Economics as pathology, part two
The other day I complained about an article by Brookings economist Ted Gayer. So did Brad DeLong, Paul Krugman, Ryan Avent, and Ezra Klein. As I am a nobody writing on an obscure website, I was roundly ignored by all parties, but Gayer has responded to the others. His response only reinforces the impression that he sees the world entirely in terms of platitudes from Economics 101.
Gayer’s basic shtick in his response is to set up a dichotomy: either people and businesses behave rationally or they don’t; either “firms are better at identifying profit-making abatements” or “regulators are better at identifying profit-making abatements”; either people do what economists predict or we might as well abandon capitalism. There are, after all, no gray areas in matters of faith.
When DeLong points out that McKinsey gets paid lots of money to identify profit-making abatements for businesses (which, by definition, hadn’t identified the profit-making abatements prior to hiring McKinsey), Gayer responds that it isn’t “evidence against the profit-maximizing assumption” because … the companies paid McKinsey to help them maximize profits. Those who haven’t hired McKinsey presumably know, in advance of hiring McKinsey, that there are no profit-making abatements available to them. Efficiency consulting, like all resources, is optimally distributed in this best of all possible worlds!
It’s handy: if your definition “what businesses do” is “profit-maximizing,” and your definition of “profit-maximizing” is “what businesses do,” then yes, it’s hard to find counter-evidence. Businesses do in fact do what they do, and not something else.
Even better: Responding to Avent’s point about the housing bubble, Gayer warns against “abandoning economic principles” just because people mechanically applying those principles have been spectacularly wrong in the recent past at the cost of widespread suffering. Let’s not be hasty!
What Gayer’s really concerned with, however, is nestled in this self-referential argument: If we accept that sometimes people and businesses don’t rationally maximize profit, then we must abandon the dogma that “market mechanisms” are always and everywhere more efficient than “prescriptive command-and-control regulations.” But we can’t abandon it; we know it’s true, because people and businesses always maximize profit. The assumption justifies the dogma, the dogma justifies the assumption, and around we go.
There are two responses to this closed loop of an argument:
1. Command-and-control regulations are sometimes more effective. In a perfect market peopled by Vulcans, market mechanisms … well, still wouldn’t be sufficient to capture public goods, but would be the best tool for most purposes. But as much as it may break Gayer’s heart, we do not live in perfect markets peopled by Vulcans. We live in flawed, distorted markets peopled by human beings. Sometimes to achieve our collective goals, we can’t rely on market mechanisms alone.
2. The division between market mechanisms and command-and-control regulations is itself a false dichotomy. The government, alone or in partnership with the private sector, can help reduce the transaction and administrative costs of efficiency investments by spreading information, properly aligning incentives, scaling up fledgling markets, reducing the cost of efficiency technology, etc., etc. There are a panoply of means to this end: R&D, direct investment, tax incentives, performance standards, education/communication programs, innovative financing mechanisms, government procurement policies, removal of perverse regulations, and on and on. There are more policies in heaven and earth, Gayer, than are dreamt of in your economics.
The thing is, when you’re living in the world of perfect markets and rational actors — the world of “basic principles of economics,” where human life behaves like the ideal gas of physics lore — intervention in the market is a net cost by definition. (That this neatly dovetails with conservative ideology and the interests of powerful industries is, um, worth noting.) You can point out ways that human life isn’t like an ideal gas, but some economists are religious believers: if facts contradict faith, it is facts that must give way.