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Bastiat anticipates climate science denialism

February 23rd, 2017 26 comments

I’m working on the environmental policy chapter of my book-in-progress, Economics in Two Lessons, which is a reply to Hazlitt’s Economics in One Lesson, which in turn is a repackaging of Bastiat’s What Is Seen and What Is Not Seen. Hazlitt was aware of the difficulties posed for laissez-faire by pollution, and chose to avoid the issue. But, on Googling Bastiat + pollution, I came across a remarkable package in which Bastiat anticipates the climate change debate and takes the denialist side in advancee.

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Health policy: Excerpt from Economics in Two Lessons

January 8th, 2017 14 comments

Another excerpt from my book-in-progress, Economics in Two Lessons (partial draft here). As usual, praise is welcome, useful criticism even more so.

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Market Failure and Income Distribution: Notes for Economics in Two Lessons

January 5th, 2017 10 comments

For quite a while now, I’ve been working through my book-in-progress, Economics in Two Lessons (partial draft here), focusing on applications of Lesson 2

Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

Thinking about the standard market failures (monopoly, externality and so on), I’ve come to the conclusion that I need to say more about the interaction between market failure and income distribution. I’ve already looked at the opportunity costs involved in income redistribution and predistribution, but different kinds of questions are coming up in relation to issues like monopoly, privatisation and for-profit provision of public services.

The discussion here and at Crooked Timber has been very helpful in stimulating my thoughts, but I need to do a lot more clarification. Some preliminary thoughts are over the fold: comments and criticism much appreciated.

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Education: Excerpt from Economics in Two Lessons

December 29th, 2016 21 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

In the section over the fold, I’m looking at education.

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Public Services: Excerpt from Economics in Two Lessons

December 28th, 2016 10 comments

As we saw in Section …, Lesson 1 does not apply to public goods, which can be used all, without any diminution of their usefulness, and for which no price can be charged. Many of the core activities of government may be regarded as providing public goods. These include public health measures, the control of air pollution, urban planning, police services and national defense.

More abstract services such as the legal system, the definition and enforcement of property rights, systems of weights and measures and so on are also public goods. Less obviously, macroeconomic management is a kind of public good (or sometimes a public bad). The level of economic activity, the rate of inflation, exchange rates and interest rates affect everyone, though in different ways.

Most advocates of Lesson 1 recognise at least some of these forms of public good provision as essential. The big disputes arise over services such as health, education and welfare services, which have long been provided, or at least funded, by governments. These services are commonly referred to as ‘human services’, and typically involve a personal relationship (doctor-patient, teacher-student, caseworker client and so on) between the service provider and the recipient.

Although these services are sometimes referred to as public goods, they don’t, in general, meet the criteria economists use to define public goods. A hospital bed or school place provided to one person isn’t available to others, and prices can be charged for access to these services.

On the other hand, neither do these services the standard conditions of Lesson 1. There are two central problems that arise. First, these services are expensive and recipients are rarely in a position to pay for them directly. As a result, all of the problems of risk and insurance, discussed in Chapter 10 …, apply to the financing of these services.

The second problem is that the relationship between providers and recipients typically involves an imbalance of information, power or both. A student is not in a good position to judge whether the education she is receiving is good or bad. Similarly, a patient must rely on their doctor’s expertise and professional ethics to get the appropriate treatment. In other cases, such as that of police services, there is also an imbalance of power, which may be misused.

Advocates of Lesson 1, such as Milton Friedman in Free to Choose have generally accepted the need for public funding to overcome the problems of financing education and, at least in some instances, health care. However, Friedman and others have assumed that any other problems can be overcome by market competition and consumer choice. Indeed, they have argued that market competition will help to prevent corruption and abuses of power that arise when governments provide services directly.

As a result, market advocates have favoured policies based on concepts such as ‘contestability’ and ‘contracting out’, in which for-profit firms compete to provide publicly funded services. The archetypal example is the perennial proposal for school ‘vouchers’, that is, funds allocated to students or their parents which can be paid to whichever school they choose to attend.

This idea was elaborated into a complete ‘reinvention of government’ by writers like Osborne and Gaebler in the late 20th century and implemented, to a large extent, in the wave of market liberal reform led by the Thatcher government in the UK. As a result, we have accumulated plenty of experience of market contestability and for-profit provision.

Theoretical analysis doesn’t give any clear answer as to which model of provision is likely to be best for services like health and education. However, after several decades of experience with market-oriented contestability, the empirical evidence is stark. For-profit provision of such services is at best problematic, and at worst disastrous.

The only other model with success comparable to that of public service provision is not-for-profit provision by organisations with a charitable or activist mission. Church-run schools and hospitals, and activist-run services like women’s shelters and services for the unemployed and homeless, have complemented the public sector, meeting needs that have been unrecognised or underserved.

The issue is not, in the end, one of public versus private. Rather it is the fact that market competition and the profit motive inevitably associated with it is antithetical to the professional and service orientation that is central to human services of all kinds.

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Monopoly and Regulation: Excerpt from Two Lessons book

December 24th, 2016 24 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

In the section over the fold, I’m looking at public ownership.

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Monopoly and Regulation: Excerpt from Two Lessons book

December 17th, 2016 12 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. Rather than work sequentially, I’m jumping between:

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.
and
Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

In the section over the fold, I’m looking at monopoly and regulation. Next up, public ownership.

As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

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Austrian economists and environmental policy

December 8th, 2016 40 comments

While working on my long-forthcoming book, Economics in Two Lessons, I came across an interesting article by Edwin Dolan published (with commendably openness to criticism) in the Quarterly Journal of Austrian Economics. The conclusion

On a theoretical level, Austrian writers delight in claiming the moral high ground, condemning polluters as aggressors against property rights. On a practical level, however, they leave pollution victims in the lurch. They invite them to sue, but propose a set of legal standards that would guarantee that polluters would always win. They oppose all government measures to reduce pollution, whether through regulation or through measures to make polluters pay. As a result, at least in cases of environmental mass torts, the Austrian paradigm is a polluter’s dream and a victim’s nightmare. It offers far too little of any practical value toward securing property rights, too little toward facilitating environmental coordination, and too little toward promoting libertarian justice. Much work remains to be done.

Intellectual property: Extract from Economics in Two Lessons (expanded and amended)

May 25th, 2016 74 comments

Another draft extract from my book-in-progress, Economics in Two Lessons. It’s the last part of the section on “predistribution”, dealing with Intellectual Property. Next up, “redistribution” through taxation and public expenditure.

As always, encouragement is welcome, constructive criticism even more so.

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Minimum wages and predistribution: Extract from Economics in Two Lessons

May 15th, 2016 44 comments

A bit out of order, this is another draft extract from my book-in-progress, Economics in Two Lessons. It’s part of the chapter on income distribution, meant to follow the section on unions, and precede the Australia-US data point and the discussion of corporate profits [links to CT, but all published here also]. After this, I plan to conclude the “predistribution” part of the chapter with a discussion of intellectual “property”, then move on to “redistribution” through taxation and public expenditure.

As always, encouragement is welcome, constructive criticism even more so.

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Predistribution and profits: extract from Economics in Two Lessons

May 15th, 2016 14 comments

Over the fold, another extract from my book-in-progress, Economics in Two Lessons. Encouraging comments appreciated, constructive criticism even more so.

Predistribution and profits

As we’ve seen in previous sections, the social constructions of property rights and institutions surrounding employment makes a big difference to the determination of wages and working conditions. These social constructions affect ‘predistribution’, the distribution of income and wealth that arises before the effects of taxes and public expenditure are taken into account.

Predistribution is equally relevant to the other big source of personal income: profit derived from private businesses and corporations. Without legal structures designed specifically to protect businesses from the risks of failure, profits would be far less secure, and the difficulty of establishing and running a business much greater. Corporate profits are not a natural outcome of a market society, but the product of specific structures of property rights introduced to promote corporate enterprise.

The risks of running a business in the 18th century, and well into the 19th, were substantial and personal. There was no such thing as bankruptcy: a business failure meant debtors prison, where debtors could be held until they had worked off their debt via labor or secured outside funds to pay the balance.

After a brief and disastrous experiment in the early years of the 18th century (the South Sea Bubble), joint stock companies were also viewed with grave suspicion.

The prevailing view was Quoted in John Poynder, Literary Extracts (1844), vol. 1, p. 268. [1]

Corporations have neither bodies to be punished, nor souls to be condemned; they therefore do as they like.

This is often misquoted as

“Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?

Adam Smith was similarly scathing, though with more of a focus on the principal-agent problem

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own…. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

Exceptions were made only for specially authorised quasi-governmental ventures like the East India Company, focused on foreign trade. In general, limited liability companies were not permitted in Britain or most other countries. The partners in a business were jointly liable for all its debts.

These same rules applied in Britain’s American colonies and continued to prevail in the United States until the middle of the 19th century. The introduction of personal bankruptcy laws put an end to debtors prison, greatly reducing the risks of running a business. The creation of the limited liability company was an even more radical change.

These changes faced vigorous resistance from advocates of the free market. David Moss, in When All Else Fails, his brilliant history of government as the ultimate risk manager, describes how the advocates of unlimited personal responsibility for debt were overwhelmed by the needs of business in an industrial economy. The introduction of bankruptcy and limited liability laws took much of the risk out of starting and operating a business.

By contrast, in Economics in One Lesson, Hazlitt doesn’t mention limited liability or personal bankruptcy and seems to assume (like most defenders of the market) that these are a natural feature of market societies. More theoretically inclined propertarians have continued to debate the legitimacy of bankruptcy and limited liability laws, without reaching a conclusion.

This debate over whether bankruptcy and corporation laws are consistent with freedom of contract is really beside the point. The distribution of income and wealth is radically changed both by the existence of these institutions and by the details of their design. In particular, the massive accumulations of personal wealth made possible by capital gains from share ownership would simply not exist. Perhaps there would be comparable accumulations of wealth derived in some other way, but the owners of that wealth would be different people.

A crucial policy question, therefore, is whether current laws and policies relating to corporate bankruptcy and limited liability have promoted the growth of inequality and contributed to the weak and crisis-ridden economy that has characterised the 20th 21st century. The combination of these factors has produced absolute stagnation or decline in living standards for much of the US population and relative decline for all but the top few per cent.

There can be little doubt that this is the case. As recently as the 1970s, a corporate bankruptcy was the last resort for insolvent companies, typically leading to the liquidation of the company in question. As well as being a financial disaster, and a source of shame for all those involved. For this reason, nearly all major companies sought to maintain an investment-grade credit rating, indicating a judgement by ratings agencies that bankruptcy was, at most, a fairly remote possibility.

Since that time, bankruptcy has become a routine financial operation, used to avoid inconvenient liabilities like pension obligations to workers and the costs of cleaning up mine sites, among many others. The crucial innovation was “Chapter 11”, introduced in the Bankruptcy Reform Act of 1978.

The intended effect of Chapter 11 was that companies could reorganise themselves while going through bankruptcy, and re-emerge as going concerns. The (presumably) unintended effect was that corporate managers ceased to be scared of bankruptcy. This was reflected in the spectacular growth of the market for ‘junk bonds’, that is, securities with a high rate of interest reflecting a substantial probability of default. Once the preserve of fly-by-night operations, junk bonds (more politely called ‘high-yield’) became a standard source of finance even for companies in the S&P 500.

At the same time, legislative changes and the growth of global capital markets greatly enhanced the benefits of corporate structures, while eliminating many of the associated costs and limitations. At the bottom end of the scale, the ‘close corporation’ with only a handful of shareholders, became the standard method of organising a small business. This process was aided by a long-series of pro-corporate legislative changes and court decisions (notably in Delaware, which has long led the way in this process, and where vast numbers of US companies are incorporated). At the top end, the rise of global financial markets from the 1970s onwards allowed the creation of corporate structures of vast complexity, headquartered in tax havens and organised to resist scrutiny of any kind.

At the behest of these corporations, governments have negotiated agreements supposedly designed to ensure that corporate profits are not taxed twice in different jurisdictions. In reality, using a combination of complex corporate structures and governments (notably including those of Ireland and Luxembourg) eager to facilitate tax avoidance in return for a small slice of the proceeds, the effect has been to ensure that most global corporate profits are not taxed even once in the countries where they are earned.

What can be done to redress the balance that has been tipped so blatantly in favor of corporations. The obvious starting point is transparency. Havens of corporate secrecy, from Caribbean islands to US states like Delaware must be made to reveal he true ownership of corporations, in the same way that tax havens like Switzerland, used mostly by wealthy individuals, have been forced to disclose the ownership of previously secret accounts.

The use of complex corporate structures to avoid tax is a much more difficult problem to tackle. Some measures are being taken to attack what is called “Base Erosion and Profit Shifting’, but past experience suggests that slow-moving processes of this kind will at best keep pace with the development of new forms of avoidance and evasion. It’s necessary to re-examine the whole structure of global taxation agreements. Instead of focusing on the need to avoid taxing corporate profits twice, the central objective should be to ensure that they are taxed at least once, in the place where they are actually generated.

More generally, though, the idea that corporations are a natural part of the economic order, with all the human rights of individuals, and none of the obligations needs to be challenged. Limited liability corporations are creations of public policy, useful to the extent that they promote the efficient use of capital but dangerous to the extent that they facilitate gross inequalities of income and opportunity.

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Why is global finance so profitable (crosspost from CT)

May 12th, 2016 21 comments

In a recent post, I asserted that

activities like tax avoidance/evasion and regulatory arbitrage aren’t peripheral flaws in a financial system primarily concerned with the efficient global allocation of capital. They are the core business, without which the profits of the global financial sector would be a tiny fraction of the $1 trillion or so now reaped annually

As I’m working on income distribution issues my long-running book project, this seems like a good time to see if this claim can be backed up by hard numbers.

First up, here’s my source for the $1 trillion number (actually $920 billion). As a plausibility check, I’ve tried to estimate the total size of the global financial sector. Various sources, including Wikipedia estimate that the banking and insurance sector accounts for 7-8 per cent of US gross product. Extrapolating to world gross product of about $80 trillion that would give around $6 trillion for the total size of the sector. The US is almost certainly more financialised than the world as a whole. Still, the profit number looks about right. A trickier question is whether the rents accruing to managers and top professional in the sector should be counted as part of profits. I’d guess that these rents account for at least another $1 trillion, but I have no real idea how to test this – suggestions welcome.

Is tax avoidance/evasion and regulatory arbitrage a big enough activity to account for a substantial share of a trillion dollars a year? Gabriel Zucman estimates that there’s $7.5 trillion stashed in tax havens, of which around $6 trillion is untaxed. He estimates the tax avoided at $200 billion . I’ll estimate that half of that ($100 billion) is creamed off in financial sector, mostly as profits or rents. That implies a profit margin of a bit under 2 per cent, which seems reasonable.

Tax evasion by wealthy individuals is only a small part of the story. Legal tax avoidance is almost certainly more important. Most of that involves companies, but it’s important to distinguish between “close” corporations, which hide the activities of an individual or family and large global corporations. I don’t have any idea how to measure the cost of avoidance through close corporations. As regards global corporations, Zucman estimates that “a third of U.S. corporate profits, or $650 billion, are purportedly earned outside the country, with a cost to the US of $130 billion a year . Extrapolating to the world as a whole, that would be at least $500 billion. Again, assuming the financial sector creams off half of the sum, we get $250 billion (the fact that the finance sector itself accounts for around 40 per cent of all corporate profits means there’s a problem of recursion that I haven’t worked through)

Then there’s manipulation of exchange rate and bond markets. I have no idea how to measure this, but given that the notional volume of trade in some of the markets concerned is measured in the hundreds of trillions, it seems plausible that the profits and rents from market-rigging must be at least in the tens of billions.

These are probably the biggest scams, but there’s also regulatory arbitrage, privatization (a huge source of rent over recent decades), domestic tax avoidance and more.

Adding them up, I’d suggest that $500 billion a year is a low-end estimate for the profits and rents associated with various forms of anti-social financial sector activity.

There’s lots of potential error around these numbers, but the order of magnitude seems reasonable to me. As against the claim that the explosion in financial sector activity and profits over the past 40 years has been driven by the benefits of a more efficient allocation of capital by rational markets, the claim that it’s all about tax-dodging and socially unproductive arbitrage seems pretty plausible.

Obviously, the social cost of a financial system devoted to undermining tax and regulatory systems far exceeds the profits earned from the activity. That’s true of any kind of socially destructive, but privately profitable, activity. But the problem is greater in the case of financial sector activity because of the disastrous effects of financial crises.

A data point on minimum wages

April 29th, 2016 23 comments

I’m currently working on a section of my Economics in Two Lessons book dealing with minimum wages in the context of predistribution policies, so I thought I would compare Australia with the US, where the idea of a $15/hour minimum wage is currently a hot topic. In Australia there are two kinds of minimum wage. The PPP exchange rate is estimated at $A$1.30 = $US, which is fairly close to the market exchange rate at present, so I’ll give both $A and estimated $US equivalents

The standard minimum wage for workers aged 21 and over is $A17.29 hour ($US13.30) applying to employees under standard award conditions. These include four weeks annual leave, sick leave, employer contributions to pension plans and so on.

More comparable to the situation of US minimum wage workers are “casual” workers, employed on an hourly basis. Casual workers get a loading of at least 25 per cent, bringing the wage up to at least $A21.60 an hour ($US16.60), to compensate for the absence of leave entitlements. In addition, they have entitlements including:

* “Penalty” rates for weekend and night work (usually a 50 per cent loading, 100 per cent on Sundays)
* For workers employed on a regular basis, protection against unfair dismissal.

The policy question is: what impact have these high minimum wages had on employment and unemployment. That’s too big a question to answer comprehensively, but we can look at the obvious data points: the official unemployment rates (5.7 for Oz, 5.5 per cent US) and the 15-64 employment population ratios (72 per cent for Oz, 67 per cent US). So, it certainly doesn’t look as if the Australian labor market has been crippled by minimum wages.

Note: I’ll respond in advance to the widespread misconception that Australia is a special case due to mineral resources. Mining accounts for about 2 per cent of employment in Australia, and (because most mines are owned by multinationals) its contribution to Australian national income is also so, probably around 5 per cent.

* Workers aged 18 get about 70 per cent of the adult minimum, equivalent to around $US11.50 for casuals. But the great majority of US minimum wage workers (about 80 per cent) are 20+.

Are recessions abnormal (crosspost from Crooked Timber)

November 9th, 2015 14 comments

I’m on to the macroeconomics section of my book in progress, Economics in Two Lessons. The key point of this section is that, whereas the academic economics profession has wasted most of the last thirty years on the project of founding macroeconomics on (some near approximation of) standard neoclassical microeconomics, the validity of the core results of neoclassical microeconomics depend on the assumption that the economy is operating at full employment[^1]. This observation isn’t original – it was why Keynes saw his theory as saving capitalism from itself. Even the title I used in this post on the macro foundations of microeconomics turns out to be a reinvention of the wheel.

Having noted the importance of the full employment assumption in the abstract, how relevant is it? If the economy is, with notably rare exceptions, at, or close enough to, full employment, then it seems safe enough for economists to continue, as the profession has for 40 years or so, to treat macroeconomics as a special subfield with little relevance to the rest of the discipline.

To put the question simply, are recessions abnormal?

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TANSTAAFL: What about “free” TV, radio and Internet content?

October 11th, 2015 35 comments

Another excerpt from my book in progress, Economics in Two Lessons. There’s a partial draft here if you want to read it in context. I could spend a lot more time on the topic of advertising, but much of the ground has been covered in Akerlof & Shiller’s latest Phishing for Phools. As always, both praise and useful criticism are very welcome.

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Income distribution: where should we start ?

September 26th, 2015 18 comments

Here’s another draft extract from my book-in-progress, Economics in Two Lessons, looking at income distribution. The entire draft section on this topic is available here. And the introduction, describing the general approach of the book is here.

Praise is welcome, and useful criticism even more so. As a reminder, this is an extract. If you think a crucial point has been missed, point it out, but bear in mind that it may be addressed elsewhere in the book.

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Economics in Two Lessons: Income Distribution

September 7th, 2015 44 comments

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. Rather than work sequentially, I’m jumping between:

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.

and

Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

In the section over the fold, I’m looking at how opportunity cost reasoning applies to policies that change the distribution of income, wealth and other entitlements.

As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

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War and technological progress

August 22nd, 2015 46 comments

One of the big benefits of blogging for me is the chance to try out my ideas on an audience I couldn’t easily reach (or at least hear back from) in any other way. That’s particularly true when I’m writing a book, which is always a difficult process for me. My last post, on the opportunity cost of war produced a great comments thread. Particularly useful was a discussion, started by Chris Bertram at Crooked Timber, of the oft-heard claim that war stimulates scientific and technological progress. I’ve used my response, along with points appropriated from commenters to draft a new section for the book, pointing out how this claim ignores the problem of opportunity cost.

As always, comments of (nearly) all kinds are appreciated, and useful ones may be recycled.

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The opportunity cost of war

August 19th, 2015 37 comments

What is true of natural disasters is even more true of the disasters we inflict on ourselves and others. Of these human-made calamities, the greatest is war. The wars engaged in by the US, Australian and other governments come at the opportunity cost of domestic programs that could save thousands of lives every year. The cost of war, in terms of American (and Australian) lives, is many times greater than battlefield casualty counts would suggest.

That’s the theme of this extract from my book-in-progress, Economics in Two Lessons. You can find a draft of the opening sections here.

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Are natural disasters economic disasters ?

August 14th, 2015 14 comments

Yes. This has been the latest in our series “Short Answers to Misconceived Questions”.

Actually, there’s a longer answer over the fold, another extract from my book-in-progress Economics in Two Lessons. You can find a draft of the opening sections here.

This extract is a subsection of Part 2, in which I explore the implications of Lesson 1:
Market prices reflect and determine opportunity costs faced by consumers and producers.
The conclusion is

if the damage bill measures the cost of restoring assets to their pre-disaster condition, it is also equal to the opportunity cost of the disaster, namely the goods and services that would otherwise have been produced.

I’ll be interested to see whether readers’ reaction is “That’s obvious” or “That’s obviously wrong”, assuming of course that you have any reaction at all. As always, civil comments of all kinds are welcome, particularly constructive criticism.

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Competitive equilibrium (excerpt from Economics in Two Lessons)

July 18th, 2015 45 comments

I’m now coming up to (what I hope will be) the most challenging part of my book-in-progress, Economics in Two Lessons. The core theoretical point the first part of the book (Lesson 1) is that, under a set of ideal assumptions, competitive equilibrium prices both reflect and determine the opportunity costs faced by consumers and produces. This means that there is no way to rearrange consumption to make someone better off unless someone else is made worse off. (I’ve already mentioned my reasons for avoiding the term “Pareto-optimal” in this context.

What I’m trying to do here is to spell out the logic underlying these results in a way that foreshadows the discussion of market failure and income distribution, in Lesson 2, but still shows the power of market mechanisms. I’ll probably need a few goes at this, and this is my first try. Critical comments on everything from the underlying theory to editorial nitpicks are welcome. Sincere praise is also welcome of course, but constructive criticism is best of all.
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TISATAAFL

July 11th, 2015 32 comments

Another excerpt from my book-in-progress, Economics in Two Lessons. To recap, the Two Lessons are

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.
Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

In this section, I’m working on Lesson 1, leading up to the point (my restatement of what’s usually called the First Fundamental Theorem of Welfare Economics) that an ideal competitive equilibrium is one in which there are no unexploited potential gains from technical improvements or mutually beneficial exchange. For reasons I’ve spelt out already I don’t want to use the term “Pareto-optimal” to talk about this. I also want to confine “efficient” to its normal meaning of “technically efficient” and avoid the common economist practice of extending this to cover various definitions of “market efficiency”. So, I’m talking about “free lunches” or, more formally, benefits with no opportunity cost.

In Lesson 2, I’ll be looking, among other things, at the Second Welfare Theorem, which says any outcome with no free lunches corresponds to a particular initial allocation of property rights, broadly defined to include taxation obligations and entitlements of all kinds.

Now please comment, criticise and hopefully enjoy

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To help poor people, give them money (Draft excerpt from Economics in Two Lessons)

June 16th, 2015 97 comments

Here’s another draft excerpt from my book in progress, Economics in Two Lessons. To recap, the idea of the book is to begin with the idea that market prices represent opportunity costs for the households and business who face them (Lesson 1), and then go on to explain why market prices won’t in general equal opportunity costs for society as whole (Lesson 2). A lot of the book will be applications of the two lessons, and this section is an application of Lesson 1.

As before, all kinds of comment and criticism, from editorial points to critiques of the entire strategy are welcome.

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Economics in Two Lessons

June 12th, 2015 56 comments

I’m still redrafting the opening section of my book, on the concept of opportunity cost. Some applications to specific problems coming soon, I promise. In the meantime, comments and criticism, including editorial corrections and nitpicks, much appreciated.
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Opportunity cost: A Fabian idea?

May 26th, 2015 124 comments

As part of the research for Economics in Two Lessons, I’m looking in to the history of some of the ideas I’m talking about, including Pareto optimality, externalities and of course opportunity cost. I’m undecided as to whether I’ll include this material, perhaps as starred (skip if you feel like it) sections, or in an Appendix. Suggestions on this point are welcome.

My research on the intellectual history of opportunity cost has so far gone no further than Wikipedia, which attributes the term to Friedrich von Wieser, an Austrian economist in both the national (he was Minister for Finance there in 1917) and theoretical senses. Turning to the article on von Wieser, I was surprised to read that he put forward an argument very similar to mine regarding the relationship between opportunity cost and the distribution of wealth

Instead of the things that would be more useful, there are things that pay better. The greater the difference in wealth, the more striking are the anomalies of production. The economy provides luxury to the capricious and greedy, while it is deaf to the needs of the miserable and poor. It is therefore the distribution of wealth that decides what will be produced, and leads to a consumer of a more anti-economic variety: a consumer wastes on unnecessary, guilty enjoyment that which could have served to heal the wounds of poverty. —Friedrich von Wieser, Der Wert Natürliche (The Natural Value), 1914.

It turns out, even more surprisingly to me, that von Wieser was linked to a Viennese group of Fabians.

I’m still trying to digest this, and work out where to go next with it. Can anyone point to useful information about von Wieser?

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Economics in Two Lessons: Draft Preface

May 23rd, 2015 38 comments

Over the page, the draft preface for my book-in-progress, Economics in Two Lessons

I got some great comments first time round, but I can see it would be easier if I presented my drafts in a more orderly fashion, though not necessarily sequential. So, I’ll begin at the beginning. Comments, both critical and favorable, much appreciated.

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The most misleading definition in economics (draft excerpt from Economics in Two Lessons)

May 19th, 2015 33 comments

After a couple of preliminary posts, here goes with my first draft excerpt from my planned book on Economics in Two Lessons. They won’t be in any particular order, just tossed up for comment when I think I have something that might interest readers here. I’ll update as I go, in response to comments and criticism; this may create some difficulties reading the comments thread, but hopefully the improvement in the final product will be worth it.

To remind you, the core idea of the book is that of discussing all of economic policy in terms of “opportunity cost”. My first snippet is about

Pareto optimality

The situation where there is no way to make some people better off without making anyone worse off is often referred to as “Pareto optimal” after the Italian economist and political theorist Vilfredo Pareto, who developed the underlying concept. “Pareto optimal” is arguably, the most misleading term in economics (and there are plenty of contenders). Before explaining this, it’s important to understand Pareto’s broader body of thought, one which led him in the end to embrace fascism.

Pareto and the libertarian path to dictatorship

Pareto sought to undermine the version of liberalism that dominated 19th century economics, according to which the optimal (most desirable) economic outcome was the one that contributed most to human happiness, often (if somewhat loosely) summed up as ‘the greatest good of the greatest number’. Particularly as developed by the great philosopher and economist John Stuart Mill, this is a naturally egalitarian doctrine.
The egalitarian implications of the classical framework reflect the fact that the needs of poor people are more urgent than those of the better off. So, the happiness of the community as a whole all be increased by policies that benefit the poorest members of the community, even if these benefits come at the expense of those who are better off. It follows that a substantial degree of income redistribution will be social desirable and that large accumulations of individual wealth, which contribute only marginally to the happiness of a small number of people are undesirable in themselves, though they may in some circumstances be a by-product of desirable policies.
Pareto’s big achievement, further developed by a large number 20th century economists, was to show that much of economic analysis could be undertaken without invoking the concept of utility. Hence, interpersonal comparisons of happiness, which invariably lead to the conclusion that redistributing wealth more equally is beneficial, could be dismissed as ‘unscientific’.
Pareto didn’t stop with an attack on the economic implications of Mill’s approach. Mill’s philosophical framework implied support for political democracy, including the enfranchisement of women. Since everyone’s welfare counts equally in the classical calculus, the political process should, as far as possible, give everyone equal weight.
Pareto reversed this reasoning, arguing that a highly unequal distribution of income was both inevitable and desirable; he proposed what he called a power law, described by a statistical distribution which also bears his name. Pareto’s “Law” may be summed up the 80-20 proposition, that 20 per cent of the population have 80 per cent of the wealth.
The supposed constancy of income distribution implies that any attempt at redistribution must be essentially futile. Even the aim is to benefit the poor at the expense of the rich, the effect will simply be to make some people newly rich at the expense of those who are currently rich. Pareto called this process ‘the circulation of elites’. (In his dystopian classic 1984, Orwell has the Trotsky-like character Emmanuel Goldstein present the same idea as the starting point of The Theory of Oligarchical Collectivism. Orwell almost certainly derived the idea from James Burnham, an admirer of Pareto whose work Orwell saw as the embodiment of ‘power worship))
All of this led Pareto to become one of the first advocates of a political position combining an extreme free-market position on economic issues with hostility to political liberalism and democracy. Pareto welcomed the rise of Mussolini’s fascist regime, and accepted and accepted a “royal” nomination to the Italian senate from Mussolini. However, he died in 1923, less than a year after
Pareto was not really a fascist however. Rather, he developed a version of liberalism similar to that of his more famous successors, Hayek and Mises, both of whom embraced and worked for murderous regimes that had come to power by suppressing democratic socialist parties. Like Pareto, neither Hayek nor Mises can properly be described as fascists – they weren’t interested in nationalism or in the display of power for its own sake. Rather, their brand of liberalism was hostile to democracy and indifferent to political liberty, making them natural allies of any authoritarian regime which adheres to free market orthodoxy in economics. (Fn Supporters of Hayek and Mises commonly describe themselves as “libertarians”, but their alliance with brutal dictators makes a travesty of the term – they have been derisively described as “shmibertarian”).

Pareto optimality

Now back to “Pareto optimality”, and why it is such a misleading term. Describing a situation as “optimal” implies that it is the unique best outcome. As we shall see this is not the case. Pareto, and followers like Hazlitt, seek to claim unique social desirability for market outcomes by definition rather than demonstration.

If that were true, then only the market outcome associated with the existing distribution of property rights would be Pareto optimal. Hazlitt, like many subsequent free market advocates, implicitly assumes that this is the case. In reality, though there are infinitely many possible allocations of property rights, and infinitely many allocations of goods and services that meet the definition of “Pareto optimality”. A highly egalitarian allocation can be Pareto optimal. So can any allocation where one person has all the wealth and everyone else is reduced to a bare subsistence.

Recognising the inappropriateness of describing radically unfair allocations as “optimal”, some economists have used the description “Pareto efficient” instead, but this is not much better. It corresponds neither to the ordinary meaning of “efficient” nor to the meaning with which the term is commonly used in economics, which is also misleading, but in a different way.

The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs. Conversely, if there is a positive opportunity cost for any benefit, then we can’t make anyone better off without making someone else worse off. So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.

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The political is personal

May 18th, 2015 39 comments

Working on my Economics in Two Lessons book, I’ve had to address the concept of Pareto optimality, which naturally raises the question of how it fits into Pareto’s larger body of anti-democratic and anti-egalitarian thought, which culminated, at the end of his life, in his embrace of Mussolini’s fascism. This led me to an article (paywalled, sorry) published by Renato Cirillo, in 1983, defending Pareto against the charge of being a precursor of fascism. Cirillo asserts that, far from being a fascist, Pareto

“manifested consistently a strong attachment to a type of liberalism not dissimilar to the one later attributed to Mises and Hayek”

These are rather unfortunate examples, in view Mises writings in praise of fascism and work for the Dollfuss regime, and (even more), Hayek’s embrace of Pinochet, at the very time Cirillo was writing [^1].

This, along with my discovery that Locke was actively involved in the expropriation of the native American population, justified by his theory of property, led me (back) to the question of the relationship between the writings of political theorists (broadly defined to include economists, sociologists and philosophers engaged with these issues) and their personal political activity and commitments. I’ve come to two conclusions about this.

First, for serious writers on political theory, political engagement is and ought to be the rule rather than the exception. I don’t mean that philosophers should (necessarily) run for office. Rather someone whose political theory doesn’t lead them to have and express views on the great political issues of their day probably doesn’t much of interest to say about theory either (unless of course, their theory leads them to some form of quietism). That’s true of the writers whose commitments were creditable (for example, John Stuart Mill and Bertrand Russell) as well as the discreditable cases I’ve mentioned.

Second, it makes no sense to look at the theoretical writings and ignore the political commitments with which they are associated. For example, it is easy to construct readings of Pareto, Mises and Hayek in ways that make them appear either as friends or as enemies of political liberalism. Their (remarkably similar) actions make it clear which reading is correct. Eventually, of course, ideas outgrow their creators to the point where original intentions, and the texts in which they were expressed, cease to be relevant. But, as the Locke example shows, that’s a very slow process. As long as a writer is regarded as having any personal authority, the weight of that auhtority must be assessed in the light of their actions as well as their words.

[^1]: To be sure, none of these writers can properly be described as fascists – they aren’t interested in nationalism or in the display of power for its own sake. Rather, their brand of liberalism is hostile to democracy and indifferent to political liberty, making them natural allies of any fascist regime which adheres to free market orthodoxy in economics.

Economics in Two Lessons

May 16th, 2015 6 comments

I’ve been promising for a long time to write a new book, framed as a reply to a free-market tract Economics in One Lesson by Henry Hazlitt, published in 1946, but still in print and popular among free market advocates. Its popularity reflects the fact that it’s a reworking of Bastiat’s “What is Seen and What is Not Seen”, still one of the best statements of the case for free markets.

Bastiat’s argument is implicitly based on the concept of opportunity cost but, since the term wasn’t coined until 1914, he doesn’t use it. Neither, more surprisingly, does Hazlitt. Once this is made explicit, Hazlitt’s rather ponderous, and misleading statement of his “One Lesson”

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

can be boiled down to the much simpler statement “Market prices reflect opportunity cost”. In important respects, this is true, particularly when we consider the problem from the perspective of choices about how to allocate an individual, family or government budget. With fixed aggregate levels of public expenditure, for example, more money for the military means less for schools, and vice versa.

There are plenty of other questions about private and public decisions for which Hazlitt’s One Lesson is useful. Another example is the well-supported finding that the best way to fight poverty is to give money to poor people. This is unsurprising given that poor people themselves will usually have a much better idea of the opportunity costs they face than will those seeking to help them.

But as a general statement, Hazlitt’s One Lesson is false, which is why my working title is Economics in Two Lessons”. Lesson Two is “Market prices do not reflect all the opportunity costs we face as a society”
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