Do Market Failures Justify Government Intervention? (with Michael Munger)

Michael Munger: Well, let me tell you a little bit about how we got to this story. As you said, Bill Keach was a mutual friend of ours. In fact, the three of us met once at a conference down south and had some very good scotch during the conference. It’s such a shame that we didn’t get a photo of you and Bill together. Maybe not as tall as Friedman and Stigler, but close. Bill was 6’8″ and incredibly tall. In fact, Bill and I carpooled to Duke University. And, to my surprise, the car Bill was in was a Mini Cooper. Bill was in a Mini Cooper because the front seats fold all the way back over the back seats, which meant that the car was uniquely able to accommodate his gigantic 6’8″ legs.

One day, Bill and I were parking in a parking lot when a woman walked in front of us on her way to the office. By coincidence, we got out of our cars at the same time. I’m not small, but Bill is 6’8. She stopped, looked at our car, and said, ” moreThe Mini Cooper is so small that she thought it was a clown’s car.

Well, the thing about Bill is, he used to talk like Eeyore, and he was like, “Everything’s bad.” But when you actually talk to him, you find out he had a great sense of humor. He passed away recently.

Russ, one of the reasons I bring this up and talk about this is because exactly 10 years ago today, Bill and I were working on this paper in a coffee shop on the North Carolina coast, and what we were struggling with was the idea of ​​how to phrase the problem of government failure in a way that was comparable to what you were saying about market failure.

Market failure has a long history in economics. In some ways, the idea of ​​market failure was prompted by the events of the late 1920s and 1930s, now known as the Great Depression. But the question is, why are there such large fluctuations in overall economic activity?

So the classical explanation, the classical economic model, doesn’t really explain these cycles very well. But the argument was that prices should be determined naturally.

And the question in the early 1930s was, would the government Intervene Would that either shorten the time it takes prices to settle or reduce the extent of the decline in the first place? So can we make the recession shorter and shallower? And the traditional answer is, “No, no, because that would distort prices and make things worse.”

So this laissez-faire, this kind of hands-off approach, was unacceptable to both politicians and the public.

So people have been looking around for a solution: How can we explain these big swings in aggregate economic activity, and are there ideas that might help us find where government should intervene?

The Austrian response, you know, was Ludwig von Mises, who wrote this book in 1920. SocialismThe Austrian school argued that governments do not have enough information. Without prices, there are many reasons why governments cannot intervene effectively. Rebuttals of public choice theory in the late 1950s and early 1960s confirmed the Austrian argument, but added the problem of incentives.

So I wrote recently that to understand an economic system, you have to look at it through two eyes: incentives and information. And the problem is, by looking at it through two eyes, incentives and information, Better Can you expect better results than what you can get from the market?

Because markets create a stream of information, and markets generate information from prices. Is there a better way than this?

So the public choice answer would usually be to argue that government doesn’t know enough, and that government bureaucrats have the wrong incentives, and therefore we probably can’t do any better.

Now, there was one response that I don’t think the civil choice movement took very seriously, and it came from the Cambridge Welfare School. Let me explain a bit about the Cambridge Welfare School.

So Oskar Lange famously said: “Socialists have every reason to be grateful to Professor Mises, a great spokesman for their cause. His powerful challenge forced socialists to recognize the importance of an adequate economic information system. Therefore, as the most important memorial of sound economic accounting, the statue of Professor Mises should occupy a place of honor in the great hall of the Ministry of Socialization of a socialist state.”

And his argument — Lange’s argument — was that Mises was right. May There is not enough information. I need to put more effort into gathering information than I thought I would.

So, what information do you need? another The market failure school, or the equilibrium school. The Cambridge school was about welfare economics and asking, “Can we get better outcomes?” The equilibrium school was about, “Are markets going to produce consistent outcomes or will they end up being chaotic?”

So Leon Walras asked in the late 1890s, “What must we do to prove that the theoretical solution to the problem of determining the equilibrium price is exactly the same as the solution arrived at by the market?” That is, we can come up with the ideal. Will the market approach it? “Our task is very simple: we have only to show the upward and downward movements of prices and solve by trial and error a system of demand and supply equations.”

Well, what is “chikan” in French? at the same timeSo, Tatonement It is the process by which the market discovers the correct price.

What’s interesting is that Oskar Lange did just that. Partatonement— that exploration — and he said, “What governments should do is experiment. So what we should do is experiment with different policies.”

That was the very point that President Roosevelt made when he spoke about the experiment, and that is the point that proponents of government control and market interference were making about the experiment.

So the Austrian criticism that government doesn’t have enough information is probably correct, but the public choice theory of the 1950s turned around and said, “Government can never have enough information, and it can never have the right incentives,” because if you look at Ronald Coase or Gordon Tullock, they say, “The people in government, the people who support government, don’t see the political issues.”

What I found was that Cambridge economists, particularly AC Pigou, were very keen to address the political issues: incentives and and Information problem.

And I actually found in many places that AC Pigou in the 1920s should be credited as the first public choice theorist. I can read you a quote if you like, but I’ve written a few things about this.

What’s interesting is that the Cambridge economists, the welfare school, recognized the information problem to a degree that many later generations have not acknowledged. But their answer was tentative. They wanted governments to have enough power to run constant experiments.

And the key here is that it must be insulated from political motives, that is, completely free from democratic pressures.

This is why in the 1930s the Roosevelt administration, many of its theorists, and the British people were such big fans of Mussolini, not because they wanted to be Fascists, but because they recognized that the problems of political motivation were very serious.

So I’ll end my introduction with just one more thing, because I think this intellectual history will be interesting for people who grew up in the public choice tradition.

The public choice tradition teaches us that those who support government intervention don’t understand the information problems, they don’t understand the incentive problems, and then when politics intervene, the scales fall off for them.

That’s not true. They have actually been aware of these problems for a long time, they just have different solutions.

However, there is a paper written by Abram Bergson in 1938 that is not so widely read now but should be read. In 1938 Bergson states that “Knowing the production function and the indifference functions of the individuals gives us enough information about the economic welfare function to determine the maximum position (if there is one).” Here are the details:all It’s all a matter of execution. So what you need is