Econoclasm: Lesson four

I will interrupt myself here to note that yes, there are people who are pursuing economics as an empirical science, and they have indeed demonstrated that the so-called neo-classical economic theory as taught to first-year college students is not a description of the real world. My point in this presentation is that many people, including journalists and politicians, believe that it is. This pernicious falsehood horribly contaminates public discourse. So yes, it does require debunking.

 

There are a couple of additional problems with the concept of the free market that don’t stem directly from the faulty assumptions. One is called “public goods.” These are goods that are “non-excludable,” which means that nobody owns them and you can’t require people to pay to use them; and non-rivalrous, which means that one person’s use of them does not deplete them for others. 

An example is the oxygen in the air, but many public goods are created or protected by public policy. Straightforward examples are national defense and law enforcement, although obviously we can disagree about how much and what kinds of these goods we should be buying, and how to allocate the cost. Many public goods are created because they are thought to have positive externalities, that is they benefit all or most people beyond their direct recipients. Examples are public education and national parks. (Even if there are admission fees, they amount to far less than the actual cost of maintaining parks.) 

The road and highway network is another very familiar example. It is not entirely non-rivalrous because, as I noted above, congestion makes it somewhat less valuable for everyone, and it’s also not entirely non-excludable because people without driver’s licenses or properly insured and inspected cars are technically forbidden to use it. These concepts are actually matters of degree. But the key point is that the market would produce much less in the way of roads and bridges than would be optimal for the general welfare. Investors might build a bridge or a highway here and there and make their investment back in tolls, but the result would be highly inadequate for the demands of modern commerce, work, school and social life. We can argue about the provision of public goods, but the point is they are not traded in markets and are not created in response to market demand.

One last point about Economics 101 may be the most important, is likely to be overlooked or even denied in the U.S. today. Economists claim they can show that if all their assumptions are true – perfect information, willing sellers and willing buyers, perfect competition, no externalities – the hypothetical free market will create what is called a Pareto optimum. That is a situation in which no person can be made better off without making someone else worse off. This is the basis of the claim that the free market allocates resources “efficiently.” 

But there can be a Pareto optimum in which everybody has an equal or close to equal share; and one in which one person has 90% of the wealth and the remaining million people have 10%. The latter is actually much closer to the situation we’re in right now. 

But there is nothing in the theory of the market to support a claim that whatever distribution results is just, or fair, or desirable. If you don’t think it’s fair that one person has 90% of the wealth, there is no reason in the theory of the market why you shouldn’t tax 99% of that wealth away and share it with everybody else. Maybe you can think of arguments against doing this, but they aren’t to be found in introductory economics. The question is simply ignored.

Liberalism, in the modern sense, can be thought of as favoring government policy to repair the defects of the market, and make it more like the theoretical ideal. Environmental and workplace safety regulations limit some externalities. Food labeling requirements and protections against fraud limit information asymmetry. Generous investment in public goods fills important gaps left by market forces. Provision of basic income support and social services reduces inequality. Regulations prevent the formation of monopolies or break them up when they occur. The irony is that conservative libertarians who oppose most liberal policies are actually rejecting attempts to make the world more like their theory claims it should be.