Dani Rodrik has offered a methodological critique of free-market economists (citing Gary Becker, Tyler Cowen, and Greg Mankiw as examples among blogging economists), grounded on the claim that in recommending “first best” free-market policies they (simplistically) overlook complications introduced by “second best” problems: market imperfections, information asymmetries, distributional issues, general-equilibrium feedbacks. He constrasts them with the (more sophisticated) second-best-oriented interventionists: Joe Stiglitz, George Akerlof, Bob Shiller, Paul Krugman, himself. Tyler Cowen offers a reply.

Here is Rodrik’s take on the “first-best” group:

You can tell what kind of an economist someone is by the nature of the response s/he offers when confronted with a policy issue. The gut instinct of the members of the first group is to apply a simple supply-demand framework to the question at hand. In this world, every tax has an economic deadweight loss, every restriction on individual behavior reduces the size of the economic pie, distribution and efficiency can be neatly separated, market failures are presumed non-existent unless proved otherwise (and to be addressed only by the appropriate Pigovian tax or subsidy), people are rational and forward-looking to the first order of approximation, demand curves always slope down (and supply curves up), and general-equilibrium interactions do not overturn partial-equilibrium logic. The First Fundamental Theorem of Welfare Economics is proof that unfettered markets work best. No matter how technical, complex, and full of surprises these economists' own research might be, their take on the issues of the day are driven by a straightforward, almost knee-jerk logic.

As a "first-bester" myself, let me ask: is this an accurate picture of my beliefs? Let’s go down the checklist:

• Apply a simple supply-demand framework? Whenever possible, yes. Especially when writing for a nonspecialist audience. The economic way of thinking is our comparative advantage as economists.

• Every tax has an economic deadweight loss? Every tax on desired goods and services (as opposed to say pollution), yes. Doesn’t it?

• Every restriction on individual behavior reduces the size of the economic pie? Again, if we are talking about restrictions on voluntary exchange and production (and not restrictions against theft and assault), yes. Don’t they?

• Distribution and Efficiency can be neatly separated? In principle, yes. See Coase.

• Market failures are assumed non-existent unless proved otherwise? Yes, placing the burden of proof on the would-be market-corrector is more reasonable than assuming that market failures exist merely because someone imagines or asserts it to be so.

• Market failures are to be addressed only by the appropriate Pigovian tax or subsidy? Maybe in Mankiw’s view, but not in mine. In my view they are to be addressed by appropriately defining and enforcing property rights. We don’t know enough to find the right Pigovian tax or subsidy. Giving the government the power to tax an externality and trusting it to optimize is extremely foolish.

• People are rational and forward-looking to the first order of approximation? Sure. At least I trust John Doe to know his own rational interests than I trust a philosopher-economist (e.g. Joe Stiglitz or Robert Frank) to divine Mr. Doe’s rational interest.

• Demand curves always slope down? Yes. Is there a serious counter-example?

• Supply curves always slope up? No, in some cases they can be vertical. I’ll even believe backward-bending if you show me evidence.

• General equilibrium interactions do not overturn partial-equilibrium logic? On the contrary, they can. For example, general-equilibrium reasoning shows that major tenets of Keynesian economics are based on a partial-equilibrium reasoning combined with the fallacy of composition. See Roger Garrison.

• The First Fundamental Theorem of Welfare Economics is proof that unfettered markets work best? No, not at all. The theorem merely provides a set of sufficient conditions for reaching an optimum. It is mostly used by critics of the market, who fallaciously argue that the failure of one of the sufficient conditions to hold is proof that the unfettered market is not best (as though we were talking about a necessary condition). The reasons for believing (not “proof,” because it’s not a mathematical proposition) that unfettered markets work best are not in Arrow-Debreu but in Mises, Hayek, and Kirzner.

Comments are open.