A REFRESHER ON THE LIMITATIONS OF THE WELFARE ECONOMICS PARADIGM.

The back to school sales are starting up, and that might be as good a reason as any for today's review session, courtesy of Aunt Deirdre and Cafe Hayek.

For more than 100 years – and especially since the 1930s – it has been considered by most economists to be a perfectly acceptable scientific move to identify and describe on chalk boards possible ways that markets might fail to achieve perfection, then to label these failures as “market failures,” and finally to conclude that the state should be charged with the responsibility of ‘correcting’ these imperfections. As McCloskey suggests, it’s a wholly unscientific move to assume – simply to assume – that government officials have the motivation, information, and power of omnibenevolent, omniscient, and omnipotent gods.

The Cafe Hayek post continues the instruction using one strong argument.

McCloskey in addition – in the book quoted above, as well as in many other of her works – correctly notes that the economists who identify these theoretically possible “failures” and “market imperfections” almost never attempt to quantify their real-world significance. Were such measurements reasonably carried out, the results in all cases would almost surely be swamped – magnificently swamped – by the the size and significance of market successes.

There are other elaborations that we've highlighted at Cold Spring Shops.  Long ago, we raised the prospect of rent seekers capturing the policy.

The welfare economics paradigm begins with some fairly tight theorizing (under conditions 1, 2, 3, and 4, a competitive equilibrium exists and is Pareto optimal. The role of government becomes either to provide the basic rules of trading, or to make transfers of endowments to provide the initial allocation from which the Pareto optimal equilibrium will emerge) and continues with additional theorizing (under any of conditions 1', 2', 3', and 4' existence or Pareto optimality do not follow) leading to proposals for policies that a properly-informed government can implement. Here is where the paradigm breaks down, as there is a great deal of research, which the public choice advocates view as persuasive, to the effect that traders can discover and improvise ways to eliminate the inefficiencies, or that the theoretically preferable policies break down, or that the agents of the government are themselves rational maximizers.

Call me a Strong Skeptic, if you wish, on any hope for Platonic Perfection once the blackboard prescription becomes law. "It matters not whether a government insurance agency acting as a monopsonist toward physicians, surgeons, and pharmacists, or whether the secretary of Health and Human Services seats a board of Wise Experts. Rents will exist. Rent-seekers will seek rents. Rents will be dissipated. The taxpayers will not necessarily be better served."

But there's yet another possibility, one also due to McCloskey, lurking in that long-ago excerpt.  "Government actions have the potential to address some outcomes from some kinds of markets. Whether those policies work properly, or achieve allocative efficiency, or some kind of equity, or might be done more effectively by other means, remains an open question."  Think carefully: if your standard for optimality is allocative efficiency, meaning all gains from trade are recognized and realized, doesn't it follow that a "market failure" involves some gains from trade not being realized?  The institutional arrangement that harvests those gains from trade might be some tax, transfer, or regulation.  Or not.  "The assumptions underlying the standard market efficiency theorems are sufficient conditions for market efficiency, not necessary ones."  But they look so pretty on the blackboard.  "Makes policy analysis somewhat more challenging than market-failure-warrants-government-intervention, no matter how pretty the optimal policy response looks rendered into four-color diagrams or sigma-algebras."  But the people who are advising the Jarrett regency just will not learn.  "Perhaps it would benefit some public policy intellectuals to be more familiar with the argument."

I found, however, another Cafe Hayek quotation that works as well to conclude today's lesson.

I'll give Cafe Hayek's Don Boudreaux the final word. "What is required of anyone wishing to cast doubt on the efficacy of private-property markets guided by real-world market prices is a believable explanation of how the economy might be operated better by an alternative system."

Critique is simple.  Praxis is hard.

We've seen what the Jarrett regency has done with their vulgar Welfare Economics Paradigm. There is a boundary in academic economics between outlining an argument, and advocacy, and yet, equipping students with the intellectual tools to see the possibility of the Blackboard Vision of Wise Experts going wrong is part of the job.  They can keep that argument in mind, or not, when they vote.