Friday, 8 October 2010

Markets fail, so we need more markets

Bernard Hickey, one of New Zealand's business journalists, has been putting about some rather odd ideas that only prove he doesn't seem to understand economics. Matt Nolan and Eric Crampton have covered his nuttiness so I won't say anything more about that. What I think interesting is a point Eric made when he said,
The case for markets never lay in their perfection but rather in the relative imperfection of alternatives. I'm teaching intermediate micro this semester. We go through the welfare theorems, and they're beautiful. We know that they don't apply generally. However, it's really hard to improve on the imperfection of markets. Both markets and policies are imperfect instruments. Markets fail relative to blackboards, but regulatory solutions often fail relative to the real world market alternative.
This is a basic point that many people miss. A version of this idea I like is by Oliver Willaimson,
Students of the NIE eschew hypothetical ideals-which work off of omniscience, benevolence, zero transaction costs, full credibility, and the like-and deal instead with feasible organizational alternatives, all of which are flawed. Coase (1964) and Demsetz (1969) were among the first to take exception with the asymmetric standards that were once used in the "market failure" literature-according to which markets are beset with failures whereas "omniscient, omnipotent, benevolent" governments (Avinash Dixit 1996, p. 8) would reliably administer efficacious remedies. As we all should have recognized (but needed to be told), all feasible forms of organization-government included-are flawed.

What I have referred to as the remediableness criterion is intended to rectify this asymmetric state of affairs. This criterion holds that an extant mode of organization for which no superior feasible alternative can be described and implemented with expected net gains is presumed to be efficient.

To be sure, public policy analysis becomes more complicated when analysts can no longer condemn extant modes because they deviate from a hypothetical ideal, full stop. The remediableness criterion presses the public policy analyst to display a superior feasible alternative. If, moreover, a proposed feasible alternative cannot be costlessly implemented, then the costs of implementation are appropriately included in the net benefit calculus-which has major ramifications for the path dependency literature. Finally, grounds for rebutting the efficiency presumption need to be addressed-which brings in politics (Williamson 1996, 1999). Absent rebuttal, the remediableness criterion stands as a reminder of the obvious: it is impossible to do better than one's best. (Williamson 2000: 601-2)
Government can not do what Hickey seems to want to believe they can do, they are flawed and usually when compared to markets they are more flawed. Thus if Hickey want to show that the use of markets is wrong he has to show that there is a superior feasible alternative can be described and implemented by the government with expected net gains. That isn't easy to do.

So the argument, as Eric notes, for markets isn't that they are perfect, rather its that they are less imperfect than the alternative.
  • Williamson, Oliver E. "The New Institutional Economics: Taking Stock, Looking", Journal of Economic Literature, Vol. 38, No. 3 (Sep., 2000), pp. 595-613.

1 comment:

Mark Hubbard / Tribeless said...

Thank goodness the academic economists are finally taking Kim Jong Hickey on, and showing up his 'nuttiness'. It's depressing the traction he seems to get in the mainstream media for his appalling - often contradictory - ideas for Fortress New Zealand. From the comments field at he seems to be training up an army of true 'useful idiots', and I suspect he'll be finding a home with the odd 'useful idiot' in Parliament also - especially the Keynesian Cunnliffe.