Quote of the Week

If The Road [to Serfdom] was often misconstrued as a blast against the welfare state, it found readers in German-speaking Europe where its message was understood the other way around — as an insightful analysis of recent history and as a plea for a system, liberalism, that had never really been tried in Germany. In English, The Road was a conservative manifesto; in Germany, it turned out to be revolutionary. As a result, The Road‘s actual influence on German politics may have been more profound and lasting than it has been in the English-speaking world, a fact usually ignored by American Hayek scholars.

— François Godard, “The Road to Serfdom’s Economistic Worldview,” Critical Review 25, 3–4 (2013), pp. 378–379.

Rules of Inequality

Two economists, Chris Dillow and Randall Holcombe, discuss income inequality and Joseph Stiglitz’ The Price of Inequality. For those who have not read the book, you can read my review. Dillow wonders why some libertarians — surely, not me! — do not oppose inequalities caused by rent-seeking. As if in direct response, Holcombe reviews Stiglitz’ book, showing how similar the liberal and libertarian positions on inequality can be. Both Holcombe and Dillow reference Stiglitz’ comment on the rules of the game. Stiglitz writes that inequality “is not the result of the laws of nature or the laws of economics. Rather, it is something that we create, by our policies, by what we do.” Those sentences can be hard to interpret. Stiglitz is not claiming that market forces will not create income inequalities. Rather, what he means is that the laws of nature and economics are not necessarily binding, and what is binding is our legal structure — we, as a democracy, can decide what the proper distribution of income should be. Put this way, Stiglitz’ argument is much more difficult for some libertarians to swallow.

What kind of distribution of income does economic theory predict? At its most basic, differences in income are caused by differences in marginal productivity. Your productivity is measured in how much value the marginal person in your profession produces, determined, in part, by the demand for final products. Medical services are worth more than grocery services, so a doctor will make more than a grocer. If you tried to explain the growth in income for management, especially in finance, in this fashion, you might make the claim that the productivity of management, at the margin, has increased. Managerial talent is in high demand.

Holcombe, Dillow, and Stiglitz discuss the role of rent-seeking in causing income inequality. When libertarians think about rent-seeking, they think about monopoly rents, in the sense of decreasing competition. A corporation, for example, might lobby government to introduce a law that hurts the firm’s competitors. Corporate subsidies is a clear example of rent-seeking. But, a broad definition of rent-seeking can also include opposition to restrictions on competition, which is not so obviously wrong. For instance, the NYSE might lobby government to lower the capital gains tax. Energy companies might spend money to pressure Congress to allow oil drilling in parts of Alaska. This kind of rent-seeking produces outcomes which are justifiable within a libertarian framework (and in general, too: there are many non-libertarians who think the capital gains tax should be zero). Yet, Stiglitz does not discriminate. He criticizes rent-seeking across the board.

Much of rent-seeking is “reactionary,” in that it responds to legislated laws which override marginal productivity. That rent-seeking can return income distributions to how they would be in the free market is an important point, because it is what differentiates the argument Stiglitz is making from the less controversial argument that Holcombe endorses. Few liberals, apart from some libertarians, support an income distribution based on marginal productivity alone. A liberal polity may agree — as has been the case so far — to redistribute some fraction of income or wealth to its worst off, because there are other concerns that override the justice of marginal productivity theory. Government can also change the income distribution through regulation. Businesses lobby to lower taxes and regulatory costs. To those who see these taxes and regulations as necessary, businesses who fight them are seeking additional rents. Stiglitz’ complaint against rent-seeking is not an implicit endorsement of an income distribution based on marginal productivity.

This brings me to something Dillow quotes,

And that this inequality is not inevitable.  It is not, as Rich said yesterday, like the weather, something that just happens to us. It is not the result of the laws of nature or the laws of economics. Rather, it is something that we create, by our policies, by what we do.

— Stiglitz, “The People Who Break the Rules Have Raked in Huge Profits and Wealth and It’s Sickening Our Politics.”

At the end of the day, the rules of the game which are binding are those which are legislated. Distributions caused by differences in marginal productivity can be changed. Inequality is not like the rain, something out of our control. No, we can decide, as a society, what the proper distribution of income ought to be. We will tax some and give to others. We will regulate industry, increase the workers’ bargaining power. There exists a gamut of tools a liberal society can employ to redistribute income, each with its costs and benefits. At least, that’s Stiglitz’ message.

Something else to consider is how little inequality rent-seeking may cause. “Crony capitalism’s” role in inequality is easy to exaggerate. Our GDP is ~$15.6 trillion. How much is spent on lobbying? One source puts the 2011 figure, which is a maximum in their data, at $3.5 billion. How much does the U.S. spend on corporate welfare? I’m not sure what year this figure is for, but Aljazeera cites $110 billion. Putting both of them together, and assuming the figures for 2013 are similar enough: .7 percent of GDP. We can assume that the estimate is below the true number. But, the amount of income directly redistributed through rent-seeking is still relatively small. Further, much of that income is distributed to the employees of those firms, not just management — rent-seeking does not always distribute between income groups.

There are other theories that may have more explanatory power. How much inequality does inheritance explain? Think about that question in the context of low growth and high rates of return on capital. More importantly, how much do productivity differences explain? If it explains 90+ percent of the income distribution, then the progressive and libertarian views on inequality do not match very much at all.

Holcombe writes, “there is a substantial consensus that government is the cause of many of the problems people perceive.” He is saying the same thing as Dillow, “It is just silly for libertarians to pretend that inequalities are fair.” Both are assuming that opposition to rent-seeking creates a large common ground between libertarians and progressives. But, the types of collusion some progressives, such as Stiglitz, want to include are more than what most libertarians, and many non-libertarians, would be willing to concede. And, ultimately, rent-seeking may not explain very much inequality at all. There may be more important causes of inequality, where the question of justice is more ambiguous. The common ground between libertarians and progressives is much smaller than the battlefield.

ABCT and the Price Level

I remember my monetary theory professor using an aggregate demand/supply graph to illustrate supply-side theories of the business cycle, where a supply shock shifts the supply curve to the left. All else equal, a negative supply shock will lead to an increase in the price level — the same amount of money chasing less goods. This is how some people interpret Austrian business cycle theory (ABCT): there is a negative supply-side shock to the capital stock. It follows that the price level for capital goods rises. But, the evidence suggests the exact opposite, falling prices in the capital (intermediate) goods sector. That interpretation is wrong. ABCT is a demand-side theory, and it predicts just what the evidence shows, a falling price level for capital goods.

I also discuss what predictions ABCT makes regarding the general price level. The simple answer: none. This is why the ABCT cannot explain the depth of a recession on its own. I make my case in the second part of the post.

If you think that Hayek’s theory is about a supply-shock, read “The Maintenance of Capital.” The article presents a theory of the value of the heterogeneous capital stock. It’s related to Hayek’s business cycle research, in that it clearly frames the issue in the context of aggregate demand. Note his discussion of “capital consumption.” Capital consumption is not the same thing as a supply-side shock to the capital stock. Remember, the value of the capital stock is imputed (derived) from the final product. A rise in the price of an input is caused by an increase in demand for that input’s output. A fall in the demand for the final product, leads to a fall in the value of those inputs — capital consumption. This is important to keep in mind, because this is one of the basic parts to ABCT.

Let’s call an economy “neutral” when the allocation is optimal (don’t worry about frictions and imperfections). Picture an economy as a production possibilities frontier (PPF), with capital goods on one axis and consumer goods on the other. The PPF represents potential mixtures of output, given some given amount of resources. Not all points on the PPF are equally valuable. The neutral economy produces where the opportunity cost is lowest, which is a specific point on the PPF. Essentially, ABCT predicts that an excess supply of money will cause an economy to become non-neutral, by producing on some other point along (or inside) the PPF. This is shown in the graphic below, where the PPF is on the right — consumer goods on the y-axis and capital (or producer) goods on the x-axis. There are two marked places on the PPF; the uppermost circle is the original mix of output, and the lower circle is the new mix of output.

Output Combinations and the Hayekian Triangle

(Don’t worry about the Hayekian triangle on the left panel.)

Forget about central banks and interest rates, and focus on an excess supply of money. Hayek and Mises believed excess supplies of money to be non-neutral. Specifically, they thought excess supplies of money changed the prices of capital goods relative to those of consumer goods. The stylized process by which this happens is that new money is introduced through the loanable funds market, as banks extend loans. That borrowed money is used to buy certain inputs, raising the price of those inputs, and thus the profitability of producing them. The economy moves towards producing somewhere lower on our PPF curve, above (the second point on the curve). This means less consumer good output, since more resources are being used to manufacture intermediate (capital) goods. But, the level of consumption remains the same, so as the supply of consumers’ good falls, their price increases. This sets off a process of reversion, where the structure of production has to re-adapt to society’s time preference (intertemporal equilibrium).

Where is the shock to the capital stock? As amount of current inputs going into the production of future inputs increases, it changes the nature of capital. If the value of capital is imputed from the final product, and the final product capital is being used for changes, then the value of the capital stock will change. The excess supply of money, by raising the price of inputs, creates “false” profits. To keep it simple, “false” profits are non-neutral. These profits will make the new structure of production seem of high value. But, the reversion process corrects this, and there is a change in the pattern of demand. The investment during the boom is “malinvestment,” and the capital stock loses much of its value (it’s consumed), by virtue of the fact that the “false” demand for its output collapses.

Note that the prediction is a fall in the value of the capital stock. The physical stock of capital remains the same. The prices of capital goods, however, collapse. The type of inputs produced by the boom-time structure of production are not as useful as they first seemed. The range of productive uses narrows, and if the capital is highly specific it might become completely useless (Hayek makes this point explicitly in Prices and Production, and references the debate on idle resources).

To put the same point differently, imagine a supply/demand graph. The price of a capital good is decided at the margin at which the supply and demand curves meet. ABCT predicts that the demand curve will shift to the right during the boom, and then to the left during the process of reversion. Thus, the bust coincides with a falling price level for capital goods. The supply-side shock, just to be able to compare and contrast, predicts that the bust coincides with a leftward shift of the supply curve, or an increase in the price level for capital goods. The intuition behind that process is that as the amount of a type of capital decreases, the least valuable end that last input is useful towards increases in value (since there is less capital, there are less ends that can be satisfied — and, optimally, the most valued ends are satisfied first). This is not what ABCT predicts. Rather, ABCT says that, during the bust, the least valued end will decrease in value, because, as it turns out, what producers thought were highly valued ends were just distorted profit signals, caused by an excess supply of money.

The theory fits the empirical evidence, at least in this respect,

PPI Intermediate Materials 2001-2012

What about the general price level (consumers’ + producers’ goods)? ABCT is somewhat indeterminate in this regard, because capital consumption occurs while the price of consumers’ goods increases. It’s also ambiguous whether the excess supply of money will end through a rise in the price level, or through some kind of aggregate reflux mechanism. What brings about the primary effects of the ABCT are not changes in the money stock, but changes in relative prices. To explain a decline in the general price level, Austrians usually employ another theory, typically referred to as “secondary deflation.” Because this is no longer really within the scope of the ABCT, Austrians are somewhat vague on this point. But, I think this point is worth discussing, because it shows that ABCT most likely cannot explain a major business cycle on its own.

Rothbard provides an entire section (pp. 14–19) to explaining secondary deflation in America’s Great Depression. He employs a very strict quantity theorist definition of inflation/deflation: an increase/decrease in the money supply (although, I’m not sure this is consistent with some of the causes of deflation he discusses). Some of the causes he gives assume a gold standard, relevant then, but not now. Still, I think they can be generalized. He cites an outflow of gold (or, more broadly, let’s call it capital), forcing banks to contract their balance sheets. He also cites debt liquidation, where credit simply cannot be repaid. Finally, a third force is the increase in the demand for money. The deflationary process is, strictly speaking, separate from the process described by ABCT; related to it, but not directly. Rothbard considers the deflationary process beneficial. In the preface to “Monetary Theory and the Trade Cycle,” Hayek also distinguishes deflation from the process described by ABCT, but writes that “an indefinite continuation of that deflation would do inestimable harm.”

There are multiple margins to judge deflation on. Rothbard’s point, which is valid, is that what matters are relative prices, not general prices, so that deflation doesn’t necessarily cut into profits — especially if capital good prices fall faster than consumer good prices (which is empirically true). I will come back to this shortly. Other channels through which deflation may not be beneficial include those akin to Fisher’s theory of debt deflation. A New Keynesian model will also tell you that a non-inflationary environment forgoes the benefit of inflation to reduce the demand for money, if we are in a liquidity trap, where interest-bearing assets and money are equally attractive, because of low interest rates. I’m not going to comment on the validity of these theories. They are nevertheless worth considering, and I will say why that is below.

Debt deflation and liquidity traps aside, knowing why Rothbard is somewhat wrong is important. Note a claim he makes on the height of unemployment caused by an Austrian business cycle,

Since factors must shift from the higher to the lower orders of production, there is inevitable “frictional” unemployment in a depression, but it need not be greater than unemployment attending any other large shift in production. In practice, unemployment will be aggravated by the numerous bankruptcies, and the large errors revealed, but it still need only be temporary.

America’s Great Depression, p. 14.

This is, by the way, the exact claim Paul Krugman makes in his criticism of ABCT, what he calls the “hangover theory.” The initial boom period requires substantial capital readjustment, as well, but during this period the unemployment rate is relatively low — either around its “natural” level (~4–5 percent), or below. I think the critique is not as strong as some make it out to be, because the bust is a sudden change in relative demand, with significant capital consumption. During the boom, there is competing demand for consumer and capital goods, so one sector doesn’t necessarily suddenly become unprofitable. The shift in the allocation of labor is much less painful during the boom. Still, Krugman (and Rothbard) have a point: ABCT cannot explain the depth of unemployment very well.1 You need an additional story, and the scapegoat many Austrians like is government, bad supply-side policy and regime uncertainty. But, blaming government is not always right.2

Explaining the direction the general price level moves in is relevant to explaining the depth of unemployment. Putting debt deflation and liquidity traps aside, deflation is good if it’s neutral. If the demand for money increases and deflation is non-neutral, the unemployment rate and the output gap will grow. Assume the money stock at time t is M1, but the demand for money at time t+1 calls for a stock equal to M2. If the supply of money doesn’t increase, there will be a demand shortage. There will be people who want to increase their cash balances by selling non-money assets, including labor and goods/services. But, there isn’t enough money to meet their demand for it. If deflation is neutral, a falling price level will cause a falling demand for money. If deflation is not neutral, the demand for money remains the same there is a shortage of money, and therefore of demand, and trade that would have taken place does not — output falls. Deflation can be non-neutral if some key prices don’t fall to clear the market, including the price of labor and, perhaps, other capital goods that are heavily complimentary to labor. This is monetary (dis)equilibrium theory. You need this theory to explain the depth of the recession.3

Austrian business cycle theory does not offer us ideas on the direction the general price level takes during a bust. Empirically, deflation is the norm. ABCT cannot explain this deflation, except through use of alternative theories. Further, while the ABCT explains the boom and the direct causes of the bust, it cannot explain other elements of the bust that are caused by confounding factors. But, ABCT definitely does not predict an increase in the price level of capital goods, which is what would happen in a supply-side shock. Rather, it predicts declining capital good prices, which fits the evidence.

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Notes:

1. I discussed a similar criticism in an August 2011 article, “Rethinking Depression Economics.” I think that much of my insight is valuable, but, at the time, I had not considered the role of monetary equilibrium to the extent I should have.

2. Bad supply-side policy can explain a lot of unemployment. The high unemployment of the Great Depression is explained in large part by bad supply-side policy. Alternative theories should be seen as complimentary. Look at the difference in unemployment between Spain and the United States, both of which have similar output gaps. Spain is an example of bad supply-side policy. The U.S., however, is an example of bad demand-side policy. As the unemployment rate falls, the output gap remaining equal, supply-side theories of unemployment have less explanatory power.

3. Hayek understood this. Apart from his comments on the negative effects of deflation, see “The Gold Problem” (published in Good Money, Part I) and “Monetary Nationalism and Monetary Stability.” I think he realized the power of Hawtreyian (?) explanations of the Great Depression, which focused on international gold flows and reserve hoarding by part of central banks. He wanted to synthesize these theories with his own.

Explaining Religion’s Survival

One challenge to atheism is: if belief in God is so wrong, why has religion survived for as long as it has? Why have humans been religious, for as long as we know? I have a Hayekian theory. If you are religious, and my theory offends you, assume it applies to every other religion except yours.

I was thinking of a situation where the morally dubious option is very attractive, but something external to me makes it unattractive. For the record, I am for all intents and purposes an atheist. Also, your moral intuitions may differ from mine, but to interpret my point try to step into my shoes. Suppose you are given two options,

  1. You can continue with your current life, but you will not fulfill your most valued dreams. Your current life includes a healthy, loving relationship with your wife.
  2. You can re-start your life, with the guarantee that you will be able to fulfill your most valued dreams. For you, let’s assume, that means being a famous football player, able to sleep with the most beautiful women in the world.

What would make me say “no?” I find it morally dubious to abandon my wife, even if it turns out that she would never be aware of anything. I have a commitment to my wife (or, I would, if I were married), and it just seems wrong for me to abandon her — even if she would be ignorant to it (her alternative life would exist without me ever being in it) — so that I can sleep with dozens of beautiful women in my alternative dream life.1 But, when I was thinking about it, this wasn’t the intuition that made me choose option (1). Rather, I had a feeling that I would be judged, and that I would pay in some way for choosing (2). I am an atheist, but I felt that I would be judged by God. I have never been religious, but that feeling of being judged by some spiritual being did not evolve endogenously; it had to be imparted to me culturally.

“Don’t cheat on your wife” is not the only value religion imparts on believers. In fact, there were probably many religions that did not stress monogamy, and there were probably even religions that valued polygamy. But, most religions do try to instill certain values, and most religions ask for peace between members. The religions that have survived — the most popular and most robust religions — tend to require strict adherence to some set of values. Greek mythology, for example, is partly designed to teach people certain moral rules. These rules might not have religious origins, but rules without religion usually don’t have an omnipotent, omniscient enforcer.

The belief that you are being judged by someone who you can’t evade, who knows your motivations, and will unflinchingly apply the rules by which He commands you to live your life is very powerful. It makes getting away with morally dubious behavior impossible. To get around this constraint, you have to have a very strong belief that there is no spiritual enforcer. I am very skeptical of the existence of God.2 Yet, for whatever reason, having a sense of an omniscient, omnipotent enforcer strongly weighs on my moral intuitions.

Let’s take a step back and move in another direction, that will loop back to the question of why religion has survived. In Rules and Order, Hayek lays out the foundations for a theory of spontaneous order. The set of rules that govern entire societies/communities aren’t designed by a single mind, rather they emerge over time and are selected based on their survival value. It’s easiest to explain Hayek’s argument through an example. Suppose we live in world where there are various communities, each with its own set of rules. Over time, one community develops the heuristic “do not murder,” probably because they notice how much more well-off they all are if they can trust that their neighbors will not murder them. That’s the thing: this rule makes this community better off relative to others, so the probability of the rule being adopted by others is high. Alternatively, a rule that promotes disorder is likely to be abandoned, because societies that employ it will be relatively less successful than societies that don’t (all else equal).

Religion can impart rules that promote disorder, such as a willingness to wage war against non-believers, but these rules usually guide inter-, not intra-, community relations. Rules that do promote intra-community disorder usually die out over time. Implicit antisemitic rules in Christianity, for instance, have mostly died out, because communities that promote religious tolerance and cosmopolitanism are typically more successful than those that do not.

Order-inducing rules can emerge without religion. In fact, most rules that religion codifies probably emerged independently. They were adopted, because they make sense and are order-promoting. But, there is an advantage that religious rules have over non-religious rules, and it’s that religion promotes a kind of self-regulation. Non-religious rules can be enforced by secular institutions of governance, but this is easier today than it was 200+ years ago. If it wasn’t for self-enforcing rules, society may not have advanced to the point where it’s at today. A fear of God (or, the gods) is a powerful enforcement mechanism. So is the vaguer, but related, notion that there is a spiritual enforcer that will make us pay for our morally dubious decisions, even if everyone else is ignorant of our choice.

There is a strong impulse to spread religious values (although, not in all religions — Judaism is remarkably insular). If religious values promote peace, and if these values are “self-enforced,” it will be good for society to spread religion to non-believers, so that they too will be constrained in the same way. There are other motivations behind spreading religion, of course. But, a religion that relies entirely on conquest will not be very successful. Roman and Greek religion, for example, did spread through conquest, but the strongest reasons for accepting certain deities were probably cultural. And, Roman and Greek religion did not survive for long when superior alternatives were made available, even when these alternatives were oppressed (as was the case during the Roman Empire).

If there is no God (or no gods), why has religion survived for as long as it has? Or, if there is a God (or gods), why have false religions survived? Because religions impart order-promoting values, and the idea of an omnipotent, omniscient God that judges all of our choices is a powerful mechanism of self-enforcement. Religious societies were probably simply more successful than non-religious societies, which is most likely the reason why non-religious societies did not exist (or were very rare) prior to the growing secularist movement. Even in increasingly secular societies, there is still an implicit notion of a final judge that we can’t avoid — this is still the same mechanism of self-regulation. One thing that does seem to follow from my theory — and this might make some uncomfortable — is that as superior alternative processes of enforcement arise, religion will become less relevant.

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Notes:

1. There is the additional fact that I would rather be with my wife than with any other woman, but this isn’t a particularly strong feeling for many men, and it was even weaker historically.

2. But, it’s important to me that I cannot be certain of God’s non-existence.

What Makes Austrian Business Cycle Theory Attractive

Tyler Cowen links to a recent paper which explores credit expansion and financial crashes. Cowen comments that Austrian Business Cycle Theory (ABCT) needs more Minsky. I disagree. It reminds me of a passage that I had highlighted in Piketty’s Capital in the Twenty-First Century, on bubbles and self-fulfilling expectations. One thing that makes ABCT so attractive to me — one of the most attractive facets of Austrian economics, in general — is the emphasis on rule-following behavior. This requires interpreting Hayek’s 1930s work on industrial fluctuations through a 1940s Hayekian lens. One way to interpret the business cycle is to ask why certain rules work for some period of time, which we can call the “boom,” and why these rules suddenly create erroneous decisions during another period of time, the “bust.”

Piketty offers a conventional psychological theory of the self-fulling bubble,

[T]hese anticipated future prices themselves depend on the general enthusiasm for a given type of asset, which can give rise to so-called self-fulling beliefs: as long as one can hope to sell an asset for more than one paid for it, it may be individually rational to pay a good deal more than the fundamental value of that asset (especially since the fundamental value is itself uncertain), thus giving in to the general enthusiasm for that type of asset, even though it may be excessive. That is why speculative bubbles in real estate and stocks have existed as long as capital itself; they are consubstantial with history.

— p. 172.

The above is representative of a fairly common way of explaining bubbles and financial crises. Other explanations, such as Minsky’s might be more sophisticated, but they essentially grasp towards the same idea. I find their insight to be somewhat trivial, because they are vague theories that simplify agents’ behavior in financial markets to “they buy what they think everyone else will buy.” But, and this is an empirical question, I doubt that very many investors make their choices based on the expectation that an asset will continue to rise in value, despite that price diverging from “fundamentals.” Instead, what we see is investors justifying their decisions based on their reading of the “fundamentals” — i.e. the national housing market will not suffer a bust —, only to find out that their interpretation is wrong.

What ABCT does, once fully synthesized with Hayek’s later work on knowledge, institutions, and rule-following behavior, is embrace rational, informed decision-making in financial markets, and then explain how these rules can lead to welfare reducing outcomes if these rules are “distorted.” Hayek’s early model simplified all of these behavior-constraining rules to profits. Investors chase profits, because profits signal healthy, strong investment. Where assets grow in value is where there are profits. To investors, these increased revenue streams are the “fundamentals.” They invest in an asset because that business, or that market, is doing well. Any theory of the business cycle has to explain why these expectations, and the “fundamentals” (the heuristics) that guide them, are suddenly reversed — why do markets, which usually read the “fundamentals” so well, fail in bulk?

Minsky needs ABCT, not the other way around. The ABCT is, so far, the most complete demand-side theory of reversed expectations. I will refrain from claiming it’s the best, because so far maybe it hasn’t been compared to adequate alternatives. And, undoubtedly, ABCT is far from perfect, itself. You also need to take an empirical approach, because the lessons of ABCT have to be generalized — the narrow model is not perfectly applicable (as is the case with every theory). But, the point I want to make is that the credit-boom aspect is not what’s unique to ABCT. You can find that in Minsky. Other economists have made similar connections (e.g. Alan B. Taylor). What’s unique to ABCT is how it puts the story together by trying to explain investors’ behavior, and why this behavior turns out to be systemically suboptimal. It provides a sophisticated explanation, and I don’t think Minsky — or others who rely on psychological, rather than institutional, explanations — succeeds to the same degree.

Quote of the Week

In 1952,…only 6.5 million Americans (4% of the U.S. population, or roughly 9.5% of households) owned any common stock — below the 1920s level of 15 to 20% of households and far below the 2007 figure of 49.1%. In 1952, approximately half (46%) of equity investors owned only one issue (ed. emphasis mine).

— Janice M. Traflet, A Nation of Small Shareholders (Baltimore: The Johns Hopkins University Press, 2013), pp. 4–5.

To Know How Government Fails…

Hayek once wrote something along the lines of, “To know where markets fail, we need to know how they can work.”

I’ve written quite a bit about governance these past two weeks. A long post would be repetitive, so I’ll keep my point short and sweet. I’m motivated — or, at least, reminded of this — by Daniel Kuehn’s brief critique of Bob Murphy’s recent article on space exploration. He thinks that some libertarian economists don’t take externality arguments seriously enough. They aren’t willing to concede the a priori possibility of the existence of a public good. I certainly see where Daniel is coming from, and I agree to some extent or another. But, I think there is another, related problem.

Most economists, libertarian or otherwise, probably do agree that there are such things as externalities, information asymmetries, et cetera. The reason they do think that these do not call for public provision of the affected goods and services is because they assume, a priori, that government can’t fulfill this task without creating more inefficiency than we originally started out with. I think this is certainly a possibility, and is definitely true regarding some (probably extensive) range of goods and services. But, it doesn’t necessarily have to be true.

Libertarian economists also probably overstate the case against government. Or, maybe they don’t. But, I don’t think there is any set of theory out there that can tell us for sure. Actually, there is — The Myth of Democratic Failure (?), “Voting as Communicating,” The Calculus of Consent, “The Allocation of Goods by Voting,”… —, but it doesn’t usually inform libertarian policy prescription and there is probably a lot of room left for research. Libertarians rarely ask themselves, “How do institutions of governance communicate local knowledge and coordinate disparate plans between agents to provide order?” But, to know where government fails at achieving order, we have to understand the process by which it reaches the order it does. If we have no theory about how exchange-based governance works, how can we comment on what the proper role of government is?

This is a theme I’ve been pushing on this blog, because I don’t think most libertarians take it seriously enough. Before we can say how governments fail, we have to know how governments work.