As the author of a book on opportunity cost, I might be expected to be enthusiastic about the idea that trade-offs are always important in economic and policy choices. This idea is summed up in the acryonymic slogan TANSTAAFL (There Ain’t No Such Thing As A Free Lunch). In fact, however, a crucial section of Economics in Two Lessons is devoted to showing that There Is Such A Thing As A Free Lunch. It is only when all free lunches have been taken off the table that we reach a position described, in the standard jargon, as Pareto-optimal.
If a policy is not Pareto optimal, it’s possible to find one that is better in every respect. In the jargon, the first policy is dominated by the second.
That observation is relevant in a couple of crucial contexts. Lots of climate deniers want to claim that there is a trade off between reducing carbon emissions, through investment in renewables, and improving the living standards of poor people, by building coal-fired power stations. In reality, renewables are cheaper and more reliable than coal, and millions of poor people living near coal-fired power stations die every year from particulate pollution. Even without considering global heating, coal fired power is a dominated option.
Exactly the same is true in relation to pandemic policy. Any policy which leaves R > 1 (the pandemic keeps spreading) is dominated by stricter policies that ensure R < 1. The first policy will not only lead to continuing deaths, but it can never be relaxed. So, it will entail more economic losses in the longer run. By contrast, once the prevalence of the disease is reduced to zero, the stricter policy can be relaxed (to be slightly more realistic, it may need to be reintroduced on a temporary basis to deal with local outbreaks).
In this context, it’s striking that none of those talking about an R > 1 policy in Australia are prepared to spell out the trade-offs they envisage. That’s because any attempt to do so would expose the bankruptcy of their reasoning.
fn1. I also point out how Pareto’s economic analysis foreshadows his embrace of Fascism.
I’ve got quite a few events coming up in the next ten days. I’ll be in Adelaide for the Writers Week (program here), appearing at the Pioneer Women’s Memorial Garden, King William Road on Wednesday 4 March at 2pm in conversation with Jane Goodall, on the theme the Common Good. I’ll be signing copies of Economics in Two Lessons.
I’ve fitted in two earlier events on Tuesday 3 March. At 12 noon, I’ll be talking about the economic cost of the bushfire disaster, at the University of Adelaide (Level 6, Faculty of the Professions Building, Pulteney Street). Then at 5:30, I’ll be talking about Economics in Two Lessons to the Economics Society of Australia, Marjoribanks 126 SANTOS Lecture Theatre, Level 1, Nexus Building 10 Pulteney Street, Adelaide, SA 5000
On Monday 9 March, I’ll be back in Brisbane at the Customs House for the launch of The Brisbane Dialogues, an attempt to promote civil discussion across political divides. I’ll be debating North American philosopher Stephen Hicks on the topic (suggested by me) “Postmodernism is a rightwing philosophy”. As long-time readers will recall I was making this point long before Kellyanne Conway brought it to wider attention with the idea of “alternative facts“.
Here’s a review of Economics in Two Lessons, by Nikki Dumbrell in the Australian Journal of Agricultural and Resource Economics. It’s the first in an academic journal, and captures all the main points nicely.
Free market economics (or ‘One Lesson Economics’, Hazlitt 1946) refers to the idea that markets, left alone with very minimal intervention, will achieve equilibrium and as such allocate resources to their most valued use. This idea is persistent. Indeed, famous schools of economic thought (and individuals’ careers) are built on this idea. Economics in Two Lessons, by Professor John Quiggin (Distinguished Fellow of the Australasian Agricultural and Resource Economics Society) recognises the importance of One Lesson economics but challenges the completeness of this way of thinking. He draws readers’ attention to where and how markets might be imperfect or might not exist and asks readers to consider how One Lesson economics might perform in these scenarios. The short answer is ‘poorly‘.
To tease out the shortfall of One Lesson economics and the importance of Two Lesson economics, the central theme of the book is opportunity costs. ‘The opportunity cost of anything of value is what you have to give up in order to get it‘ (p.3). The book is divided into two parts: Lesson One and Lesson Two. Each part includes an introduction to the lesson and subsequent chapters with examples. Quiggin summarises Lesson One as ‘market prices reflect and determine opportunity costs faced by consumers and producers’ (p.7). Lesson Two follows and broadens the scope from consumers and producers to society, ‘market prices don’t reflect all the opportunity costs we face as a society’ (p.8). In addition, Lesson Two extends the definition of opportunity costs to say that the opportunity cost of something of value (to you) includes not only what you must give up, but what others must give up as well.
The 70 years between the publication of Hazlitt’s (1946) book and this book has provided a number of real‐world examples for Quiggin to debate the value of One Lesson and Two Lesson economics in a critical analysis of market mechanisms and economic policy. For example, Quiggin draws on the Great Moderation, the Global Financial Crisis, increasing inequality, episodes of mass unemployment (for which most examples are accompanied by empirical evidence from the United States), and multiple forms of pollution such as chlorofluorocarbons linked to ozone depletion and climate change. The book balances this evidence of market failures with history of economic thought to deliver a well‐rounded understanding of the key differences between Lesson One and Lesson Two. It is important to note that the above‐listed examples relate to both microeconomic and macroeconomic issues. Quiggin points out that ‘in standard economics courses, analysis of opportunity costs, and market failure is typically confined to courses on microeconomics. This is a mistake. Lesson Two tells us that market prices don’t reflect all the opportunity costs we face as a society’ (p.152). Lesson Two also emphasises the importance of the opportunity costs of government choices, not just consumer and producer choices.
While opportunity costs are a foundation concept of economics, and an important instrument for Quiggin to illustrate how and why free markets can both succeed and fail, he also shows that it remains a concept difficult to grasp for many economists. For example, a survey of 200 delegates at the 2005 American Economic Association Annual Meeting (Ferraro and Taylor, 2005), drawn on by Quiggin, showed that only 22 per cent were able to correctly identify the opportunity cost of a decision in a hypothetical scenario. The clarity with which Quiggin writes on opportunity costs appears timely.
Another important contribution of this book is to remind readers that markets operate in a social environment. For example, property rights (that form the basis of trade in a market) are a social construct. Therefore, society and governments (not just consumers and producers) are intrinsically involved in the establishment and operation of markets. To forget or ignore this, as is often done by advocates of the free market, is detrimental.
This book has something to offer all new and long‐time students and practitioners of economics. Firstly, Quiggin’s ability to distil jargon and illustrate what can be complex concepts with real‐world examples makes this book accessible and thought‐provoking for all, regardless of any prior economic experience. Secondly, Quiggin recommends much relevant (often seminal) further reading for anyone who wishes to use this book as a launching pad to further discovery. Thirdly, as the earlier example from the 2005 American Economic Association Meeting indicated, many in the profession could use the clarity of economic thought that Quiggin offers. Ultimately, the book provides a framework to think about: (i) the challenges that arise when markets are missing or imperfect; (ii) the role for both market forces and government policy in response to economic problems; and (iii) the consequences (positive and negative) of different responses to economic problems. As we continue to face numerous complex economic problems, I hope to see this book and the ideas within it attract much attention.
Following the release of Economics in Two Lessons, Sophie Roell of Five Books invited me to do an interview. The Five Books format is that the interviewee (usually an author) nominates the best five books (not including their own) on a given topic. My topic was the Best Books on Learning Economics, with the explanation
these are not textbooks for students studying economics. They’re books for the intelligent, general reader to learn what economics is about—and what the important issues are—without doing any actual [technical] economics.
I’ve picked books by Milton Friedman, Paul Ormerod, Tony Atkinson, Thomas Piketty, and Abhijit Banerjee & Esther Duflo. The interview is here.
Ross Gittins has a very nice piece in the SMH today, with some kind words about Economics in Two Lessons which he recommends as “the best book to introduce you to economics”. Ross says that the crucial concepts in economics are: Opportunity cost (of course!), the Invisible Hand (roughly, my Lesson One), imperfect competition, market failure and externalities (the microeconomic component of my Lesson Two).
His final para gives the lie to those who imagine economists oppose action to save the global enviroment
As for external costs (“negative externalities”), Quiggin notes that the leading British economist Lord Nicholas Stern has described climate change as “the biggest market failure in history”. So now you know why so many of the nation’s economists are appalled by Morrison’s dereliction.
With much of Australia suffering catastrophic fires and the beginning of a new war with Iran, lots of people are thinking about the idea that such disasters are good for the economy, because of the work generated in rebuilding homes, producing war materials and so on. In my book Economics in Two Lessons, I explain why this is wrong (this is one point where I agree with Henry Hazlitt’s Economics in One Lesson. Here’s a link to Chapter 6: The opportunity cost of destruction
US President Eisenhower got it right when he said
Every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed.
And the same is true for the destruction visited on us by Morrison, Trump, Murdoch and the rest of the global denial industry. The workers who will be needed to rebuild homes, farms and infrastructure could instead be employed producing useful new things. Those forgone alternatives are the opportunity cost of destruction
I did an interview about Economics in Two Lessons with Brisbane based economist Gene Tunny. You can listen to it here.