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May 2007

A note on the dopey "Hip Heterodoxy"

Allow me to deconstruct part of one paragraph of yet another whiny, dopey critique of mainstream economics, "Hip Heterodoxy", by Christopher Hayes.

The problem, then, that heterodox economists face is that they are economists who don't "think like economists." Many point out that humans aren't rational, or not nearly as rational as the theory would have them be (and, further, that in the aggregate this creates market failures). Others point out that humans are social creatures, not individual agents, and their preferences and behaviors are forged by social structures: institutions, habits, social mores and culture all mediate and drive economic behavior. Others say that price and value aren't interchangeable and that prices don't arise from the simple intersection of supply and demand curves, while some argue that unequal power between different sectors of society affects how markets operate.

1. Humans aren't rational? By "rational" economists mean that people respond to incentives. Nothing more. And if rats, pigeons, and snails are rational--see, for example, "Demand Curves for Animal Consumers" by John H. Kagel, et al., Quarterly Journal of Economics, 96(1), 1981--wouldn't it make a lot of sense to assume that people are also?

2. Preferences can be "forged by social structures: institutions, habits, social mores, and culture"? THis is perfectly compatible with mainstream economics. We economists have relatively little to say about what determines preferences or tastes. We emphasize the other major determinant of choice: the opportunities individuals have.

3. "[P]rice and value aren't interchangeable": no kidding! Look up in any elementary economics text the phrases "consumer surplus" and "producer surplus" and you'll find fuddy-duddy mainstream economics completely agrees.

4. "[U]nequal power between different sectors of society affects how markets operate": I'm sorry, I'm old-fashioned, but this is a bit vague. What do you mean by "power"? What "effects"? But it's at least possible that this "heterodox" assertion is also compatible with mainstream ecomomics. If "power" derives from purchasing power, which in turn derives from income and resources, mainstream economics absolutely agrees that power affects markets.

5. "[P]rices don't arise from the simple intersection of supply and demand curves": O.K., we don't teach this one. But once again, I'm not sure what's being asserted. What does determine prices, then?

If you're scoring at home, that's one, maybe one and a half,  points out of five that are valid.

Also note that the article has a thesis that is contradicted in the article itself: heterodox economists are supposedly shunned and silenced, but "an explosion of new research programs and methods have provided strong evidence that many of the pillars of that consensus rest on a foundation of sand. In fact, just before the reception, AEA president George Akerlof, a Nobel laureate as respected in the profession as they come, gave what was in many senses a radical address, attacking some of the discipline's most basic assumptions about what drives human economic behavior."

Maybe just bad heterodox economics is rejected?

Three on politics.

Senator Tom Coburn asks Republicans to fight pork:

Establishment Republicans can either continue to bash the Porkbusters, or they can find common cause with this movement. Conservative Republicans who cheer Porkbusters aren’t expecting to see grand reform overnight. They would simply be content with Republicans acting like Republicans. That’s advice the GOP would be wise to follow.

Dick Morris and Eileen McGann provide explain Hilary Clinton's "simple and clear position on Iraq". Pretty funny.

Peter Ferrara on the Democrats' fiscal plans:

Those conservative commentators who argued last year that Democrats would be better at fiscal discipline than the Republicans played a major role in bringing down the Republican congressional majorities. They are being proved quite wrong.

Lott's Freedomnomics available

Some years ago, Nobel Prize-winning economist Robert E. Lucas, Jr. was asked what subjects he thought were on the economics frontier. He replied, “In economic policy, the frontier never changes. The issue is always mercantilism and government intervention vs. laissez faire and free markets."

Many economists would agree: the fundamental issue in applied economics is how much of the economy's goods and services should be allocated by government and how much by markets. Some economists, including me, believe that the burden of proof should almost always rest with those who advocate government allocation. Over the last thirty years, my side has convinced a few people, but we haven't--this is a significant understatement--convinced everyone. And we may now be losing ground.

I think this is partly because we have not argued our side as well as we could have. In economics courses we focused for too long on the model of perfect competition and its aptly-but-creepily-named Invisible Hand. The formal model is abstract; it rests on extremely restrictive assumptions, assumptions that are easily criticized; and as one famous economist, Harold Demsetz, pointed out long ago, it is not really a model of competition at all.

A better way to try to convince people is to patiently accumulate and present many examples of the market at work. These examples, in turn, can be shown to rest on a simple premise: the market provides big incentives to enhance social welfare. The argument for government intervention is usually either that something good is not being provided, or not being provided sufficiently, or else, something bad is not being stopped, or not being lessened sufficiently, by the market. But in all such cases, there is a huge profit incentive for someone to solve the problem. And experience shows that individuals in free markets are incredibly imaginative and resourceful in doing just that. (The solutions require that the individuals be able to appropriate some of the gains from the solutions but that requirement is also subject to satisfaction through imagination and resourcefulness.)

Which brings me to John R. Lott, Jr.'s new book, Freedomnomics.Free (Amazon states it will be published June 4, but my older daughter has already seen it in D.C. area bookstores. I got an advance copy courtesy of John.) Freedomnomics focuses on incentives. It presents a wonderfully rich set of examples of how people respond to incentives. No background in economics is necessary to understand and enjoy these examples. The book uses them to make four points.

1. Problems that the market supposedly can't solve often are. My favorite example of this in the book is radio. In the early days of radio broadcasting "radio hosts and entertainers usually had to work for free" (p. 87, footnote omitted). No one had figured out how to make radio a viable business. The problem was that once a radio show was created and transmitted through the air, anyone with a receiver could listen. So why would listeners pay? Note that this is an example of the infamous free rider problem by which the market allegedly sometimes fails to provide good things. But in 1922, with the "discovery" of advertising, radio became a viable business. Another example of a supposedly difficult problem is that a new car's value plummets "as soon as a buyer drives it off the lot", but Lott reports that this isn't, factually, really a problem (pp. 35-37). A third alleged problem is that businesses will try to cheat and defraud customers. But Lott describes in detail a market mechanism--reputation--that strongly disciplines such attempts (pp. 49-82).

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