult that it might seem.
Steve S. makes the point about homeowners’ associations. If there was a really large one, wouldn’t it similar to a small state? If you argue that it’s not because you’re free to enter and leave, the same argument could nominally be made for states as well. Finer distinctions are necessary.
Doc Merlin
Jun 22 2010 at 2:14am
I agree with those above that a large home owners association can essentially be a government.
This is true of viral contracts that don’t have an escape clause or a way to break the contract. The way to keep this from happening is to modify what a contract is in common law. Currently in common law a contract requires consideration to be enforceable, but doesn’t require a way to secede.
In short, to prevent housing organizations from becoming governments, it is necessary to institute a right of succession.
Randy
Jun 22 2010 at 5:42am
“The swindle is that (3) implicitly assumes that whenever markets fail, government is the solution.”
That’s because the term “government” is most often used in the same way as one would use the term “god”. That is, as an idea of the good, and the point being that we need to separate the idea from the reality. I have resolved to stop using the term “government”, and to replace it in most situations with the term “political organization”. “Political organization” is accurate, and leads to a better understanding of the outcomes to be expected from the activities of the members of that organization.
fundamentalist
Jun 22 2010 at 9:06am
Great post!
However, I won’t concede his definition for the goal of the market:
Who’s idea was that? Who assigned to the market that goal? Historically, that has never been the goal of the market, and it never has been the definition or goal of the market by the standards of free marketeers. As Mises wrote, the market is a process of discovery. The goal of the free market is nothing more than to bring buyers and sellers together and let the price mechanism of the market determine the allocation of resources. Resources go to the people who value them the most. Does that process leave some people worse off than others? Absolutely! Those who don’t pay attention to the market process, or those who think they know better than the market process, often are left worse off. The market rewards those with superior entrepreneural skills and punishes those who lack them.
Seabrights’ concept of market efficiency smacks of socialism in that it assumes we should all march together lock step (or goose-stepping) to greater prosperity with no inequality of wealth. Instead, the market punishes some and rewards others. Mises wrote that this is how the market created civilization. Division of labor created greater prosperity than did self-sufficiency, so the market punished self-sufficiency. But division of labor requires cooperation with those who produce what you need, so the market punishes those who refuse to cooperate. The market punishes dishonesty, greed and laziness. It rewards effort, ingenuity and entrepreneural skill. That’s how it creates civilized people and new wealth.
William Newman
Jun 22 2010 at 9:10am
Noah Yetter wrote “So Mr. Seabright can show us that markets are not optimal. So what?”
It can be worse than that. Years ago I read a collection of papers on the microeconomics of various cases where free trade might not be a good idea, and I remember being annoyed by the treatment of returns to scale and concentration of industry. Without any explicit acknowledgement or justification, it was constructed in such a way that government can correctly recognize and quantify the returns to scale and concentration, but evidently and implicitly, private actors either don’t recognize it, or institutions like contract law are too screwed up for them to commit to vaguely-Coase-ish ways to get the incentives right, or antitrust bans the formation of one huge highly-capitalized firm to take advantage of the the opportunity, or something. Thus, it’s not necessarily just sleight of hand going from a sound demonstration that institutions give suboptimal results to an assumption that institutions for active government intervention give better results. It can also be beating up market institutions based on an unsound analysis, logically sound only on its own artificial terms, analyzing models of “markets” in which the analyst has wished away some of the obvious important features that make real-world market institutions such formidable competition for interventionist institutions.
It’s rather like modeling various vaguely-Keynes-ish interventions in terms of models which substantially exclude real-world considerations like rational expectations (e.g., excluding those considerations sufficiently completely that if the assumptions involved were stated explicitly, it would require an assumption that key private actors must be extremely stupid compared to the governmental actors who comprehend the theory behind the interventions). That can be in some sense valid in its own little logical universe, but after exclusion of a consideration as potentially important as that, it’s not obvious that outcomes in the strawman universe will resemble outcomes in the universe that we inhabit.
Ryan
Jun 22 2010 at 1:55pm
fundamentalist: Who’s idea was that?
Vilfredo Pareto
http://en.wikipedia.org/wiki/Pareto_efficiency#Pareto_efficiency_in_economics
fundamentalist
Jun 22 2010 at 2:02pm
Ryan, Yes, I’m familiar with Pareto Efficiciency, and maybe Pareto thought markets should be Pareto Efficient, I don’t know. But there never has been a reason to assign that role to markets, unless you are looking for an excuse to abandon markets. Pareto efficiency would be a nice guide for the state when it intervenes in the markets, but it should never have been accepted as a purpose for markets.
fundamentalist
Jun 22 2010 at 2:07pm
Wiki: “It is commonly accepted that outcomes that are not Pareto efficient are to be avoided, and therefore Pareto efficiency is an important criterion for evaluating economic systems and public policies.”
Commonly accepted by socialists, maybe. The state should always seek Pareto efficiency in its dealing, but to do so in the market will cause not only socialism but the complete destruction of civilization, as Mises warned.
mark
Jun 22 2010 at 5:18pm
“1. Markets are great, under some conditions (no externalities, perfect information, commodity-like products).
2. Those conditions often fail in practice.
3. Therefore, in practice we often need government”
Excellent concise summary.
Paul Seabright
Jun 23 2010 at 4:02am
I’m very glad of the close attention Arnold Kling (whose blog I have long admired) has been giving to this book. But I’m surprised he thinks the sentence quoted here is used to draw the conclusions he (rightly) deplores. I spend a lot of the book (particularly in chapters 16 and 17 for example, but also in many passages elsewhere) discussing how predatory behavior is as much the province of governments as of private sector agents. Unlike Arnold I’m very interested in the bottom right quadrant, inter alia because historically the boundaries between government and criminal groups have often been very fuzzy. I don’t claim Arnold and I would agree on all points, but we can agree that the “intellectual swindle” is indeed a swindle. Only it’s not my swindle.
liberty
Jun 24 2010 at 1:29pm
Wow – there are clearly no Austrians or true Masonomists here *pin drop*
1. Your “swindle” is already well handled by Public Choice theorists.
2. Your conditions of when markets succeed are hard core neoclassical — commodity-like products?? That’s good?? Everything should be like wheat and corn – no innovation, no differentiation, no iPods, no real world competition driven by profit and loss and market selection?? (See my recent RAE paper for my thoughts on this).
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