My Princeton UP interview on Economics in Two Lessons

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April 23, 2019

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Since 1946, Henry Hazlitt’s bestselling Economics in One Lesson has popularized the belief that economics can be boiled down to one simple lesson: market prices represent the true cost of everything. But one-lesson economics tells only half the story. It can explain why markets often work so well, but it can’t explain why they often fail so badly—or what we should do when they stumble. As Nobel Prize–winning economist Paul Samuelson quipped, “When someone preaches ‘Economics in one lesson,’ I advise: Go back for the second lesson.” In Economics in Two Lessons, John Quiggin teaches both lessons, offering a masterful introduction to the key ideas behind the successes—and failures—of free markets. Here, he explains why two-lesson economics means giving up the dogmatism of laissez-faire as well as the reflexive assumption that any economic problem can be solved by government action.

How did you come to write this book?

The idea was to offer a progressive response to Henry Hazlitt’s Economics in One Lesson, a free-market tract that remains in print seventy years after its initial publication. I originally intended it to focus on microeconomic ‘market failures’ like monopoly and air pollution. However, perhaps because the title claimed so much, the project grew to encompass the whole of economics, including macroeconomic issues such as unemployment and the business cycle, and the fundamental question: Who gets what?

What  is the core idea of the book ?

The core idea of the book is the concept of opportunity cost, which I define as follows:

The opportunity cost of anything of value is what you must give up so that you can have it.

Opportunity cost applies at the social level as well.

The social opportunity cost of anything of value is what you and others must give up so that you can have it.

Sometimes but not always, individual and social opportunity cost align as a result of what Adam Smith called the ‘invisible hand’ of the market. The core of economic policy is to determine when social and private opportunity costs differ, and what can be done about it. At least in a qualitative sense, most of the issues in economic policy can be understood with anapplication of opportunity cost reasoning. The technical analysis that forms the basis of most economics courses is only needed if you want to obtain quantitative estimates.

What is the ‘first lesson’ ?

Hazlitt doesn’t spell out his ‘one lesson’ properly, saying only that it is necessary to trace all the economic effects of any act of policy all the way to their conclusions, rather than relying on immediate benefits and surface appearances. This is a restatement of the title of Hazlitt’s main inspiration, Bastiat’s classic nineteenth-century work ‘That which is seen, and unseen’. Hazlitt implicitly assumes that once all the consequences of any act or policy are taken into account, the opportunity costs of government action to change economic outcomes always exceed the benefits.

The central idea underlying the claim made by Bastiat and Hazlitt is that market prices tell us everything we need to know about opportunity costs. This isn’t always true, but the kernel of truth is embodied in Lesson One, as I call it.

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

The first part of the book shows why Lesson One is so important, and gives applications to a wide range of issues.

So what is Lesson Two ?

Economists have long known that, under conditions of ‘market failure’, market prices may not reflect opportunity costs, and that in these circumstances there is a case for government action to yield improved outcomes. The classic examples include air pollution and other ‘externalities’, monopoly and the exercise of market power, information problems and public goods such as scientific research. This leads directly to my Lesson Two.

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

I originally planned a book in which Lesson Two would have been all about market failure; that book would have been finished much sooner. As I worked on the book, though, I felt dissatisfied. I started to think more about the problems of unemployment and growing inequality, and realised that these were both examples of Lesson Two.

In a recession or depression, markets, and particularly labor markets, don’t properly match supply and demand. This means that prices, and particularly wages reflect or determine opportunity costs.  Looking hard at the data, I concluded that a market economy is in recession, in this sense, as often as not.

As regards the distribution of income and wealth, the market outcome depends on the system of property rights from which it is derived.  The choices that determine property rights are subject to the logic of opportunity costs just as much as the choices made within a market setting by firms and households. Over recent decades, changes to property rights of all kinds have consistently driven society in the direction of greater inequality.

So, we need Economics in Two Lessons.

Are there really only two lessons, or are there many?

The ‘two lessons’ set out the principles for reasoning about prices and opportunity cost. Any number of implications can be drawn about specific economic issues. Among the lessons drawn in the book are:

* There is such a thing as a free lunch.
* If you want to help poor people, give them money.
* There is no ‘silver lining’ to the destruction caused by war and natural disasters.
* Advertising generally makes us worse off.
* A carbon price would be the best response to climate change (but it’s unlikely to happen any time soon).

There’s plenty more in the book, and plenty more yet to be written.

An unpresidential election

It’s become a cliche to observe that Australian elections have shifted to a ‘presidential model’, in which the central element is a popularity contest between the incumbent PM and the Opposition leader. This has been accompanied by the minimisation of policy differences, as both sides seek the middle ground, and by the adoption of a ‘small target strategy’, particularly by the Opposition (governments have a record from which they can’t easily hide). This election is different, though you might not know it from the media coverage which demands, and receives, photo-ops of the leaders going from one place to another, wearing clothes they wouldn’t normally dream of, and handing out goodies. What are the differences this time?

First, neither leader is all that popular. For the Liberals, this doesn’t make much difference, since Morrison is about the best they’ve got in that respect. By contrast, Labor is running as a party rather than Team Shorten, even leaving him off some advertising material

The converse of this is that local candidates and local issues matter more than usual. There are a string of seats presenting problems for both parties. On the ALP side, there’s Herbert, held by 37 votes last time, and the epicentre of the Adani dispute, and Lindsay, where the sitting member, also narrowly elected in 2016, was pushed out over harassment allegations. Surprisingly enough, a seat-specific Newspoll showed both still at 50-50.

The LNP have many more problems of this kind. There are several seats where sitting members (mostly women) have been pushed out or quit in disgust, hardline rightwingers (notably Abbott, Dutton and Hunt) facing independent challengers and a strong push from Getup, members who seem to have put their personal lives ahead of doing their jobs (Christensen) water issues facing the Nationals in NSW, and Barnaby Joyce, who ticks nearly all of the boxes above.

I’m not sure how much of this is reflected in polling. In cases where the independent has a better chance of winning than Labor, the “two-party preferred” measure is irrelevant in any case.

Finally, as in 2016, and unlike any other election since 1993, the opposition party is offering a clear change rather than a small target. As it turns out, the noise of an election campaign means that this has made little difference. The rhetoric is shrill, but so it was when the parties were, in fact, virtually identical.

The main effect is that, if Labor is elected, it won’t need to spring any surprises on the electorate. It will also have a “mandate” for its policies for what that’s worth. That’s not much, in my opinion. At most, it gives centrist senators a justification for cutting a deal with the government to pass its policies.

Why were the Turks our enemies in 1914? Because Britain refused their offer of alliance in 1913

Both my grandfathers fought in the Great War, one in the Middle East and one in France. They survived (or I wouldn’t be here), but one was badly wounded in a gas attack. I’ve thought about this on Anzac Day for most of my 60+ years, but last year I learned something I hadn’t thought about and, as far as I can tell, hardly anyone else in Australia knows. We were only fighting Turkey because the British government refused their request for an alliance. I wrote about this last year, and I’m reposting it now.

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Today’s the Day

It’s now April 23 in the US, the official release day for Economics in Two Lessons. That’s nearly eight years after I started work on the book. I think it’s been worth the wait. The painful process has produced something better than I originally planned, with plenty of help from commenters here and elsewhere.

According to Amazon, the book is often bought along with Crashed, by Adam Tooze, which is great company to be in.

[Begin plug] If you’ve read and liked the book as it appeared here, this would be a great time to contribute a quick review [End plug]