18th November 2018
New book project: Economics for Economists – What about roads, what about schools
I’ve started this book project.
Click HERE to read the book as it progresses.
== STARTING TEXT – BASED ON A A FEW HOURS OF WORK ===
ECONOMICS FOR PROFESSIONAL ECONOMISTS
This book aims to correct the widespread failures of economics education. Most economists jump straight from a market failure to a role for government. They have little or no economic intuition and give little or no consideration to government failure.
For example, consider recommendations from a recent competition policy report in Australia regarding town planning:
“Land can be used for a variety of purposes, including residential, industrial, commercial and conservation, which can include national parks. However, the unfettered market may not deliver an outcome across these various uses that is considered optimal for society as a whole. Hence, governments allocate land to particular uses through planning, zoning and development assessment”
The report assumes market failures (without discussing the details) and then rushes to justify the role of government in allocating land to procure uses through planning and zoning.
Such kind of thinking is rampant in policy circles and represents a massive, even catastrophic failure of economics education.
Economists have not been taught the underlying logic of economics perhaps since the time of Alfred Marshall. The discipline of economics has become a branch of geometry and calculus – and while these mental gymnastics have a role in distinguishing elements of economic reasoning under certain limited contexts, they fail to provide the intuition regarding real life.
For instance, there is no mention of the word “infrastructure” in Mas-Colell and Whinston’s textbook of microeconomics. After waving their arms about in relation to “public goods”, and conducting considerable amounts of mental gymnastics, the authors consider their job done.
The result is that even the best economics graduates struggle with infrastructure policy. They don’t know what is infrastructure and assume, simply because it is now commonplace, that the government has a role in this area. Even in the broader economics literature there is virtually no book that analyses infrastructure from first principles. This applies to a range of issues other than infrastructure as well, such as schools, health system, town planning and public transport.
The failure to relate economics to real life has led to severe policy making problems.
Their education seems to impart to the students of economics an instinct for government intervention – when the instinct should have been quite the reverse. While the original economists like Adam Smith would have constantly questioned the role of government, economists that come out of university today have a natural proclivity to justify government intervention.
When economists who are trained only in the mathematics of the discipline and not in its logic or intuition, join government as economists, the results are often very poor. Their innate bias for government intervention combined with lazy thinking which is typical of all government departments, leads to further intervention by government in matters where it has got no business or capacity. The results can be quite disastrous.
The persistence of traffic congestion is, for instance, a classic instance of the way governments think and operate. They simply have no capacity to understand the individual preferences of various users of roads and they refuse to even consider the possibility that they are actually creating a terrible outcome for society in this process. They have managed to create in this instance an outcome comparable with the “bread queues” of Soviet Russia – a complete and total failure of production, supply, distribution and consumption. Some extraordinarily stupid assumptions underpin government intervention in roads, and each of these assumptions leads to the denial of any role for markets or the price system.
One can barely begin to describe the extreme arrogance and stupidity of the way governments think. Virtually anywhere a government manages anything, one generally ends up with suboptimal outcomes with undersupply in some cases, oversupply in others, high prices, high costs, huge losses for taxpayers, unjustified subsidies, and an infinity of other distortions. The incentives and inevitable incompetence of governments leads in most cases to what are best characterized as socialist outcomes.
The main functions that a government is expected to perform – security and justice – are themselves so complex that governments invariably fail to deliver these functions effectively and efficiently. The idea of handing over many other functions to government – such as the supply of infrastructure and schools – surely must amount to borderline dementia.
This book aims to be the finishing school for economists so that they are able to think meaningfully about real life. This book does not compete with standard economics which is assumed to be the foundational knowledge for readers of this book.
THE MISSING ECONOMIC INTUITION AND UNDERSTANDING OF GOVERNMENT FAILURE
Most economists have never learnt to think like economists. Economics is all about incentives and about understanding the logic of why people do certain things. What this book aims is to build an intuition for economics, an intuition that incorporates incentives and a rich understanding of the price system and markets, an intuition that prevents economists from supporting any government intervention – including existing interventions – without extremely deep questioning. A crucial aspect involves the understanding that only markets are able to deal with complex information. The geometries or calculus of economics do not reflect the infinite richness of real-life tatonnement or catallaxy.
Very soon, no matter how intense the course they have attended, graduates of economics forget their geometry and mathematics. There is virtually no professional economist I’m aware of who can recall all this mathematics. It is only the academics who teach on a daily basis who continue with their understanding of the technical aspects of economics. What should remain behind once all the maths is forgotten are the core ideas of economics. But unfortunately, since students are not taught the core ideas of economics nor how these apply to real life, there develops an arrogance in their minds that economists can somehow resolve policy problems.
They forget that the key message of economics is humility and that even governments do not have – and cannot have – the instruments to understand, leave alone resolve, complex information. Information that is diffused across the world in numerous forms cannot be obtained by government under any circumstances, leave alone processed optimally.
The economist should therefore study how markets resolve the market failures and humbly figure out ways to support markets in their endeavour to fix the problem. Economists need to learn that there is no method available to mankind apart from the market to identify, understand and resolve the myriads of differences of preferences and affordability.
Every single sensible policy should involve analysing any associated government failures and only after both the market and government failures have been understood, and it is made clear why the government can improve at low cost the so-called imperfections of the market, only then should economists even consider any government option. Otherwise any government option simply cannot exist.
Once a market failure has been identified it is critical to also look and examine at great length the actual situation on the ground, including historically. For example, there are invariably a large number of market mechanisms to deal with market failures or challenges. In the case of occupational licensing there is an infinite variety of mechanisms used in the marketplace to resolve issues of information asymmetry.
In my over 35 years of experience in government departments in India and Australia I have not come across anyone with the ability to understand complexity. Indeed, it is the first principle of communication within government to simplify matters so that the executives and ministers are able to form of a view. These people are time poor and do not have the headspace to read, leave alone understand complexity. Some of them might well have been capable of advanced mathematics in their younger days but the nature of their job makes it impossible for them to act in a logical and coherent manner. They invariably resort to shortcuts and in almost all cases these shortcuts lead to the wrong results.
Markets, on the other hand, have no choice but to specialise and to remain at the cutting edge frontier of logic and reason. Their entire existence depends upon making the right decision under the market circumstances. They cannot afford mistakes. That is why it is markets and not governments that create iPhones or computer chips. Markets have no choice but to sue the best possible knowledge available to humanity.
As a general rule, policy in government is made largely to justify someone’s whim. There is no reward for deep and sophisticated thinking that considers – for instance – how markets can be supported to create optimal outcomes for society. The inability of government decision makers to understand complexity – or rather the impossibility of their understanding complexity – does not lead to humility and a desire to revert to the market. Instead, it leads to arrogance and the delusion that they are somehow able to solve complex problems.
The first example I discuss in this book is of roads. Government policy makers assume that the coordination problem is so significant in this case that the private sector cannot manage it. But most economists are not aware that even today tens of thousands of kilometers of roads in France are in private hands. Second they are ignorant about the methods and options by which roads can be charged. They assume that only tolling is possible but there is the “McDonald method”.
Or consider the case of schools. Most economist are not aware – in fact are completely ignorant – about the fact that schools have been managed in the private sector since times immemorial and that only after Macaulay did the idea of government schools come in, and it led to the immediate decline in the number of private schools as well as quality of schooling in general in the West (and in India where it was first started). James Tooley explains this well. Basically, a range of perverse incentives set in when governments manage schools.
And then consider health care. When everyone is responsible for their own health then incentives are fully aligned. It’s only when incentives are not well aligned and other people get involved in managing our health that health system incentives get perverse and we get seriously bad results.
Then we can consider the field field of urban planning which allegedly has significant failures so the government has to get involved. Once again, this is a classic example of government failure and not sufficient market failure.
Then we have the field of public transport in which the government has got directly involved.
REGULATORS FAIL BECAUSE THEY DON’T HAVE SKIN IN THE GAME
For instance, it is extremely harmful to create situations in which regulators do not have skin in the game, such as independent panels for town planning. In such cases we can expect freaks and lunatics including academic “geniuses” to come in with their “big” ideas and tell us how we should behave. It is a futile exercise to ask a third person who has no interest in our well being or understanding of our priorities to tell us how we shall live.
In each of these cases we see massive government failure.