Cafe Hayek

The Psychology of Climate Change and Intervention

Writing in today's New York Times, Nicholas Kristof argues that we're not as frightened of climate change as science counsels that we should be, and that our fear's inadequacy is rooted in our evolutionary past.  We are, Kristof correctly says, evolved to fear immediate, visible threats and not so much those threats - such as climate change - that are more distant, more speculative, and less visible.

Contrary to Kristof's conclusion, though, this fact doesn't necessarily justify climate-change regulation.  The same evolved structure of our brains that causes us to discount relatively distant and speculative climate-change effects also causes us to discount relatively distant and speculative economic effects.  So this economist, trained to see the invisible hand, points out that too many people are insufficiently aware of - and, hence, insufficiently fearful of - those relatively distant and invisible threats posed to a healthy economy by government regulation.

I, Toaster

Whenever I hear or read someone proclaim that "the market doesn't work," I try (if the situation permits) to ask him or her how is it that an ordinary pencil exists.  Its production requires the cooperation of literally millions of people from around the world.  Not one in one-thousand of these people know each other.  Many of them, were they to meet, would positively hate each other.  And yet, pencils exist in appropriate abundance, and can be acquired almost free of charge.  (If you're in the United States, go up to strangers on the street, in shopping malls, or at your school or workplace and ask for a pencil.  You'll not wait long before someone gives you one without expecting it to be returned.  I do this experiment frequently; it works.)

It's an amazing fact.  An impersonal process directed largely by prices, with each step along the way created and operated by entrepreneurs and producers seeking chiefly their own betterment, results in incredibly complex coordination that very well satisfies consumer demands -- and at a cost to consumers astonishingly low, when you consider the complexity of the process and the millions of persons whose creativity and efforts are necessary to make it a reality.

This, of course, is the Leonard Read's account of "I, Pencil."

Reason's Radley Balko finds a recent effort that (however inadvertently) drives home the importance of Read's theme.

The arc of emergent order

Video from Mike Munger.

Markets and Rationality

One of the few quotations that I have posted on my office door is from Will Durant's 1939 book The Life of Greece:

The crossroads of trade are the meeting place of ideas, the attrition ground of rival customs and beliefs; diversities beget conflict, comparison, thought; superstitions cancel one another, and reason begins.

I'm pretty sure -- a la the important research of Leda Cosmides and John Tooby --  that the human mind is not naturally reasonable or rational in any general sense.  We are evolved to survive, and then evolved to survive in environments drastically different from the expansive commercial society that today spans the globe.  Evolved from apes and hunters-gatherers, there's simply no reason to flatter ourselves that we, as a species, are as "rational" and as dispassionate and as enlightened and as aware and as educable as some economic models are sometimes interpreted to make us out to be.

But not to worry too terribly much: competitive, decentralized markets -- commerce -- generally manage to produce results that make us seem to be more rational and smarter than we really are.  This interesting paper by John List and Daniel Millimet, winner of the 2008 Arrow Prize for Senior Economists, uses experiments to make this point.  Here's the abstract of "The Market: Catalyst for Rationality and Filter of Irrationality":

Assumptions of individual rationality and preference stability provide the foundation for a convenient and tractable modeling approach. While both of these assumptions have come under scrutiny in distinct literatures, the two lines of research remain disjointed. This study begins by explicitly linking the two literatures while providing insights into whether market experience mitigates one specific form of individual rationality—consistent preferences. Using field experimental data gathered from more than 800 experimental subjects, we find evidence that the market is a catalyst for this type of rationality. The study then focuses on aggregate market outcomes by examining empirically whether individual rationality of this sort is a prerequisite for market efficiency. Using a complementary field experiment, we gathered data from more than 380 subjects of age 6-18 in multi-lateral bargaining markets at a shopping mall. We find that our chosen market institution is a filter of irrationality: even when markets are populated solely by irrational buyers, aggregate market outcomes converge to the intersection of the supply and demand functions.

(Here's Steve Horwitz's blog post, over at The Austrian Economists, on the List & Millimet paper.)

Now in light of current events, there are at least two takes on the List-Millimet findings.  One take is that these findings cast doubt on the widespread belief that irrationality and excessive exuberance are root causes of today's economic woes.  A second, and very different take, is that today's economic woes cast doubt on List's and Millimet's findings.  (A note for those persons sympathetic to the latter take: List's and Millimet's findings are not the product of armchair theorizing; they are the result of controlled experiments with real people.  So it would be illegitimate to assert that the real-world event that we call today's financial meltdown automatically disproves these scholars' findings and arguments.)

Law Ought Not be Centrally Planned

Here's a letter that I sent recently to the Baltimore Sun:

Diana Schaub rightly argues that no judge should allow empathy for parties in a courtroom to dilute his or her commitment to apply the law dispassionately ("Why empathy is the enemy of justice," June 14).  But the need for judicial impartiality does not imply that judges should avoid engaging with the real-world contexts and details that surround every legal dispute.

In a free society, law isn't simply, or even chiefly, a set of explicit commands handed down from a sovereign (be it a monarch or a democratically elected legislature).  A great deal of law - indeed, most law - emerges undesigned from the daily practices of ordinary people interacting with, and sometimes bumping into, each other.  People on their own often find ways to minimize these conflicts, and these ways become embedded in people's expectations.  These expectations, in turn, become unwritten law - law that good judges find and enforce impartially.

Sincerely,
Donald J. Boudreaux

Here comes everybody

Clay Shirky was definitely on to something.

Live from Iran, brought to you by everybody.

Source of Desirable Jobs

Here's a letter that I sent a few days ago to the Washington Times:

Peter Leitner wants Uncle Sam to stop G.M. from selling its Hummer division to China-based Sichuan Tengzhong, LTD., in part because this sale allegedly would be a practice in "forever hijacking scores of U.S. jobs" ("Hummer sale to China," June 5).  Mr. Leitner is blind to the full scope of the modern economy.

Most U.S. jobs today depend critically on economic openness of the sort that Mr. Leitner decries.  Capital from abroad; inputs from abroad; customers abroad; and consumer goods from abroad (that lower prices in the U.S. and so raise Americans' real wages) - each of these consequences of economic openness plays a large role in creating countless jobs in the U.S. and, ironically, in imparting to all jobs in America much of the attractiveness that makes the prospect of losing these jobs so difficult.

Making America more closed to trade would indeed keep fewer U.S. jobs from 'moving abroad,' but it would also make these jobs less worth keeping.

Sincerely,
Donald J. Boudreaux

Hayek (and Fukuyama) on the Use of Knowledge in Society

Reviewing Matthew Crawford's Shop Craft as Soul Craft, Francis Fukuyama writes, in this past Sunday's New York Times Book Review:

Highly educated people with high-status jobs - investment bankers, professors, lawyers - often believe that they could do anything their less-educated brethren can, if only they put their minds to it, because cognitive ability is the only ability that counts.  The truth is that some would not have the physical and cognitive ability to do skilled blue-collar work, and that others could do it only if they invested 20 years of their life in learning a trade. “Shop Class as Soulcraft” makes this quite vivid by explaining in detail what is actually involved in rebuilding a Volkswagen engine: grinding down the gasket joining the intake ports to the cylinder heads, with a file, tracing the custom-fit gasket with an X-Acto knife, removing metal on the manifolds with a pneumatic die grinder so the passageways will mate perfectly. Small signs of galling and discoloration mean excessive heat buildup, caused by a previous owner’s failure to lubricate; the slight bulging of a valve stem points to a root cause of wear that a novice mechanic would completely fail to perceive.

Indeed so.  This insight that a successful economy must continually use knowledge that is dispersed, unimaginably detailed, and often unable to be articulated fueled F.A. Hayek's skepticism of government intervention.  Here's Hayek, from his 1945 article "The Use of Knowledge in Society":

Today it is almost heresy to suggest that scientific knowledge is not the sum of all knowledge.  But a little reflection will show that there is beyond question a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place.  It is with respect to this that practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation.  We need to remember only how much we have to learn in any occupation after we have completed our theoretical training, how big a part of our working life we spend learning particular jobs, and how valuable an asset in all walks of life is knowledge of people, of local conditions, and of special circumstances.  To know of and put to use a machine not fully employed, or somebody's skill which could be better utilized, or to be aware of a surplus stock which can be drawn upon during an interruption of supplies, is socially quite as useful as the knowledge of better alternative techniques. And the shipper who earns his living from using otherwise empty or half-filled journeys of tramp-steamers, or the estate agent whose whole knowledge is almost exclusively one of temporary opportunities, or the arbitrageur who gains from local differences of commodity prices, are all performing eminently useful functions based on special knowledge of circumstances of the fleeting moment not known to others.

No fact about an advanced economy is more vital to understand than this one - and very, very few are as vital.

Where orders emerge

Indiana Jim comments on this post:

But remember, as I reminded when you guys shut down comments, YOU are the ones who advertise "where orders emerge".

If you want "followers" count me out (I am not simply an "audience" that you are entertaining or informing). If you mean what you say and want orders to emerge, count me in.

I'm not sure exactly what he means, but I suspect he means that if you believe in emergent order, you have to tolerate it on your blog. You can't have any rules or regulations. This is a subtler complaint than "censorship" but I believe it makes the same intellectual error and understanding this error is of much more importance than improving the comments on this blog.

Emergent order isn't always good. And there is no virtue in allowing it to emerge as a goal. The error (and if I am misconstruing you, Indiana Jim, I'm sorry) is the same mistake people make when they say that under capitalism, there's no planning. In fact, there's an immense amount of planning but it's done privately, voluntarily, and without coercion.

Similarly, I don't try to raise my children without rules and restrictions, trusting that order that will emerge. Order will emerge, but I suspect I wouldn't like it. An owner of a business doesn't just throw open the doors of the business, invite the employees in, and expect that they'll figure out what to do, that order will emerge. There are still dynamics in a business even with the boss's rules and regulations. The boss cannot steer the employees with precision like robots. The same thing happens in a family. And it happens on this blog.

Understanding emergent order means understanding the limitations of one's ability to steer it. I can't steer the comments very well through exhortation, evidently. I've tried a few times now and little has changed. So I am looking for a technology that will help me steer it. Or a set of rules. A different order will emerge that may turn out to be better or worse than what we have now. And I'm not even sure how to measure better or worse though one of my goals is more learning and less yelling.

Indiana Jim wonders if we mean what we say, whether we indeed want orders to emerge. In general, I want orders to emerge from the bottom up rather than control being imposed from the top down. But imposing (or trying to impose) order within this blog is not a violation of my principles. I don't just start typing randomly and hope my points will emerge, that the letters will arrange themselves.

Having said all that, we do produce this blog together, Don, and I, and you, the reader. That's part of the reason there are comments, to produce something greater than just the posts and yes, Indiana Jim, as you point out later, we get benefits from the experience, too. And yes, even after whatever rules or infrastructure Don and I decide to put in place, order will emerge here that is not totally under anyone's control.

Socialism

The left stole the term "liberalism." Maybe the fans  of emergent order  can steal "socialism."  Richard Sprague thinks it would be wrong and he's right. But I kind of like the idea of turnabout.

Smith Understood This Reality

The division of labor is limited by the extent of the market -- and so it becomes ever-finer as the market's extent expands.

No Man of System

Here's a letter that I sent yesterday to the Washington Post:

George Will wisely warns that government micromanagement of the economy will be followed by consequences both unintended and undesirable ("'Shock And Awe' Statism," May 31).  The economy is vastly more complex than such planners suppose.

Writing in 1698, Charles Davenant criticized the arrogance of such planners: "It is hard to trace all the circuits of trade, to find its hidden recesses, to discover its original springs and motions, and to shew what mutual dependence all traffics have one upon the other.  And yet, whoever will categorically pronounce that we get or lose by any business, must know all this, and besides, have a very deep insight into many other things."*

Sincerely,
Donald J. Boudreaux

* Charles Davenant, Discourses on Publick Revenues (1698), p. 388.

True Greatness

There is a large inverse relationship between someone's greatness of character and the likelihood that that person will one day be immortalized in marble or in history books.

Society progresses only through the countless decencies, creative acts, honest exchanges, and faithfulness to responsibilities performed daily by millions of persons, nearly all of whom will be forgotten within a few decades of their deaths.  Unfortunately, the monuments we humans build are chiefly to conquerors, tyrants, arrogant pretenders, and buffoons -- persons who, through the very acts that win them their 'honor,' help to undermine the progress promoted by the decent, unheralded many.

Brooks channels Hayek

David Brooks, in this provocative critique of Republican Libertarianism, uses the insights of Hayek without mentioning him. Brooks's theme is that Republicans emphasize the market and freedom without realizing that these are means not ends. He argues that people care about community and order, not freedom per se. The key part is the last paragraph of this excerpt:

....Democrats have been able to establish themselves as the safe and orderly party. President Obama has made responsibility his core theme and has emerged as a calm, reassuring presence (even as he runs up the debt and intervenes rashly in sector after sector).

If the Republicans are going to rebound, they will have to re-establish themselves as the party of civic order. First, they will have to stylistically decontaminate their brand. That means they will have to find a leader who is calm, prudent, reassuring and reasonable.

Then they will have to explain that there are two theories of civic order. There is the liberal theory, in which teams of experts draw up plans to engineer order wherever problems arise. And there is the more conservative vision in which government sets certain rules, but mostly empowers the complex web of institutions in which the market is embedded.

Maybe it's a quibble but I think it's misleading to talk about the market being embedded in the "complex web of institutions" Brooks calls civic order. The market is one of those institutions and they all work together.

Civic order in the classical liberal vision is a bottom up emergent order that takes advantage of knowledge that the top down engineering approach misses. This is true in pecuniary activity such as buying and selling but it's also true in non-pecuniary activity--who I want to associate with religiously or in my hobbies or how much time I have for my children or my parents. Freedom doesn't just mean the right to be selfish. It's the right to associate with whom I choose. The classical liberal prescription for the good life isn't about making as much money as possible. It's about the freedom to choose. It's about voluntary rather than coercive solutions, decentralized rather than centralized solutions, bottom-up emergent solutions that are the result of many actions and actors rather than top-down solutions by experts.

Unfortunately, economists and Republicans and columnists often use "the market" as short hand for economic freedom. But most people take it to mean the stock market or at most, the pecuniary parts of our lives. This mistake is why people ask how poor people can possibly survive if there is more liberty. Or the argument that the market "delivers the goods" but alas, it produces inequality. Some respond by trying to argue that economic freedom does indeed help the poor. They're right but that doesn't comfort the skeptic who is worried abot today's poor person. But freedom doesn't mean poor people starving. Freedom means that the government doesn't try to solve the problem of poverty, but rather it leaves the door open to voluntary community rather than coerced community.

Brooks understands that while pocket book issues are important, they don't inspire. Freedom is important not because it makes us rich but because it makes our lives more meaningful. Not because freedom lets us prosper--it does--but because freedom lets us express all that is important about our humanity. Top down approaches deaden that humanity.

I talk about these issues in The Invisible Heart and The Price of Everything. The Invisible Heart deals with the free-riding problem that arises with voluntary aid to the poor.

My Imaginings are So Beautiful!

Reason's Nick Gillespie and Matt Welch explain with eloquence and spirit why what Adam Smith called "the man of system" is not visionary but, rather -- and at best -- self-absorbed and out-of-touch.

Here's a slice from Gillespie's and Welch's fine essay:

Consider the president's recent "major" speech about transportation, yet another Castro-like exhortation in which Obama boldly rejected the failed policies of the past in favor of the failed policies of the future.

"Our highways are clogged with traffic," he noted, before unveiling his big fix: Shiny new trains that go almost twice as fast as cars. Forget that, as urban historian Joel Garreau has long documented, our country has been decentralizing its living and working patterns for decades now, migrating from virtually all urban centers (except maybe for booming Washington, D.C.) to relatively low-density suburbs. In a big, spread-out country where individualized service at the coffee stand, on cable TV, and in your computer is the new normal, our chief visionary officer is talking about a one-size-fits-all solution that will surely bomb even bigger than NBC's Supertrain.

Creative Destruction

What happens when firms and industries disappear in economies reasonably free?  Here's some insight from a report yesterday on NPR.  (HT to my dear friend, and fashionista, Betsy.)

And I chip in here with my own complementary account from a few years ago.

On Food Inspections

Hat tip to Chris O'Leary for alerting me to this report in the New York Times.  It's a report on how food processors in California are paying for their own food inspections.  Because the chief cop-on-the-beat -- Uncle Sam -- does a poor job of inspection, food processors themselves are footing the bill for inspections.

Of course, the report has quotations from persons offering the predictable complaint -- namely, that if food processors are footing the bill for inspection, then the inspections can't be as trustworthy as those done by government. 

Those who issue this complaint overlook several important facts; here are two.  First, the agency that these complainers insist is the only trustworthy inspector (that is, the federal government) has in fact done a poor job.  It's a stretch to say that Uncle Sam is the most trustworthy agency to perform food inspections in light of the reality that he has done this task in an untrustworthy manner.

(Extra credit for those who can pinpoint the flaws in the response that says "Well, Uncle Sam has performed poorly at this task only because its regulatory budgets have been gutted during the past several decades.")

Second, food processors have incentives to create a trustworthy inspection system.  Business for these food processors is better when consumers put more trust in the products offered by these food processors.

(Extra credit for those who can explain how branding and advertising play key roles in ensuring optimal levels of food safety.)

Update: Eric Crampton, over at Offsetting Behavior, tells a telling tale.

Rizzo vs. DeLong

Mario Rizzo, over at ThinkMarkets, explains well the difference between economists who understand that the modeling tractability made possible by thinking in terms of aggregates (such as "aggregate demand") is not worth the price of losing focus on the necessity of countless resources being arranged and re-arranged in very specific ways - not worth the price, that is, if the goal is sustained and widespread prosperity.  The micro-foundations are all-important.

Mario's post is among the best that I've ever read on this topic.  Read it.  Re-read it.  Re-re-read it.  (And read the comments, too.)  Here's the heart of Mario's post:

So when [Brad] DeLong, among others, says that government spending is as good as private in restoring employment, he is speaking against the whole thrust of the principle of efficient resource allocation. The essence of our recessionary problem is not the fall in aggregate demand and the lack of business confidence that accompanies it. First, it is the misallocation of resources produced by excessive risk-taking and by excessive expansion of interest-sensitive sectors. (These were generated by excessively low interest rates over the past several years.) Second, it is the uncertainty that is natural to the discovery of more appropriate combinations of resources. Third, it is the endogenous uncertainty created by the fits and starts of stimulus, bailout and unclear monetary policies.

When government adds to investment as a result of fiscal stimulus or directed monetary expansion (like buying mortgage-backed securities, student loans, etc) it does not act as a super-entrepreneur who is trying to determine the efficient and sustainable direction of resources, including the allocation of capital goods. It spends according to economically irrelevant criteria of job creation, propping up over-expanded sectors, and preventing politically painful adjustments.

Such spending is counterproductive in the medium to long term. It is also unsustainable (once the stimulus stops) since it is not consistent with the preferences of consumers-savers-investors.

Unintended Consequence

From today's New York Times:

For decades, pulp companies have burned a wood byproduct called black liquor to fuel their plants. Four years ago, Congress passed a tax credit meant to encourage companies to blend some biofuels into fossil fuels like diesel. The paper companies realized they might be able to claim the tax credit by going the other way, blending a little diesel into their black liquor.

Members of Congress are upset.  The report suggests (although it's not entirely clear) that the problem isn't so much that this tax credit results in paper mills burning more fossil fuels.  Rather, the problem is that paper mills are getting a tax credit for doing something that they've been doing for quite some time -- namely, relying significantly on biofuels.  From the perspective of some of the members of Congress quoted in the report, paper mills are "cheating" on their taxes; paper mills are now able to pay fewer taxes without having changed their behavior in ways that (ostensibly) help society.

There are lots of lessons to draw from this little tempest.  One is that the world is invariably more complex than politicians typically assume it to be.  There's no reason to doubt that the likes of Senators Jeff Bingaman and John Kerry really are surprised and annoyed to learn that a tax credit intended to promote X sometimes does not promote X at all but, rather, has consequences that these geniuses regard as negative and that they didn't foresee.

Hayek Live

Here's a 1985 interview, more than an hour long, with F.A. Hayek.

I am proud to blog at Cafe Hayek.

More Enlightement from Adam Smith

Here's a letter that I sent yesterday to the Times of London:

American conservatives have their own reasons for opposing Barack Obama's gigantic agenda ("Right's rage at overbearing Obama," April 12).  Some of these reasons are more sensible than others.  But I offer here a deeper reason to worry about Mr. Obama's hyperactivity; it is a reason identified exactly 250 years ago by Adam Smith in his first book, The Theory of Moral Sentiments:

That wisdom which contrived the system of human affections, as well as that of every other part of nature, seems to have judged that the interest of the great society of mankind would be best promoted by directing the principal attention of each individual to that particular portion of it, which was most within the sphere both of his abilities and of his understanding.*

No person, regardless of I.Q. or office, can possibly possess more than an infinitesimal amount of the knowledge of reality necessary for the successful carrying out of 'plans' such as those offered by Mr. Obama.  Society best advances when each of us is free to pursue our own individual goals in our own ways, with government doing no more than protecting each of us from the predations and officious ambitions of others.

It is preposterous to suppose that Mr. Obama (or anyone else) can know enough to oversee the automobile industry and the banking industry, to lead the creation of "green jobs," to remake medical-care provision, and to do any of the other ambitious tasks on his agenda.  Each of those matters is light years outside of "the sphere both of his abilities and of his understanding."

Sincerely,
Donald J. Boudreaux

* Adam Smith, The Theory of Moral Sentiments (Indianapolis: Liberty Press, 1976 [1759]), p. 375.

On the Scottish Enlightenment

Here's a letter that I sent recently to the Wall Street Journal:

Bravo to the letter writers who challenge Thomas Frank's denigration of "eighteenth-century man" (Letters, April 11).  The 18th century gave us history's most momentous advance in the social sciences.  I speak here of the Scottish Enlightenment, led by David Hume and Adam Smith.  These thinkers were the first fully to grasp the fact that complex and productive social order emerges from - and can emerge only from - millions upon millions of individual actions of countless persons, each of whom aims to achieve only very localized goals.  These Enlightened Scots taught us not only that a peaceful and productive society requires no great planner or overseer, but also that efforts to enthrone any such planner or overseer inevitably lead to poverty and tyranny.

Alas, far too many twenty-first century men, such as Mr. Frank, remain insufficiently astute to learn this lesson.

Sincerely,
Donald J. Boudreaux

From Status to Contract

Some of the comments at this post prompt me to quote one of my favorite passages in all of the classical-liberal canon; it is from Henry Sumner Maine's justly celebrated 1861 book Ancient Law:

Nor is it difficult to see what is the tie between man and man which replaces by degrees those forms of reciprocity in rights and duties which have their origin in the Family. It is contract. Starting, as from one terminus of history, from a condition of society in which all the relations of Persons are summed up in the relations of Family, we seem to have steadily moved towards a phase of social order in which all these relations arise from the free agreement of individuals. In Western Europe the progress achieved in this direction has been considerable. Thus the status of the Slave has disappeared -- it has been superseded by the contractual relation of the servant to his master. The status of the Female under Tutelage, if the tutelage be understood of persons other than her husband, has also ceased to exist; from her coming of age to her marriage all the relations she may form are relations of contract. So too the status of the Son under Power has no true place in the law of modern societies. If any civil obligation bind together the Parent and the child of full age, it is one to which only contract gives its legal validity. The apparent exceptions are exceptions of that stamp which will illustrate the rule. The child before years of discretion, the orphan under guardianship, the adjudged lunatic, have all their capacities and incapacities regulated by the Law of Persons. But why? The reason is differently expressed in the conventional language of different systems, but in substance it is stated to the same effect by all. The great majority of jurists are constant to the principle that the classes of persons just mentioned are subject to extrinsic control on the single ground that they do not possess the faculty of forming a judgment on their own interests; in other words, they are wanting in the first essential of an engagement by Contract.

The word Status may be usefully employed to construct a formula expressing the law of progress thus indicated, which, whatever its value, seems to me to be sufficiently ascertained. All the forms of Status taken account of in the Law of Persons were derived from, and to some extent are still coloured by, the powers and privileges anciently residing in the Family. If then we employ Status, agreeably with the usage of best writers, to signify these personal conditions only, and avoid applying the term to such conditions as are the immediate or remote result of agreement, we may say that the movement of the progressive societies has hitherto been a movement from Status to Contract [emphasis added].

In the edition that I have (the 1986 edition from Dorset Press), this quotation is found on pages 140-141; it appears at the very end of Chapter V.

Maine's optimism about the inevitable march of progress is unfashionably whiggish and, I think, overblown.  But his understanding that progress necessarily involves freeing individuals from their status stations -- freeing persons from stations assigned by circumstances such as skin color, family name, genitalia, sexuality, nationality -- and thereby allowing individuals to determine as best as each can his or her own course through his or her own voluntary choices -- that is, through contract -- is smack-on correct.

Protectionism and Stimulus

Here, at ForeignPolicy.com, I argue that protectionism and fiscal stimulus each hinder economic growth because each thwarts the economy's capacity to allocate resources in ways that promote prosperity.

Successful Explanation of the Importance of Failure

One of my brilliant young colleagues, Pete Leeson, splendidly explains the folly of government efforts to prevent firms from failing.  Here are critical passages:

When failing businesses are allowed to fail, producers learn how to combine resources in ways that create wealth.

We take it for granted that producers know what we want. But this information doesn't appear magically. It has to be produced. The profit-and-loss system produces this information - but only when government lets failing businesses fail.

Profits and losses do for producers what traffic signals do for drivers. They tell them when to “go,” “slow down” and “stop” their productive activities. By communicating which resource combinations consumers value most and which they don't, profits and losses direct “economic traffic,” informing producers how to produce.

If government prevents ineffective producers from failing, the red light on the “economic traffic signal” stops working. Production continues and resources flow when they should halt, destroying wealth instead of creating it.

Social Engineering Vs. Piecemeal, Competitive Creation

Here's a letter that I sent to Newsweek in response to this article on Paul Krugman (an article, by the way, that quotes my GMU colleague Dan Klein):

Editor, Newsweek

Dear Editor:

Nobel laureate Paul Krugman says that he was attracted to economics because it seemed to him to reveal "the beauty of pushing a button to solve problems" ("Obama's Nobel Headache," April 6).  Alas, like all economists who mistake their theories for reality, Mr. Krugman misses far too many of the all-important nuanced and ever-changing real-world facts masked by the Greek letters that economists of Mr. Krugman's ilk use in their complex-seeming but inevitably simplistic mathematical equations.

I was attracted to economics for a reason quite the opposite of the one that appealed to Mr. Krugman, namely, because it helps explain how incalculably complex and productive social orders emerge from billions of individual actions, where no one of these actions is meant to achieve anything more than improvement in the welfare of the individual actor.  This type of economics - associated most famously with Adam Smith - teaches that it is hubris of the most extreme sort to imagine that problems can be solved by pushing buttons.  Social-engineer wannabes such as Mr. Krugman might mean well, but they are dangerous; they suffer from what another Nobel laureate economist, F.A. Hayek, called "the fatal conceit."

Sincerely,
Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

Every Sensible Person Understands the Reason for Rules; Too Few People Understand that Rules are Not Synonymous with Government Dictates

Here's a letter that I sent a couple of weeks ago to a CNN on-air personality:

16 March 2009

Mr. Rick Sanchez, Host, CNN NewsRoom

Dear Mr. Sanchez:

Re your interview today with economics students at Georgia State University: when a young man said that he is skeptical of government regulation and that he values individual liberty, you derisively accused him of believing that the economy would work well "without any rules."

The smug assurance of your accusation reveals your gross misunderstanding of the case for free markets.  That case is not that rules are unnecessary.  Rather, it's that rules written by politicians and enforced by bureaucrats generally work much less well than do rules that emerge decentrally - rules that evolve from the voluntary interactions and successes and mistakes of individuals each pursuing his or her own goals without being herded by a central authority - rules that are enforced by competition and by the exercise of personal responsibility and that, when sufficiently important, become formalized in case law declared by courts.

The distinction between what you think of as rules and the kinds of rules that permeate successful market economies is perhaps subtle.  But it's also real and important.  You should try to grasp it.

Sincerely,
Donald J. Boudreaux

Long Live Jurisdictional Competiton

I'm eager to read this latest paper by my co-blogger at Market Correction, Andy Morriss.  Here's the abstract:

The legal regimes of offshore jurisdictions have historically differed in significant ways from those applicable in onshore jurisdictions. Inevitably, legal and financial professionals have seized upon these differences to develop strategies for reducing transactions costs. A prominent example of such cross-border arbitrage was the routing of Eurodollar loans through a small group of former Dutch island colonies in the Caribbean, a practice which peaked in the mid-1980s, when virtually every major U.S. corporation made interest payments to a Netherlands Antilles finance subsidiary. The "Antilles sandwich" strategy exploited the difference between high U.S. withholding tax rates that applied to interest payments made to most foreign lenders, and the zero rate of tax that applied to U.S. interest payments made to residents of the Antilles under its tax treaty with the United States. Both jurisdictions reaped significant benefits from the strategy until the United States unilaterally terminated the tax treaty in 1987, virtually wiping out the Antilles offshore financial sector overnight. Unfortunately, because of rigidity in its governance structure, the Antilles' failed to develop alternative financial intermediation strategies to replace the Antilles sandwich structure before its demise.

The rise and fall of the Antilles' offshore financial sector provides insight into the current struggle between onshore and offshore governments over the role of offshore financial centers like the Antilles within the global economy. Concerned about tax evasion by their residents, onshore jurisdictions including France, Germany, and the United States are pressing for major changes in offshore jurisdictions' legal and regulatory regimes that may eliminate legitimate opportunities for international arbitrage. In such an environment, offshore financial centers may find it difficult to survive. In this article, we distill from the Antilles experience a theory of "regime plasticity" and examine the role that it plays in allowing offshore financial centers to adapt to changes in the legal and political environments within which they operate. How offshore financial centers react, and whether they have learned the lessons of the Antilles' experience will play a major role in determining the future of the global offshore financial sector.

Orwell in charge at the Post

Arnold had a nice letter to the editor in Saturdays Washington Post, making his very wise point that each round of financial regulation is a reaction to the causes of the latest crisis and thereby helps spawn the next crisis.

Above his letter was this one

A formula is emerging from this economic crisis. If a corporation succeeds, through market expansion or acquisition of complementary or competing businesses, it becomes "too big to fail," thereby achieving every free-market advocate's dream of paradise. The taxpayers, aka the U.S. government, underwrite the risk, and the corporation banks the profits.

Simple, right? Why did it take so long to figure this out?

SALLY CUTLER

Chevy Chase

It's an interesting definition of "free-market advocate." A free-market advocate evidently wants the government to be actively involved in bailing out big losers. Why would the Washington Post think this merits publishing. Evidently, some of the editors there also believe that free market advocates are in favor of government intervention. Bizarre.

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Markets Outstrip Our Imaginations

Keynesians believe that the economy is a far simpler institution than it really is -- Keynesianism is no product of the Scottish Enlightenment.

In my latest column appearing in the Pittsburgh Tribune-Review, I make a case for the creative and coordinative powers of free markets, including the case that economic recovery does not require fiscal stimulus.  Here are my concluding paragraphs:

No one can foresee or predict any of the details about how recovery will happen.

But economics and history tell us that our inability to foresee and predict -- or even to imagine -- how recovery will come in the absence of conscious government stimulus is no reason to conclude that recovery requires conscious government stimulus.

Yet, despite all of our experience with the marvels of free markets, the case for the massive government stimulus plans rests chiefly on people's fear that this time the market will fail.

Why suppose that this situation differs from the countless other coordination challenges successfully met by market forces? I can think of no good reason other than the fear that oozes from biased imaginations. Despite experience that should teach us differently, we can imagine market failure much more easily than we can imagine just how markets will succeed.

A Much-Better (but Unfortunately Overlooked) Distinction Between Microeconomics and Macroeconomics

Daniel Kuehn's comments on this post prompt me to reprise this post from September 2005:

Jay Leno foiled

Don't miss this great post by Greg Mankiw. It's so hard to stop market forces.

Hayek and Keynes

I've spent much time lately re-reading Hayek's and Keynes's works from the 1930s -- reading not as systematically as I would like, but diving into these works with an interest and fervor that I've not felt since the early 1980s.

I highly recommend Bruce Caldwell's splendid "Introduction" to volume 9 of Hayek's Collected Works -- a volume entitled "Contra Keynes and Cambridge."

Also, I highlight this important passage from one of Hayek's essays contained in the just-mentioned volume, "Personal Recollections of Keynes."

Keynes appears to have been misled here by a mistake opposite to that of which he accused the classical economists.  He alleged, with only partial justification, that the classics had based their argument on the assumption of full employment, and he based his own argument on what may be called the assumption of full unemployment, i.e., the assumption that there normally exist unused reserves of all factors and commodities.  But the latter assumption is not only at least as unlikely to be true in fact as the former; it is also much more misleading.  An analysis of the assumption of full employment, even if the assumption is only partially valid, at least helps us to understand the functioning of the price mechanism, the significance of the relations between different prices and of the factors which lead to a change in these relations.  But the assumption that all goods and factors are available in excess makes the whole price system redundant, undetermined and unintelligible.  Indeed some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics [boldness added - and note that Hayek, correctly, accuses Keynes of having assumed full unemployment.].

The notion that all unemployed resources of a certain aggregate class such as "labor" or "land" or "steel mills" are largely identical and interchangeable with other resources in that same class, and, hence, can be easily and profitably employed simply by increasing demands for "labor" or "land" or "steel mills," is the bastard off-spring of lazily thinking in terms of aggregates and forgetting the enormous complexities that are part and parcel of any successful, viable, market economy.

Karol Boudreaux Speaks at Mercatus

Next Wednesday, I report objectively, the lovely and talented and learned and brilliant Karol Boudreaux will speak, at the Mercatus Center, on "The South African Election and Development Policy."  You can register on-line here to attend.

More on Aggregate Demand and Micro-level Coordination

Earlier this week, Paul Krugman claimed that the current stimulus plan is "too small and too cautious."  And, as I mentioned, my colleague Tom Hazlett (and his co-author George Bittlingmayer) offered empirical evidence against Krugman's claim.

I weighed in, taking another angle, with this letter to the New York Times:

To the Editor:

Paul Krugman insists that the current stimulus plan will fail because it is too small ("Behind the Curve," March 9).  We non-Keynesian economists also believe that it will fail, but for very different reasons: the chief problem is less one of deficient aggregate demand than it is one of poor coordination of the plans of producers with the (non-bubblicious) demands of consumers.

Economic prosperity requires that workers whose jobs were created by the bubble be redeployed into jobs that are viable.  Stimulus spending does nothing to promote this greater coordination of economic activities - and, by promising higher taxes or higher inflation in the future, likely interferes with the economy's capacity to coordinate.

Sincerely,
Donald J. Boudreaux

Any deficiency in aggregate demand is more a statistical consequence of failed economic coordination (at the micro level) than it is a foundational cause of economic malaise.

There's no doubt that failures to coordinate in any individual market can cause consumer demands in that, and in other, markets to be lower than they would be were coordination more complete.  But, again, first, the problem is not one of deficient aggregage demand, and second, any deficiencies of demand are more a consequence than a cause of economic woes; to the extent that these deficient demands in each market further contribute to economic downturns, they are a secondary problem -- not the fundamental one.

As I recall my professor Roger Garrison pointing out many years ago, at the very least, Keynes's 1936 book should have been titled A Special and Secondarily Important Theory of Employment, Interest, and Money -- rather than The General Theory of the same.

Tiny Tim

The New York Times reports on the heroic efforts of Timothy Geithner:

Rarely have so few people had so little time to prop up so many pillars of the economy as those in the Treasury Department under Timothy F. Geithner.

In the six weeks since Mr. Geithner took over as Treasury secretary, he and a skeleton crew of unofficial senior advisers have been racing to make decisions that will shape the future of the banking, insurance, housing and automobile industries.

But even as he maintains a frenetic pace — unveiling plans, testifying before Congress and negotiating new bailouts with the likes of Citigroup, General Motors and the American International Group — there are signs that events are getting ahead of him.

All the aides in the world wouldn't make any difference. It's an impossible task.

Wales on Wikipedia

The latest EconTalk is Jimmy Wales, the founder of Wikipedia talking about, well, Wikipedia. The sound quality is not the best—it's very echoey—but I hope it's listenable. It was fun to hear him talk about the influence of Hayek on his thinking. It was also interesting to hear him pronounce the name of the web site. He calls it wi-key-pedia. I (and I think most everyone else) calls it wi--kuh-pedia. Hayek would be the first to point out that he cannot choose what it is called--the pronounciation emerges without being under anyone's control.

The Unsung Successes of the Market

It's become an article of faith among lots of people that recent events prove (or at least suggest) that markets don't work very well.

Let's assume -- contrary to what my assessment of the evidence tells me -- that the housing bubble and its crash, along with the current ills suffered by Detroit and other sectors, are exclusively the fault of the market.

How much skepticism of markets would this fact generate relative to the amount of skepticism that is justified?  I think way too much.  The reason is that market successes go unnoticed and, hence, unappreciated.

The vast majority of market exchanges and relationships work smoothly and to the advantage of all participants.  Indeed, the market works so well and so consistently that it creates ever-higher expectations among the broad populace.  When these expectations are dashed, if only for a handful of persons and if only rarely, the market is deemed to have failed.

But despite the current downturn, the market continues to work well in its typical silence.  Do you have trouble today finding gasoline to buy?  Are your local supermarket's shelves not stocked with food, wine, and (watch for it soon!) Easter candy?  If your cat eats your socks, will you have trouble buying several new pair?  If your car's battery dies this afternoon, must you resort to bicycling or public transportation because you can't replace your dead battery?  If you're bored this evening with nothing to do, is there no movie you can go to or no DVD you can rent?  If you miss your mom in Minneapolis or your boyfriend in Boston, can you not call them on your cell-phone -- or even buy a plane ticket and go visit them?

Two items arrived in my e-mailbox this morning to drive home the remarkable success of markets.  The first is this excellent short essay by Bob Higgs.

The second is this hilarious, short dialog between the comedian Louis C.K. and Conan O'Brien.  (Note that O'Brien mistakenly believes that our modern standard of living is caused principally by technology.) (HT Rudy Schober)

Law Differs from Legislation

Here's a letter that I sent last week to the Washington Post:

Masterfully explaining the power of Charles Darwin's ideas, George will says that "As a practical matter, we cannot expel government from our understanding of society as Darwin expelled God from the understanding of nature. But Darwinism opens the mind to the fecundity of undirected, spontaneous, organic social arrangements - to Edmund Burke and Friedrich Hayek" ("How Congress Trumps Darwin," February 8).

Perhaps, practically, we indeed cannot expel government from our understanding of society.  But Hayek takes us surprisingly far in that direction.  He helps us to comprehend that law itself (as opposed to legislation) is largely spontaneous and undesigned.  Not all legislation is law - consider the fact that highway drivers routinely exceed posted speed limits by five or ten miles per hour.  And not all law is created by legislation (or even by court proceedings) - consider the "first come, first served" rule that nearly all drivers obey for determining which of the many drivers in search of parking places in a crowded parking lot gets a particular space that is about to be vacated.

Sincerely,
Donald J. Boudreaux

Ex-post theorizing is a tad easier than forecasting

A paraphrase of a quote from an economist (can't remember which one) heard at a recent conference:

Everyone can explain why the dollar rose or fell yesterday. No one can predict what it will do tomorrow.

Says it all.

Is Keynesian Economics Really Economics?

In today's Wall Street Journal, Dick Armey very nicely explains why Washington needs less Keynes and more Hayek.  Here's a key paragraph:

Keynes's thinking was a decisive departure from classical economics, because arbitrary "macro" constructs like aggregate demand had no basis in the microeconomic science of human action. As Hayek observed, "some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics."

The wonder of the world around us

In Ants at Work, Deborah Gordon writes:

The basic mystery about ant colonies is that there is no management.  A functioning organization with no one in charge is so unlike the way humans operate as to be virtually inconceivable.  There is no central control.  No insect issues commands to another or instructs it to do things in a certain way.  No individual is aware of what must be done to complete any colony task.  Each ant scratches and prods its way through the tiny world of its immediate surroundings.  Ants meet each other, separate, go about their business.  Somehow, these small events create a pattern that drives the coordinated behavior of colonies.

When I interviewed her for EconTalk, we talked about how humans are actually a lot more like ants than people think.

Check out this extraordinary video of what ants can achieve without top-down management. (HT: Harry Blanek). Don't miss it. It is beautiful and spectacular.

Government Does Not Know Better (Or Even As Well)

Economist Bill Shughart (a former GMU colleague, by the way) has this excellent op-ed in today's Washington Times; it's on the folly of even small-scale government 'industrial policy.'  Here are Bill's concluding paragraphs:

The truth is: It is not government's function to create jobs. Putting people to work is easy, as demonstrated by Franklin D. Roosevelt's Depression-era Works Progress Administration (WPA), more accurately known as "WPA: We Piddle Around." The bigger challenge is to create wealth. Toyota failed to foresee the economic events that caused its expansion plans to unravel.

Keep this in mind when Congress and the White House are selecting economic stimulus projects to fund this year.

If highly successful private firms like Toyota - with their extraordinary market research and years of savvy and experience - sometimes embark on projects that turn sour, how can we expect politicians, most of whom have no such business know-how, to pick winners?

There is a difference, however. Companies usually risk their own money. In Washington, the politicians will be risking ours.

An Inauguration Day Thought

I join many wise people in celebrating the fact that, for all of its flaws, the American political system is one in which political power is transferred peacefully, without bloodshed.  But my celebration is tempered.  We would be an even more civilized, peaceful, and prosperous -- and truly more progressive -- society if we significantly reduced the amount of political power that there is to transfer.

Economics In One Lesson

Reason.com editor Nick Gillespie offers, in less than sixty seconds, a brilliant spoof and a serious response to the mania in Washington for using government to "stimulate" the economy.

(HT Oxford Libertarian Society Blog)

In Praise of Sweatshops

New York Times columnist Nicholas Kristof is consistently excellent on the topic of sweatshops in poor countries.  Here's the ending of yesterday's column:

Look, I know that Americans have a hard time accepting that sweatshops can help people. But take it from 13-year-old Neuo Chanthou, who earns a bit less than $1 a day scavenging in the dump. She’s wearing a “Playboy” shirt and hat that she found amid the filth, and she worries about her sister, who lost part of her hand when a garbage truck ran over her.

“It’s dirty, hot and smelly here,” she said wistfully. “A factory is better.”

Easterly on Hayek

Today's Dean of development economists, William Easterly, won the inaugural Hayek Prize, offered by the Manhattan Institute, for his splendid book The White Man's Burden.  Congratulations Bill!

Here's the Hayek Lecture that Bill delivered this past October when he was awarded the prize formally.  Like all of Bill's work, it is written in a lively, engaging, fast-flowing style, filled with humor and important facts and insights.  I whet your appetite with the opening paragraph:

Tonight we find ourselves in a moment similar to that in which Hayek wrote The Road to Serfdom in 1943. Then, as now, a great financial crash was seen as a failure of freedom. Actually, things were even worse then for Hayek’s point of view. In the aftermath of the Depression, many pointed out the apparent success of centrally planned industrialization in the Soviet Union in outperforming markets. As Hayek wrote in 1943, democracy barely existed outside of a few English-speaking societies. Even in the U.S., people noted the apparent success of government top-down planning for wartime production of arms. Under these circumstances, Hayek knew he would be caricatured as a right-wing ideologue, even though his ideas did not fit into the stale partisan debate about markets versus government. He argued that the best system in the long run relied upon the creativity of individuals at the bottom who had both political and economic freedom. In a way I will describe below, Hayek saw both government and markets as functioning better the more they were the outcome of spontaneous development from the bottom up, with nobody in charge. It took courage to criticize top-down control after the scary calamities of the Depression, yet Hayek’s vision would be vindicated by subsequent events. How many of us will show similar intellectual courage in the midst of today’s financial crash?

To the Letter!

Here's a great letter in today's Washington Post:

After witnessing the Big Three automakers come to Washington to beg for money, and seeing GM and Chrysler take the bailout ["Aid in Hand, Clock Ticks for Detroit," front page, Dec. 20], I know that I will never buy another GM or Chrysler product, and maybe not another Ford. Which is too bad, because I have one Ford and one GM car in my garage right now, and both are pretty nice vehicles.

But I'm disgusted by the automakers and by our government for undermining the American free enterprise system. Now the only way to truly revive our economy is to drive these terminally ill companies into bankruptcy by boycotting their products. Successfully doing so would free their human and capital resources to reengage in economically viable businesses. The government can force us to pay taxes, and it can misuse the revenue, but it can't (yet) force us to buy cars from a failed, nationalized industry.

Would this be painful economically? Absolutely. Would it deepen the recession? Absolutely. Would it cost us, the taxpayers, even more? Absolutely.

But it's the only way to correct the system so my children can grow up to live in a prosperous and free country.

MICHAEL HIGGINS
New Market

I don't know Mr. Higgins, or anything about him.  But I applaud the soundness of his economic wisdom.

"I, Pencil" Turns 50

This month marks the 50th anniversary of the original publication of one of the most insightful economics essays ever penned -- "I, Pencil."  It wasn't written by a professional economist; it was written by Leonard E. Read, founder and long-time president of the Foundation for Economic Education.

Although Read was no professional economist, his understanding of the way market economies work, and his ability to explain that logic in clear and compelling terms, far surpasses that of all but a tiny handful of PhD-sporting economists.

The Human Chessboard

Two quotes for would-be car czars and other experts to remember:

From Hayek's The Fatal Conceit:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

From Adam Smith's The Theory of Moral Sentiments:

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.