Draft Preface: Economics in Two Lessons

by John Quiggin on May 23, 2015

Over the page, the draft preface for my book-in-progress, Economics in Two Lessons

I got some great comments first time round, but I can see it would be easier if I presented my drafts in a more orderly fashion, though not necessarily sequential. So, I’ll begin at the beginning. Comments, both critical and favorable, much appreciated.

As the name implies, this book is a response to Henry Hazlitt’s Economics in One Lesson, a defence of free-market economics first published in 1946. But why respond to a 70-year old book when new books on economics are published every day? And why two lessons instead of one?

The first question was one that naturally occurred to me when Seth Ditchik, my publisher at Princeton University Press suggested this project. It turns out that Economics in One Lesson has been in print continuously since its first publication and has now sold more than a million copies.

Both where he was right, and where he was wrong, Hazlitt’s arguments remain relevant today, and have not been substantially improved on by today’s advocates of the free market. Indeed, precisely because he was writing at a time when support for free markets was at a particularly low ebb, Hazlitt gave a simpler and sharper presentation of the case then many of his successors.

Hazlitt, as he makes clear, was simply reworking the classic defence of free markets by the French writer Frédéric Bastiat, whose 1850 pamphlets ‘The Law’ and ‘What is Seen and What is Unseen’ form the basis of much of Economics in One Lesson. However, Hazlitt extends Bastiat by including a critique of the Keynesian economic model developed in response to the Great Depression of the 1930s.

Hazlitt presented the core of the free-market case in simple terms that have not been improved upon by any subsequent writer. And despite impressive advances in mathematical sophistication and the advent of powerful computer models, the basic questions in economics have not changed much since Hazlitt wrote, nor have the key debates been resolved. So, he may be read just if he was writing today.

Some of the key questions addressed by Hazlitt are:

  • Will Keynesian fiscal policies secure full employment?
  • Should the government invest more in infrastructure ?
  • Do minimum wages benefit workers?
  • Can price controls stop inflation ?

Hazlitt answers ’No’ to all these questions. His One Lesson is:

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

As Hazlitt develops the argument, his meaning becomes clear. The direct benefits of more jobs and public works, higher wages and lower prices are obvious. But these benefits do not come without costs, often borne by groups far removed from the beneficiaries. The true measure of cost is not a money value, but the alternative use to which resources could have been put. In Hazlitt’s words:

Everything … is produced at the expense of foregoing something else.

Economists call this foregone value ‘opportunity cost’. The decision to provide some particular good or service makes us better off if, and only if, its value to us is greater than the opportunity cost involved in its production.
But how does Hazlitt get from the idea of opportunity cost, accepted by nearly all economists, to the conclusion that government intervention in the economy is hardly ever justified? The answer is simple.

Hazlitt assumes that the opportunity cost of any good or service is its market price. So, he infers, any government interference with markets , such as the provision of ‘free’ services, must involve hidden costs that outweigh the immediate benefits.

So we can restate Hazlitt’s Lesson as:

Assuming that market prices are equal to opportunity costs, government interventions that change the market allocation must have opportunity costs that exceed their benefits.
The simplicity of Hazlitt’s argument is his great strength. By tying many complex issues to a single principle, Hazlitt is able to ignore secondary details and go straight to the heart of the free market case against government action. His answer in every case flows from his ‘One Lesson’.

But Hazlitt’s strength is also his weakness. He never spells out the relationship between prices and opportunity costs. As a result, he implicitly assumes that there is a unique market allocation, in which prices equal opportunity costs, and that the two can only differ as a result of government interference. Although he does not say so explicitly, he implies that the existing distribution of income (or rather, the one that would emerge after the policies he dislikes are scrapped) is the only one that is consistent with his One Lesson.

While markets are exceptionally powerful social institutions, they cannot work unless governments establish the necessary framework in which they can operate. The core of the economic framework in a market economy, and a central role of government, is the allocation and legal enforcement of property rights.

The market outcome depends on the system of property rights from which it is derived. In fact (as we will see later) when markets work in the way Hazlitt assumes, any distribution of goods and resources where prices equal opportunity costs can be derived from some system of property rights. So Hazlitt’s Lesson tells us nothing useful about the distribution of income or about government policies that may change that distribution.

An equally important problem is that, despite the then-recent experience of the Great Depression, Hazlitt implicitly assumed that the economy is always at full employment, or would be if not for government and trade union interference. Experience shows that the economy frequently remains in a depression or recession state for years on end. In such a situation, markets don’t properly match supply and demand. This means that prices, and particularly wages, do not, in general, determine opportunity costs.

Finally, there is what economists call ‘market failure’. Even within a market system, and accepting the initial allocation of property rights, a variety of possible problems, such as monopoly, may result in market prices that do not reflect all the relevant opportunity costs for society as a whole.

To understand the central issues in economic policy debates, we need not one lesson, but two. The first lesson, implicit in Hazlitt’s One Lesson is:

Lesson 1: Market prices reflect and determine opportunity costs faced by consumers and producers.

The second lesson is the product of more than two centuries of study of the way markets work, and the reasons that they often fail to work as they should:

Lesson 2: Market prices don’t reflect all the opportunity costs we face as a society.

Two lessons are harder than one. And thinking in terms of two lessons comes at a cost: we can sustain neither the dogmatic certainty of Hazlitt’s free-market policies nor the reflexive assumption that any economic problem can be solved by government action. In many cases, the right answer will remain elusive, involving a complex mixture of market forces and government policy.

The problem of how markets work and why they fail is at the core of most of the economic policy issues that drive political and social debate. I hope this book, and the two lessons it contains will help to clarify these issues.

{ 97 comments }

1

Brian Albrecht 05.23.15 at 1:57 am

To get from Lesson #2 to a conclusion about policy takes at least one more lesson.

Lesson 3: Governmental decision makers can, at times, have the information and incentives to incorporate the opportunity costs left out by market prices.

2

david 05.23.15 at 2:58 am

First lesson best and second lesson best!

That aside. Your self-assigned task is much more difficult than Hazlitt’s, because you want to convince the lay reader of Lesson 1 before you convince them of Lesson 2. That is, you don’t just want them to be generally skeptical of markets, you want them to have specific skepticisms. That’s fair; one wants social democrats, not communists. But it also means that the tone of righteous fury and insinuations of malevolent selfishness that permeates Hazlitt is unavailable to you. Like Pop Internationalism-era Krugman, the most persuasive rhetorical approach is to present yourself as the sensible voice in the room, regarding the two extremes with a mixture of genial pontifical superiority and exasperated amusement.

More dry wit and less calls-to-arms, if you will. Purity and righteousness is not available to an advocate of an impure position, so you need to be funny.

3

david 05.23.15 at 2:59 am

Whoops, the link to Rodrik disappeared. Here it is.

4

William Berry 05.23.15 at 4:05 am

I am having a little trouble parsing this sentence:

“Even within a market system, and disregarding equity, a variety of possible problems that mean either that markets fail to emerge or that market prices do not reflect all the relevant opportunity costs for society as a whole.”

It seems to be missing something like “arise/ appear/ emerge” after “problems”, or “there are/ there can be” before “a variety”.

Or am I completely missing the sense?

5

John Quiggin 05.23.15 at 5:18 am

@4 D’oh! I’ve rewritten this as

Finally, there is what economists call ‘market failure’. Even within a market system, and accepting the initial allocation of property rights, a variety of possible problems, such as monopoly, may result in market prices that do not reflect all the relevant opportunity costs for society as a whole.

6

Peter T 05.23.15 at 5:22 am

I think the first lesson is something like: “market prices sometimes reflect and determine opportunity costs. The times they don’t matter as much as the times they do.”

7

Bruce Wilder 05.23.15 at 5:40 am

We cannot possibly know the opportunity cost for a certainty. We are constantly making judgements and corrections, taking risks or failing to take risks. We are constantly finding out that we were wrong.

Well, normal people find that out. Not Hazlitt, apparently.

8

christian_h 05.23.15 at 6:14 am

I imagine copy editing suggestions are more than premature, but I would change the opening – non-economists likened had never heard of Hazlitt before seeing your posts.

9

christian_h 05.23.15 at 6:15 am

Autocomplete and no editing = nonsense. I meant to say “non-economists like me may have never heard…”

10

John Quiggin 05.23.15 at 6:18 am

Peter T: that’s supposed to be the combination of the first and second lessons

11

John Quiggin 05.23.15 at 6:19 am

Bruce, I certainly want to tackle uncertainty: it’s my main claim to fame, after all. I’m still struggling with the right formulation

12

John Quiggin 05.23.15 at 6:20 am

Christian H, copy-editing is not premature. I take your point, and would be grateful for a neater way of making the link.

13

christian_h 05.23.15 at 6:25 am

I would just start by explaining that Hazlitt wrote his influential book, maybe as in “In 19… Henry Hazlitt published his book… which has been in print continuously since. This book is an answer to it, as the title suggests” or something along those lines. Or start with the suggestion by the Princeton editor.

14

C 05.23.15 at 6:38 am

“The market outcome depends on the system of property rights from which it is derived. In fact (as we will see later) when markets work in the way Hazlitt assumes, any distribution of goods and resources where prices equal opportunity costs can be derived from some system of property rights. So Hazlitt’s Lesson tells us nothing useful about the distribution of income or about government policies that may change that distribution.”

This weakness in hazlitt’s case is massive. It seems your phrasing of lesson 2 underplays that weakness.

When Brian Albrecht above add a wrinkle about information and incentive issues with gov action he misses that the same issues are there in the gov activity of picking, setting up and reproducing one highly specific, hugely distribution shaping set of property right institutions (and many other state rules often not thought of as “distributive”) among many possible such sets.

15

ZM 05.23.15 at 6:49 am

I think there is a problem here which is summed up by Oscar Wilde’s saying “Nowadays people know the price of everything and the value of nothing”. I wrote an allegory using this for an assignment a few years ago on the general progress indicator.

This is Heart of My Country by Shane Howard accompanied by Shu-Cheen Yu. Shane Howard was in Goanna . It has a similar line to Oscar Wilde’s :

“we look into the heart of the land and we have to choose whether the wealth we gain is worth the wealth that we might lose”

He was also one of the singers when our choir leaders led the gurrong millenium choir. Gurrong means sea boats and the artwork was by Gail Mabo daughter of Eddie Mabo from her painting constellation with the Stars in the heavens and sea boats as the navigators used the stars to guide their sea boats to Australia. This song also has the line “does anyone make decisions of conscience anymore?” so it is also a good song for raising awareness of conscience (equity) law.

http://youtu.be/JNzyoTkAy-Q

16

Mike Huben 05.23.15 at 10:35 am

“Hazlitt assumes that the opportunity cost of any good or service is its market price. So, he infers, any government interference with markets , such as the provision of ‘free’ services, must involve hidden costs that outweigh the immediate benefits.”

This strikes me as the heart of Hazlitt’s fallacy, but it really needs to be identified as such. It also needs to be dissected into two fallacies: the assumption of equilibrium to make opportunity cost equal market price (which we know in the real world to be normally false) and the “inference” of “hidden costs that outweigh the immediate benefits.”

17

Plume 05.23.15 at 3:47 pm

It’s pretty obvious that “free markets” increase the cost of living and reduce wages for non-capitalists. They have to. Every capitalist transaction is meant to achieve a profit for the capitalist. He or she must always sell something for more than it’s “worth,” to achieve that profit. He or she must always sell a product or service for more than it cost them to produce. But it’s not just profit that kicks in. Every capitalist also wants to make as much money in personal compensation as possible, which adds yet another cost to the consumer . . . and drives wages down for the rank and file, because they are a “business cost” for the capitalist. He or she has every incentive in the world to overcharge for goods and services and radically underpay their workforce — or eliminate them altogether via automation. That’s how they optimize both their own personal take and profits for their companies.

Obviously, if we remove “profit” from the picture, prices for the consumer can be reduced, and if we eliminate private ownership of workers’ production by capitalists, we can radically increase rank and file wages, benefits, working conditions, etc. All “free market” defenses, including Hazlitt’s, basically ignore the obvious and turn logic on its head.

In short, society could easily produce far more affordable (and higher quality) goods and services, pay workers far more, plus reduce actual work hours, if they dumped the ridiculous and obscenely immoral idea that it’s a good thing to extract wealth from the many to enrich the few.

18

david 05.23.15 at 3:48 pm

On the note mentioned in @15 – Hazlitt spends his entire book attacking ideas present in 1946 – early lay Keynesianism, lay Marxism, that sort of thing. It would not be until the Cowles Commission era that economics would rigorize the intuition of Pigou’s externality and clarify exactly how it differs from public goods. Hence, e.g.:

I must insist again that in all this I am not talking of public officeholders whose services are really needed. Necessary policemen, firemen, street cleaners, health officers, judges, legislators and executives perform productive services as important as those of anyone in private industry. They make it possible for private industry to function in an atmosphere of law, order, freedom and peace. But their justification consists in the utility of their services. It does not consist in the “purchasing power” they possess by virtue of being on the public payroll.

(like Hayek of the era, “really needed” turns out to be oddly similar to “all the government services achieved by respectable Liberal/Northeastern-US-establishment government but not those advocated by these alarming Labour populists/socialists”).

So whilst it is true that Hazlitt uses hidden costs as a stick to beat up a Keynesian enemy, it’s not really fair to present this in an expansive general equilibrium context that didn’t exist in 1946, much less a neoliberal everything-has-shadow-prices-and-can-be-privatized context.

19

dilbert dogbert 05.23.15 at 3:49 pm

My wee pea brain reads and thinks the argument can be reduced to: All human effort is for naught therefore it would be best for all of us to just cut our wrists. The Iron Law of Unintended Consequences holds.

20

Lee A. Arnold 05.23.15 at 3:49 pm

1. It seems as if you are writing for two audiences, Hazlitt’s popular audience, and a more learned audience which ought to know this stuff already, as if they didn’t sleep through Econ 101. Thus you have a lot of phrases here which a popular audience will not understand: “unique market allocation” will make eyes glaze over, for example. Instead of writing, “As a result, he implicitly assumes that there is a unique market allocation, in which prices equal opportunity costs, and that the two can only differ as a result of government interference,” -you might write,- “As a result, he thinks there is a true marketplace where prices always equal the value of the goods, and this can never be wrong, except from government interference.”

(Three words less, and a kid could understand it. Your editor should love you. In fact I think you should dump the word “allocation” altogether, as should all economists henceforth, no one ever uses that word on the street, and dump “distribution” too, these are bad econ jargon. Use near-synonyms when you can’t avoid the noun, like “arrangement”, “pattern”, “budget”, “share”, etc. Try to get rid of any word ending in “-ion” unless you really cannot.)

More important, this last phrase, “as a result of government interference,” hits at a primary conceptual confusion (couldn’t avoid “-ion” here, nor does the man in the street avoid it), a conceptual confusion that is rampant in Hazlitt’s popular audience, but you don’t bring it out explicitly in this preface, and I think you need to:

The phrase “market failure” is misunderstood by almost everyone who hears it outside the classroom to mean something like this: “an imperfection which is temporary, caused by government interference, and which can be corrected by getting government out of the way, and/or introducing another market” (basically, the vaguely Stiglerian mangling of Coase, –was it Stigler?–, and which Coase was a little too polite to correct). Many go further: government cannot correct the failure, government always causes the failure.

In other words, there is a predominant folk-belief that “market failure” is something which should NEVER be happening. Because markets will ALWAYS work. This is not merely confined to the libertarian swamps.

And but of course there are two kinds: market failure that is correctable by fixing that market, and market failure that remains incurable by any market, and which needs various, continuous government applications, of various intensities up to and including complete command, fiat takeover. Maybe these should have been named separately to avoid confusion: market failure and market impossibility. (With a secondary proviso that an instance of either one of them may be transformed into the other, through long-term social or technological change, e.g.)

Perhaps you have already devoted a following chapter to correcting this misunderstanding. However, another phrase in the preface here may refract through untutored eyes as if it is your misunderstanding too: “the basic questions in economics have not changed much since Hazlitt wrote” (–haven’t market failure and institutions refined the questions a good deal? And why is this phrase in here, anyway?)

I think you can fix this stuff for Hazlitt’s popular audience by an insertion in one of the lead paragraphs + a rewrite of the last paragraph.

One of the lead paragraphs should just simply state, “The market system cannot price the value of every real thing. Hazlitt says it can.” Short and sweet as possible.

The first phrase of the last paragraph, “The problem of how markets work and why they fail…,” -might be changed to something like,- “The study of how markets work, and the study of points where they can NEVER work…” [caps here for your italics, becuz I’m lazy]. This might help to situate a lot more readers, at the beginning of the book, to the proper understanding of the concept of market failure, and help them to anticipate where you might go with it.

2. It seems to me that there is more than a bit of a diversionary tactic in Hazlitt, and you do not address it here. His very big subtext is that government spending rewards the undeserving (he could hardly say it out loud, after the Depression and at the height of another World War) and that the price system is a basic requirement to inculcate the hierarchy of individual merit, i.e. the hierarchy which became the social-psychology adjunct to classical liberalism and still is. In other words, Hazlitt’s real game is partly about YOUR individual opportunity costs. Thus he writes, as you quote, “Everything … is produced at the expense of foregoing something else.” Dog whistle, much?

And it is still central. The need for this meritocracy, in the minds of almost everyone, may be at the bottom of the recalcitrance which DeLong detects in his fellow economists’ “dumbness” in not “marking their beliefs to market” in regard to fiscal expansion. He observes, “…it is not political in [the] partisan sense: it is, rather, that the prosperity of fiscal expansion is a false prosperity.” Well we know we can hear that, straight out of the mouth of the man in the street, but why would many economists say the same thing; why would THEY say it is “false”, exactly? They know the gov’t debt is not a current issue; they know there is no current crowding out of private investment; they know, they know, they know… etc. etc. etc… We’ve gone through all the professional economic logic, and lo and behold, it’s got nothing to do with it. http://www.bradford-delong.com/2015/05/thurday-musings-on-macroeconomic-policy-and-the-right.html

Hazlittians who value his book for this meritocratic subtext (pretty much all of them; the same reason they like Road to Serfdom–) are likely to disregard your book, dismiss it out of hand, unless you clearly put on the table that the market system cannot work 100%, it never did work 100%, and now its unobstructed functioning is disregarding your (the reader’s) merits: it is cheating the efforts of the bottom 99%, unjustly rewarding the top 1% (until government is forced to step in before they crash the whole system, is forced to bail them out, thus rewarding them further.) So the Hazlitt-Hayek system of merit is completely askew, at both top and bottom: the top get more than is merited, the bottom get less than is merited. And it is accelerating; increasingly it looks as if it cannot be otherwise: it is not market failure, it is market impossibility.

You need to elaborate upon the logic of why the government has nothing to do with market impossibility, but you need only mention the evidence, because the weight of the current evidence is already on your side and everybody knows it.

21

david 05.23.15 at 3:50 pm

Quiggin, I present Plume to you as typical of the reader who would be stymied by Lesson Two because they didn’t get past Lesson One.

22

Plume 05.23.15 at 3:53 pm

david @20,

Well, that sounds somewhat witty on the surface, but it’s completely empty of actual thought. Care to elaborate, without the lame snark?

23

Cranky Observer 05.23.15 at 3:57 pm

= = =Lee A Arnold: The phrase “market failure” is misunderstood by almost everyone who hears it outside the classroom to mean something like this: “an imperfection which is temporary, caused by government interference, and which can be corrected by getting government out of the way, and/or introducing another market” = = =

I take it you have been studying the activities of the US Federal Energy Regulatory Commission and its “independent” economics thinktanks (e.g. Potomac Economics) over the past 20 years?

24

Plume 05.23.15 at 4:05 pm

When I read mainstream economists, and many who follow them and use their jargon, I can’t help being frustrated via their abstractions and their echo chambers. They start with the assumption that capitalism is this amazing system, and a permanent given, and proceed from there as if there isn’t any need to even hint that there might be better alternatives or why. Any field of inquiry that assumes such things — that there is no need to question the foundations or existence of said system in that given field — is immediately suspect. It’s basically a cheerleading squad, consciously or unconsciously, and it will always miss the part of the iceberg below the surface of the cold dark sea.

25

david 05.23.15 at 4:09 pm

Sure. Quiggin wants to write a book espousing the familiar moderate vision of MIT-flavoured neoclassical econ – markets work unless there’s specifically-identified market failures that cause individual and social benefits/costs to diverge, and state action is necessary to arrange that they no longer diverge.

Needless to say, the first two words are “markets work”. That is, Quiggin intends to take Hazlitt’s side on the role of profit in society (or, at least, his objections in that area are beyond the scope of this already-probably-too-advanced book). So at some point Quiggin’s book must also dismantle the lay Marx-flavoured intuition of profit as an unneeded diversion from the means of production. If perfect markets don’t produce desirable outcomes, then correcting market failures so that one has a perfect market doesn’t seem appealing. And perfect markets have profit, and shareholders that obtain returns on investment based on that profit.

26

Plume 05.23.15 at 4:19 pm

david @24,

First of all, I think you’re projecting with regard to what you think his book will be. His Zombie Economics, which I purchased and read when it came out, wouldn’t lend itself to your description, and I’m guessing this new book won’t either.

Beyond that, even if that is the way it winds up, I won’t be “stymied” — by either lesson. I understand them and reject their premises. You’ve made the mistake of assuming that disagreement (in this case) equals misunderstanding, which is a rather arrogant and generally foolish assumption.

27

Peter Dorman 05.23.15 at 4:44 pm

It seems to me that you can use Hazlitt’s trope against him. H says that policies to override the market are selfish and socially wasteful because Keynesians/socialists/populists ignore the “hidden” opportunity costs that others must bear. Your case is that the personal opportunity cost faced by people in the economy is often different from the social opportunity cost, which is why there ought to be corrective policies. What you are saying, then, is that free market enthusiasts ignore this difference because they are unable to see beyond their personal, direct interests — exactly H’s critique, but turned around.

28

david 05.23.15 at 4:53 pm

to return to the topic – regardless, in view of readers like yourself, the book is quite likely to be so tangled up in identifying exactly what parts of a 1940s one hit wonder author that it agrees or disagrees with, that I question the utility of Hazlitt as a framing device at all

it makes it especially difficult to raise the justice-of-endowment-allocations attack later. Lee Arnold above suggested dispensing with the jargon but I don’t think that’s tenable, since the conceptual distinction between the endowment and the consumption bundle is too specific to this framework. and worse of all: theoretical concepts like endowment, etc. are all absent from Hazlitt’s lay book itself. this means that not only does the book have to familiarize the reader with Hazlitt just to talk the reader back out of Hazlitt, it also has to familiarize the reader with how Hazlitt fits into an arcane theoretical framework and then talking them out of that too

as far as the drafts that have been posted go, I don’t think it’s unreasonable to dispense with the reply-book-as-framing-device since this isn’t shaping up to be a reply book, and the desired lines of attack are a poor fit anyway.

29

david 05.23.15 at 5:00 pm

I mean, if you squint really damned hard you can force endowment issues into being a pecuniary externality that explodes into a “real” externality under market failure, but this is conceptually confusing even in a graduate student seminar; I don’t see it working out in a pop book. Lay people don’t need to have lay intuitions translated into econojargon to be acceptable as intuitions, anyway.

30

Plume 05.23.15 at 5:01 pm

What would Hazlitt make of the EITC? Caught a few moments of Up, on MSNBC this morning, where they were discussing minimum wage increases in general, and LA’s latest in particular. Someone from AEI said it would be destructive government interference to raise them, and that a better way is via EITC. Of course, that’s government intervention as well, which he seemed not to get. It’s also externalizing business costs yet again, which is foundational for the neoliberal project. Make business costs as low as possible, and get taxpayers to cover as much of them as possible. We the people get to pick up the slack for greedy-azz employers who can’t pay their own workers more than poverty level wages.

So-called “free market” enthusiasts, consciously or not, seem to miss just how much government, at all levels, props up business, supports it, bails it out, defends it, goes to war for it, promotes and expands it, etc. etc. They also miss that without this government support, there would be no “free markets” in the first place. So they want the impossible. Government to get out of the way and for the system to continue on. That’s impossible. Capitalism would collapse without government life supports.

It’s always been a silly term, and its advocates have successfully constructed quite the delusion/illusion/fiction to buttress it all.

31

Laszlo Toth, Jr. 05.23.15 at 5:06 pm

Hazlitt: “Everything … is produced at the expense of foregoing something else.”

Which is why humanity is so well known to not produce anything, and to hoard everything, because that’s the optimal way to not forego anything.

Or, um, not.

But it’s tough to see how Hazlitt justifies the existence of an economy at all, public or private, given that text. Which is what struck me as the main fallacy of the book, but what do I know?

32

Jayson Virissimo 05.23.15 at 5:58 pm

“While markets are exceptionally powerful social institutions, they cannot work unless governments establish the necessary framework in which they can operate.”

This needs additional qualifications, otherwise it seems to be claiming black markets can’t exist even in principle.

33

William Berry 05.23.15 at 6:04 pm

JQ @5:

The complete recasting is a good idea, I think. Also, the specific mention of monopoly makes the whole thought much more concrete.

34

mbw 05.23.15 at 6:54 pm

There is another fundamental lesson, drilled home in Robert Frank’s books. Many economic activities, probably most in societies like ours, produce goods with mostly relative values, not absolute value. What matters is mainly comparisons with what others have. Arms races in these relative sectors (house sizes,…) suck resources out of absolute sectors (leisure time…) and make everybody more miserable even if one unrealistically assumes perfect information, frictionless markets, rationality, etc. One way of describing these effects would be to ascribe negative externalities approximately equal to the nominal positive value for all such goods.
The solutions to these fundamental, empirically confirmed, problem all require some degree of collective action.

35

Eli Rabett 05.23.15 at 8:20 pm

Well, markets work, but only for some. The justification of a market economy is that it works for a majority, and you add government providing social welfare programs and you don’t get revolutions.

On a slightly less serious note, if it is true, as it is, that

markets are exceptionally powerful social institutions, they cannot work unless governments establish the necessary framework in which they can operate. The core of the economic framework in a market economy, and a central role of government, is the allocation and legal enforcement of property rights.

it is also true that (as Phil Hayes points out at the Weasel’s)

Ownership’s root is the use of force or the threat of use of force. Declaring a King requires only a successful use of force or the successful threat of force. Ownership follows. See William the Conqueror, etc. Etc.

and the choice of the new owners is to continually suppress the old ones (Native Americans, etc) or give them a share of the pie. Admit that and you are half way to Marx.

36

Sandwichman 05.23.15 at 9:37 pm

I would distinguish between Hazlitt’s and Bastiat’s stated lesson and their underlying premise. Opportunity cost is just obfuscating technical jargon. Their premise is that all blessings flow from the expansion of trade, therefore any impediment to that expansion is anathema.

Political economy in one lesson:

Political economy came into being as a natural result of the expansion of trade, and with its appearance elementary, unscientific huckstering was replaced by a developed system of licensed fraud, an entire science of enrichment. — Fred E., 1844.

The complaint one makes against that anti-social jargon, which so easily passes for economic science, is that it is in ludicrous opposition to the common observation of facts. Political economy professes to be a science based on observation. But the bitter pedantry which often usurps that name usually assumes its facts, after it has rounded off dogmas to suit its clients. — Fred H., 1872.

37

Roger Gathmann 05.23.15 at 10:03 pm

what bruce said. There’s a little vicious circle there, for after we make that assumption – having made no survey of opportunity costs or how, exactly, they are priced – we then use price as a proxy for opportunity cost.
In the process, of course, we ditch the profit motive. That reappears to motivate the entrepreneur. But it is an extremely strange thing to say that the entrepreneur is engaged n recouping his opportunity costs. If that is all he is doing, why is he doing it at all? In fact,the entrepreneur would probably say I went to this trouble or I had this idea or I invested this much and it is fair that I make some money above my opportunity costs. Here, the state could be seen to interfere in some ways – say, by granting monopoly rights through IP law, for instance. But I think the idea that the price system is primary and the state, in as much as it represents the community, is secondary is a very bad way to set up a community, even if prices were to be raised to continue to prioritize the community. It would depend, of course, on what the state as the representative of the community was doing. If it was, for instance, making tremendous loans to the business community at rates well below what businesses would find in the open market, then maybe the majority of people will be harmed and a rich minority will be favored. If, on the other hand, it was making education available to the community, with the costs to be divided among tax revenues as a whole, I think the majority of the community would benefit tremendously, even though the price system for education had been screwed with.

38

Sandwichman 05.23.15 at 10:06 pm

Where “opportunity cost” comes in is to distinguish between the “authentic” expansion of trade and the “fallacious” diversion of trade from one channel to another — hence the broken window as exemplary of a futile diversion. Another name for this expansion of trade is return on investment and accumulation of capital. There must be more investment to expand trade and there must be accumulation of capital to provide the funds and incentive for expanded investment. “Accumulate! Accumulate! That is Moses and the prophets!” (there is your real economics in one lesson)

39

Anarcissie 05.23.15 at 11:48 pm

I had never read Hazlitt before, so I earnestly downloaded a PDF. I think it was a waste of electrons, but I wanted to see if I could help. I noticed right away that Hazlitt begins in medias res, which naturally draws in a whole bag of assumptions of the sort I am sure I need not describe. Of course it’s popular; it recites and confirms a lot of people’s prejudices and learned propaganda.

I think to blow this sort of thing out of the little pond it paddles in, one might want to start by asking what economics is about. ‘Production, distribution, consumption’? Those are all questionable concepts.

40

Sandwichman 05.23.15 at 11:51 pm

“the little pond it paddles in…”

Or piddles?

41

Sebastian H 05.23.15 at 11:57 pm

The book sounds like a very interesting project.

“Ownership’s root is the use of force or the threat of use of force. Declaring a King requires only a successful use of force or the successful threat of force. Ownership follows. “

That on the other hand doesn’t sound interesting. It is the leftist’s version of the libertarian “taxation is violence” trope. Ownership’s root is the idea of ‘mine’, which comes well before a toddler can credibly threaten force.

42

Sandwichman 05.24.15 at 12:12 am

“Ownership’s root is the idea of ‘mine’, which comes well before a toddler can credibly threaten force.”

Talk about not interesting! Call it the tatterdemalion theory of private property. I don’t suppose the toddler has in mind selling the object that is “mine”?

In reality I possess private property only insofar as I have something vendible, whereas what is peculiar to me [meine Eigenheit] may not be vendible at all. My frock-coat is private property for me only so long as I can barter, pawn or sell it, so long [as it] is [marketable]. If it loses that feature, if it becomes tattered, it can still have a number of features which make it valuable for me, it may even become a feature of me and turn me into a tatterdemalion. But no economist would think of classing it as my private property, since it does not enable me to command any, even the smallest, amount of other people’s labour. A lawyer, an ideologist of private property, could perhaps still indulge in such twaddle.

43

Brett 05.24.15 at 1:02 am

@Plume

It’s also externalizing business costs yet again, which is foundational for the neoliberal project. Make business costs as low as possible, and get taxpayers to cover as much of them as possible.

More that it’s less costly for everyone if we spread the costs across an entire country rather than concentrating them on specific groups. Same rationale for universal health insurance, for example.

Universal programs also leave less room for judicial and administrative fuckery, like having a claim of lower-than-minimum wages paid that never gets rectified because the local judges are too sympathetic to employers.

@Jayson Virissimo

This needs additional qualifications, otherwise it seems to be claiming black markets can’t exist even in principle.

Yep, markets can spring up anywhere where some kind of “collective security” for participants is possible such that the gains from participating from the market are higher than the losses to thievery, fraud, and so forth. That’s almost always been the state, but non-state versions can do it as well – they’re just not as good at it, as you can see with the enforcement that gangs do with black markets.

Side-note, but I tend to think of markets as a way of taming incentives that are already there, essentially taming exchange to discourage traders from alternating between trading and piracy depending on circumstances – something that was quite common in the ancient and pre-modern world with traders.

44

Plume 05.24.15 at 3:38 am

But “black markets” ride piggy back on the infrastructure created by the state. They wouldn’t work too well if they had to print, maintain and support their own currency, cut international trade deals themselves, build and maintain their own roads, bridges, waterways, power grids, etc. or go to war to keep the shipping lanes open. Take away governments, and capitalism, even in its black market version, collapses.

Ironically, the only way for us to get to actual “smaller government” or “limited government” is to replace the capitalist system, because no economic system in the history of the world is as dependent upon massive state power to keep it alive. And America, probably more so than any other nation on earth, is blind to this. Its conservative, neoliberal, propertarian and all too many liberal movers and shakers act as if the government is nothing more than a nuisance at best, and for much the right, something fundamentally evil. In reality, take it away, and there is no capitalism, which would make me immensely happy.

In short, the only people who can really make a rational, logical case for small to no “state” are we leftists, because (among other things) we realize no economic system in world history has ever been more entwined with “big gubmint.” We’d rather have a system that doesn’t require any destructive co-dependency.

45

Sandwichman 05.24.15 at 4:14 am

“the only people who can really make a rational, logical case for small to no “state” are we leftists…”

That may be true in terms of a rational, logical case. But realistic? People are hard-wired for the same old, same old.

46

Brett 05.24.15 at 6:25 am

@Plume

Take away governments, and capitalism, even in its black market version, collapses.

Existing ones do, but that’s just because the infrastructure is already there to use. You can have a black market that consists of a bunch of people congregating on a plot of undeveloped dirt, setting up stands and trading on whatever they acknowledge as a common currency. Peddlers didn’t even have that – their market is an area where a bunch of them are traveling around, unloading their wares wherever they can to the people who live there.

As for leftism, not really. Unless you’re going to assume that people will be unanimous in their decision-making, and nobody in the Workers’ Paradise ever tries to cheat one another or dodge their production quotas.

47

notsneaky 05.24.15 at 6:39 am

To echo some of what david and Peter (actually both Peters) say above, it seems a little bit strange to me that Pigou doesn’t get a mention. If you’re going to frame it in terms of opportunity costs, and then argue that Hazlitt’s fallacy is to assume that market prices correctly reflect opportunity costs, that… just seems to be begging for a differentiation between private and social costs (opportunity or otherwise). I’m guessing this is partly because people are used to thinking of Pigouvian externalities as “pollution kind of stuff” – direct impacts of something or other on something or other. But of course the concept of an externality or a market failure is more general than that. Keynesian unemployment is a kind of an externality. Monopoly power is an externality. Capital spillovers inherent in infrastructure investment are an externality. Anytime that market prices do not reflect opportunity cost, you’re in Pigou world. The case you want to make – you are making – is that externalities/”prices do not reflect opportunity costs” are the rule (not just limited to things like pollution or what not) not the exception.

48

John Quiggin 05.24.15 at 9:12 am

@47 It’s only the Preface. When I talk about externalities in detail, Pigou will get plenty of credit. But I think you are pushing the claim too far. I’m going to define externalities as a special case of “gap between prices and opportunity costs”, and not vice versa.

49

david 05.24.15 at 1:25 pm

conceptualizing monopolistic competition as a mechanism that amplifies aggregate demand externalities so as to cause unemployment (a la Mankiw or Yellen/Akerlof) is something that underpins the so-called pre-GFC New Consensus, so limiting the definition of externalities to neighbourhood effects would seem to both misrepresent the modern general use of “externality” as a concept in the econ, and extant mainstream models of Keynesian opp-cost-driven unemployment you indicated as a topic in the previous post

50

Anarcissie 05.24.15 at 1:33 pm

Brett 05.24.15 at 6:25 am @ 46 —
A footnote. My understanding of the term ‘black market’ is that it is a market which exists in defiance of the law, not merely absence of law. Clearly, that which exists in specific defiance of something, depends on what it defies (for example, the drug trade and the Drug War). The law does not take much notice of small flea markets in vacant lots, which one can assume would exist with it or without it. (‘Property’ in a flea market being actual physical possession.)

51

Plume 05.24.15 at 3:09 pm

Brett @46

(apologies to John Quiggin for the temporary sidetrack)

As for leftism, not really. Unless you’re going to assume that people will be unanimous in their decision-making, and nobody in the Workers’ Paradise ever tries to cheat one another or dodge their production quotas.

Speaking of assumptions. This is you assuming we’re talking about some Soviet style system, which we’re radically opposed to. Even more so than neoliberals, propertarians and most liberals, because, as anticapitalists, we don’t want state capitalism. And that’s what the Soviet system was. We don’t want big gubmint, which capitalism demands.

No production quotas. No need for everyone to agree about everything. Just communities working cooperatively together to the degree possible, within and without, in federation with one another, using democratic processes, within the overall constitutional frame. Power shared equally, by law. Dispersed equally, by law. All of us co-owners, with no one owning anyone else. The people directly, literally, not through proxies, not through political parties, owning the means of production, etc. . . . from the local on out. Starting there, working outward. Community, then communities, then regions, then the nation, etc.

But back to Hazlitt and JQ’s book. I will definitely read it, as Zombie Economics was well written and informative . . . . and I’ve also been interested in his discussion of Pareto optimality. But Anarcissie makes a great point or two above, especially @39. Too many economists start in medias res, as she mentions, which helps people forget all about the supremely violent start to the whole deal, and how that violence continues to this day. I wish JQ would deal with that aspect as well, and write something that includes origins, like Michael Perelman’s The Invention of Capitalism or the effects/history of globalization, like The Making of Global Capitalism (Sam Gindin and Leo Panitch). It would be excellent to read a contemporary economic analysis not starting off in mid-stream, etc.

52

Plume 05.24.15 at 3:11 pm

Sorry for the bad formatting. Again, I wish we could go back and edit our posts.

Only part that should be in blockquotes is this:

As for leftism, not really. Unless you’re going to assume that people will be unanimous in their decision-making, and nobody in the Workers’ Paradise ever tries to cheat one another or dodge their production quotas.

53

Anarcissie 05.24.15 at 4:33 pm

Plume 05.24.15 at 3:09 pm @ 51 — I wasn’t just thinking of the violence of the state and property, necessary to what we call a free market. I was also thinking of the way in which vernacular production — what people do directly for themselves — is elided. Even in the latest versions of the industrial state, and certain before it, a huge amount of value is and was created in this way, for example people giving birth to and raising their children, maintaining their little plot, getting along with their neighbors — without which nothing else would be happening. And yet it seems to be entirely off the books. Almost everything is invisible until someone turns it into money. Or maybe I haven’t read the right books. But the fact that Hazlitt is taken seriously by anyone out of the high-school-Objectivist stage causes me to believe otherwise.

In any case I would recommend that a text directed towards those as ignorant as I am begin by defining its focus and universe of discourse, say ‘capitalist industrial production in the modern state’, taking care to note that the huge, huge thing it rests on is ignored — turtles all the way down.

54

Plume 05.24.15 at 4:43 pm

Anarcissie @53,

This book would appear to deal with your point directly, and is on my list of new purchases.

Who Cooked Adam Smith’s Dinner

It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest

When Adam Smith wrote that all our actions stem from self-interest and the world turns because of financial gain he brought to life ‘economic man’. Selfish and cynical, economic man has dominated our thinking ever since and his influence has spread from the market to how we shop, work and date. But every night Adam Smith’s mother served him his dinner, not out of self-interest but out of love.

Today, our economics focuses on self-interest and excludes all other motivations. It disregards the unpaid work of mothering, caring, cleaning and cooking. It insists that if women are paid less, then that’s because their labour is worth less – how could it be otherwise?

Economics has told us a story about how the world works and we have swallowed it, hook, line and sinker. Now it’s time to change the story.

In this courageous look at the mess we’re in, Katrine Marçal tackles the biggest myth of our time and invites us to kick out economic man once and for all.

55

david 05.24.15 at 4:46 pm

I continue to think that Economics in Two Lessons is not going to weigh in substantively on heterodox models of economic organization, gauging from the concept and the drafts posted thus far.

I’m curious with how Plumeonomics deals with rural-urban inter-community economic migration, though (moving to good schools governed and funded by an existing rich community is common in the present world!), and the formation of Kiryas-Joel-esque ethnic enclaves that develop both different democratic norms and conflicting long-term economic needs. These are salient in the sense of dealing with contemporary topics of gentrification, urban decay, immigration, emigration, etc., which is an area where MIT school thinking interfaces remarkably poorly with common individualist concerns, come to think of it.

56

david 05.24.15 at 4:52 pm

Anarcissie, household production and/or household labour supplies are both old and established macro and micro research fields respectively. However, state policy instruments to affect these are not common, and across the 20th century, liberal democracies have generally not considered home economics to be the realm of economic policy rather than cultural or civil-rights reform.

To illustrate this, it would be very weird if anyone in the West considered it acceptable for a government to say “oh, unemployment is too high. Better force some women to withdraw from the labour force by repealing some women’s rights” in the way that this is often said of, e.g., work-visa non-permanent migrants. Immigration is economic policy, family law is not.

57

adam.smith 05.24.15 at 5:38 pm

hmm — I agree with others that this seems like a lot of technical jargon for a preface. I see, of course, what you’re saying, but wouldn’t it make sense to motivate on more specific examples with less technical terms and then go into the details of market failure, opportunity costs, etc. in the respective chapters? That includes the lessons themselves. They read like from an econ text book, not like a populist tract on economics.

Or, if you look at Hazlitt’s rhetorical strategy–he starts out with “here’s this thing that’s perfectly obvious to all of you, yet it’s ignored by economists.” That’s a very clever move. I haven’t thought this through, but could you do something similar to that? Make the obvious thing that Hazlitt overlooks your lesson 2?

also:

When Adam Smith wrote that all our actions stem from self-interest and the world turns because of financial gain

*sob*

However selfish man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though they derive nothing from it except the pleasure of seeing it.

Adam Smith

58

Sandwichman 05.24.15 at 5:38 pm

J.Q.: “Pigou will get plenty of credit. But I think you are pushing the claim too far.”

Not at all.

I think notsneaky has it just right. (!) Pigou’s “incidental uncharged disservices” and “uncompensated services” have their origins in Marshall’s external economies, which are indeed much broader than “pollution kind of stuff.” J. M. Clark’s analysis of “overhead costs” and K.W. Kapp’s of “cost shifting” make it clear that the word “incidental” should be interpreted as referring to outside of formal exchange but by no means as inconsequential or even, necessarily, as unintended.

59

Bruce Wilder 05.24.15 at 6:02 pm

Not to pile on here, but notsneaky did get it right.

Also, what anarcissie said about “vernacular production”.

Hazlitt says, “market economy” but what he means is, “money economy”. The money economy is a convenient fiction, a socially constructed illusion. As a reactionary conservative, Hazlitt wants to make a case for not questioning the pretence, but economics, as a branch of sociology, should be about noticing the gap.

60

Plume 05.24.15 at 7:27 pm

david @55,

I’ve already been too tangential here, so better not respond to your question. Wrong thread, etc. etc. But if you actually are interested — and I’m guessing you really aren’t — look for a display of “Plumeonomics” in the next CT thread concerning alternative systems, or just leftist thought in general.

I know, I know. The anticipation must be killing you.

Now we are free!

;>)

61

John Quiggin 05.24.15 at 8:03 pm

As regards externalities, I’m planning to trace back to Marshall’s internal/external economies of scale idea. That’s the only way to make sense of the term.

But it’s a huge stretch to go from that to giving Pigou (arguably Keynes’ most formidable intellectual opponent), credit for the Keynesian idea of an unemployment equilibrium, or for the theory of monopoly. You could equally well argue (along Coasian lines) that all these problems arise from missing markets, and that externalities are just a symptom. Prices <> opportunity cost is another general framing, and that’s the one I plan to use.

62

John Quiggin 05.24.15 at 8:06 pm

More generally, there is always going to be a big problem in getting things right, while keeping the book accessible to a broad audience. That’s a big part of the reason I blog drafts as I go.

I’m thinking about having some starred sections on the history of thought, including externalities and the stuff on Pareto I posted recently. The idea would be that these could be skipped by readers who just want the policy relevant part of the story.

63

Sandwichman 05.24.15 at 8:43 pm

“But it’s a huge stretch to go from that to giving Pigou (arguably Keynes’ most formidable intellectual opponent), credit for the Keynesian idea of an unemployment equilibrium, or for the theory of monopoly. You could equally well argue (along Coasian lines) that all these problems arise from missing markets, and that externalities are just a symptom.”

It may be a stretch that is worth the exercise, John. I would strongly suggest J. M. Clark as a bridge between Pigou’s analysis and Keynes’s. As for Coase, he took on only the “pollution kind of stuff” treated by Pigou in Part II of Economics of Welfare and ignored the labour market side addressed in Part III (influenced by Chapman’s theory of hours). This latter type of externality is not amenable to a “Coase theorem” solution (which is not to suggest that Part II externalities are amenable).

See my “Hours of Labour and the Problem of Social Cost” for a discussion of the missing link.

64

david 05.25.15 at 12:30 am

It’s a stretch, but it’s a stretch that represents contemporary establishment econ, sometimes quite literally (Yellen). I’m not asking you to give Pigou credit, I’m asking you to avoid suggesting to your readers that the idea of generalizing externalities is revolutionary or even just niche, when the inference “something bad is happening –> it must not be internalized” is probably a fairer caricature of the state of things.

Separating the history of thought into an appendix sounds good. This would allow you to prune the jargon, too.

65

Harold 05.25.15 at 2:51 am

Thanks for Joe Hickerson link. Just discovered him in last 10 years. I especially like his rendition of Ethel Raim’s Joe Hill.

66

Harold 05.25.15 at 2:51 am

Sorry, wrong thread.

67

Anarcissie 05.25.15 at 3:01 am

david 05.24.15 at 4:52 pm @ 56 —
I suppose the masters of a command economy, confronted by high unemployment, could cut the work week back, thus moving more time/energy/attention/labor into the vernacular realm.

But what I have really been concerned with has not been state management, but Hazlitt getting away with pretending or suggesting that all of economic life, in the sense of the production and distribution of value, is carried out by men in offices and shops and mediated by the state (laws, banks, money, ‘the free market’, etc.) It would be interesting to have a truly radical economics, but maybe too difficult at this time. In that case, I wish for texts that would make their domain limitations explicit.

68

dsquared 05.25.15 at 3:31 am

I have a very hard time thinking of Keynesian unemployment as an externality. It’s a failure of lesson 1, surely, not an example of lesson 2. The opportunity cost of putting an unemployed worker to work is zero (or perhaps some low number representing the leisure value of involuntary unemployment). The price of doing so is the wage rate. The whole point of a Keynesian recession is that people would be willing to work at the prevailing wage but can’t.

69

mulp 05.25.15 at 3:56 am

Is this actually a quote?

“Everything … is produced at the expense of foregoing something else.”

Totally false unless you consider getting paid to work and then spending the money to make sure those paying you gets paid eventually to come at the cost of being idle, hungry, and homeless.

Keynes pointed out that “Everything … is produced at the expense of foregoing something else.” is bogus, and that the “free market” needs a kickstart that only government can do, basically by tax and spend investing in capital assets. By tax and spend investing, idle workers are paid to build assets and then they spend their earnings to pay other workers more which will be used to pay the taxes to pay for the capital assets they benefit from.

Taxes are merely the price of civilization and that will not come without labor investment, and seldom will the “free market” figure out how to sell policing, weights and measures, contract enforcement.

And New England tried to provide for highways by the free market, but the result was basically taxation by other means. Property owners were forced to buy bonds in tollways if it were to come to their property, but the toll jumpers always bankrupted the tollways so the bonds were defaulted on. Buying a bond was thus like a tax to pay for roads to your property.

70

mulp 05.25.15 at 4:03 am

dsquared:

You missed the opportunity cost of the idle worker: no spending to add to GDP

Put them to work and they will increase GDP by spending.

Free lunch economics is based on the idea that consumers are not workers and workers are not consumers.

Economics is zero sum. That does not mean that paying someone to work instead of being idle will result in a worker being forced to idleness, but rather that paying someone to work means that must spend their income paying wages for other workers but buying production, thus increasing GDP.

Perhaps Hazlitt believes that GDP is fixed and can’t be increased??

71

Sandwichman 05.25.15 at 5:23 am

dsquared: “I have a very hard time thinking of Keynesian unemployment as an externality. It’s a failure of lesson 1, surely, not an example of lesson 2. The opportunity cost of putting an unemployed worker to work is zero…”

— the social opportunity cost, yes; the private opportunity cost, no.

In his “Studies in the Economics of Overhead Costs,” J. M. Clark (1923) had argued that labor should be considered as an overhead cost of doing business rather than as a variable cost of the employing firm because the cost of maintaining the worker and his or her family “in good stead” has to be borne by someone whether or not that worker is employed:

If all industry were integrated and owned by workers, what would be the relation of constant to variable expense? …it would be clear to worker-owners that the real cost of labor could not be materially reduced by unemployment.

72

Peter T 05.25.15 at 7:14 am

@71
“the cost of maintaining the worker and his or her family “in good stead” has to be borne by someone”.

Hmm. According to Floud et al (The Changing Body) around 20% of the populations of Western Europe were incapable of much more than a little light begging, due to malnutrition, over the two centuries years up to 1850. Maintaining people in good order is clearly a moral duty, but it does not appear to be an economic one.

73

david 05.25.15 at 8:19 am

Keynesian unemployment as externality in the Mankiw/Akerlof-Yellen sense is easy to conceptualize: the monopolistically-competitive non-price-taking employer says, I could hire you but it’ll increase my costs by a lot and only increase my share of aggregate demand (that is, demand for my firm’s output) by a little bit. So nah.

That is, price-setting decisions that impact aggregate demand are externalized and therefore aggregate demand is rationally underprovided at equilibrium.

74

notsneaky 05.25.15 at 8:38 am

IIRC Ostroy and Makowski showed that basically any kind of inefficiency/non-Pareto outcome is a result of an externality, where social costs/benefits don’t line up with private social costs/benefits at the margin.

To say the same thing as david differently, the marginal social cost of hiring an unemployed worker is lower than the private marginal cost (the wage) because the worker’s income adds to aggregate demand. Not that Pigou framed it that way.

75

Jeff 05.25.15 at 1:09 pm

Just a redundant redundancy nitpick: You say the same thing twice, two paragraphs apart, which could leave a reader with the impression “sloppy”:

“have not been substantially improved on”

“that have not been improved upon”

76

Jeffrey Stewart 05.25.15 at 1:33 pm

You may want to consider the title, Neoclassical Economics In Two Lessons because you’re not covering economics with this material. For example, you’re excluding two other contemporary schools of thought according to their respective value theories, neo-Ricardian economics and Marxian economics.

77

Plume 05.25.15 at 3:00 pm

david@73,

That’s a lot of words just to tell us what we already knew. That a business owner won’t hire workers unless they increase profit for that owner, which means our economy doesn’t work for the majority. It works for a tiny minority, based solely on their say so, and their decisions are made to benefit that tiny minority, always, instead of the majority. Capitalism’s own internal mechanics do this, and it’s pretty obvious.

So for me, anyway, I read all kinds of mainstream economics that appears to completely avoid this obvious fact, building up as it has this immense construct to obfuscate what screams from the rooftops . . . so that readers, and citizens, get deeply into the weeds of the theories, instead of waking up and realizing it’s all bullshit.

It’s like we have this Rube Goldberg Machine, and it’s a really, really lousy machine, cuz it only spits out one marble for a hundred tries. One marble going to one out of a hundred people, give or take. But for more than two centuries, we’ve had this parallel (buttressing) narrative, crafted by political economists who write as if this one marble result is logical, rational, sane and a stand-in for everything else, so it never needs to be mentioned. So they concentrate on selective minutiae of that Rube Goldberg contraption, always from the point of view of ownership, avoiding the 800 pound gorilla in the room as if their lives depended upon it — and they do, of course . . . and they study others who study this contraption, and they drop names of now famous people who studied this contraption, and they make verbs, adverbs and adjectives out of those people, so they sound even more impressive — at least to themselves and others in their little echo chamber.

But instead of studying the actual real-world consequences of this contraption and its guarantee of obscene maldistribution, inequality and ecological ruin, they end up building up this crazy support system for it, and they mock others who have seen through the bullshit.

The richest 80 humans hold more wealth than the bottom 3.5 billion.The richest 20% consume 85% of all resources. In America, the richest 1%, by 2016, will hold 99% of all wealth. But still mainstream economists write and talk as if this system actually works for everyone and as if it’s simply crazy to demand one that actually does.

78

Sandwichman 05.25.15 at 3:36 pm

Plume @76: “So for me, anyway, I read all kinds of mainstream economics that appears to completely avoid this obvious fact, building up as it has this immense construct to obfuscate what screams from the rooftops.”

See Sandwichman @36:

Political economy in one lesson:

Political economy came into being as a natural result of the expansion of trade, and with its appearance elementary, unscientific huckstering was replaced by a developed system of licensed fraud, an entire science of enrichment. — Fred E., 1844

79

Bruce Wilder 05.25.15 at 4:46 pm

Extending the discussion of external economies . . .

If I build a bridge to Nowhere, my investment changes the opportunity costs associated with transportation to and from Nowhere. Poetically, Nowhere becomes Somewhere. The opportunity costs of the resources used to build the bridge, however, disappear into the sunk cost character of the bridge itself. The marginal cost of using the bridge to move to or from the new Somewhere does not necessarily include the sunk cost of building the bridge.

This is a general problem for a money economy with sunk cost capital investment in production processes that may yield increasing returns over the relevant range of output. In a money economy, an efficient unit price for production does not necessarily solve the problem of financing sunk cost investments.

A toll could be used to finance the cost of the sunk cost investment in the bridge or the cost of maintaining and replacing the bridge, but such a price would preclude using the bridge for productive purposes that did not quite yield sufficient surplus to pay the (arbitrary) toll. A toll could offset congestion costs if the use of the bridge scales high enough, but that’s not the general case.

A lower cost of transportation increases the value of locating in Somewhere, so maybe the value of building the bridge shows up in economic rents associated with locations in Somewhere, and a government could finance the bridge by taxes on economic rents (e.g. increased property values) in Somewhere. Or, a property developer that already owned nowhere could finance a bridge that made nowhere into the more valuable Somewhere, by promising the proceeds from selling pieces of Somewhere.

There’s a general conflict between opportunity cost pricing and the need to finance sunk cost investments, the benefits of which tend to diffuse because their sunk-cost nature means that ex post bargaining over price cannot credibly take sunk costs into account. This conflict poses a problem for private business, which must find a way to earn an economic rent if it is to finance a sunk cost investment. The ability to earn an economic rent involves an exercise of an essentially political power from strategic manipulation of property rights and other aspects of the institutional setting.

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Bruce Wilder 05.25.15 at 5:21 pm

Plume @ 76

Yes, economists are mostly humbugs and economics is a civic religion, its doctrines so much irrelevant mumbo jumbo, its dogmas convenient rationalizations for the powerful doing as they will and the rest suffering what they must.

Neither the scholasticism nor the hypocrisies of religion, however, constitute any evidence that science can be or should be simple and easy.

It is not possible to achieve productive abundance without deep specialization and investment, entailing unfathomable risks and multifarious conflicts for any scheme of cooperation in an uncertain world. The problems of a decentralized polity and economy are genuinely complex and difficult, with only a limited array of second-best solutions yet discovered.

I am as exasperated as anyone with the readiness of people to buy into what both you and I think are obvious lies, motivated by ill will or ulterior intentions. It seems so unnecessary.

But, the purity of your intentions doesn’t make you smart. Or even right.

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Sandwichman 05.25.15 at 5:57 pm

“But, the purity of your intentions doesn’t make you smart. Or even right.”

Or even pure.

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Bruce Wilder 05.25.15 at 6:02 pm

Or even pure.

True dat.

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Donald A. Coffin 05.26.15 at 12:09 am

I haven’t had time to read through all this carefully. But this (http://www.digitopoly.org/2015/05/24/economics-in-one-lesson-nash/), by Joshua Gans, might be interesting. He argues that the entire concet of opportunity cost is all but meaningless unless one can specify (extrapolating a little) both an initial equilibrium and a final equilibrium as we adjust to a change in the economy.

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Lee A. Arnold 05.26.15 at 12:32 am

JQ, maybe a big glossary in non-technical language. You can have mine, and if anybody’s got a correction, please pitch in:

1. Benefit — something evidently gained.

2. Cost — something evidently lost or foregone; the negative of benefit. (Therefore, “reducing a cost” is a benefit, the negation of the negative.)

3. Scarcity — the assumption that resources are limited but wants are unlimited, and choices must therefore be made over transactions. It’s just an assumption.

4. Capital — a pattern in the world, which may be of a physical object (e.g. a tool) or may be in a mental formation, which gives a positive benefit-to-cost ratio (an efficiency) in an effort of production. This may be the single most difficult definition in economics because it was back-formed from something that is different: financial capital. It comes from ancient Rome, where “capital” meant only the money-financing of a business.) An improvement in capital means we get more in return, for the same effort (or put another way, the same in return, for less effort).

5. Transaction — a trade between two parties. Originally a trade of goods from each party, but it also could be the trade of costs to each party, which will be useful if, after the transaction, each one has reduced his or her own costs, and therefore both benefit. (This latter case happens in trade of debt-paper, or “instruments”, of different maturities or risks in financial markets, for example.) (Economists insist that transactions are always voluntary because mutually beneficial, but this is not always the case with the poor, who are forced to make subsistence transactions.)

6. Money — a quantized sign-image that can be used in any transaction, in exchange for a real benefit, or a real cost-reduction. Thus money appears to make all benefits and costs have values which are related transitively, i.e. mimicking the transitive law of arithmetic: if a=b, and b=c, then a=c.

6. Price — the cost in money of gaining a benefit, or the cost in money of reducing another cost. Determined by supply-and-demand for the object of the transaction, among all those who can be party to it at that moment in time: called a “market”.

7. Opportunity cost — the value of doing the next desired alternative transaction, in a choice between making transactions. Since you have a choice, because you might do something else, this tends to relate the prices among all your alternatives, since your rejected alternative had a supply-and-demand price, and your chosen alternative changes supply-or-demand in the market of that transaction. It is all in the next step, called the “margin”. In essence, opportunity cost is the extension of marginal analysis (which was applied to business firms) so that it also may be applied to consumers, in order to avoid direct use of the term consumer “utility” (consumer satisfaction), which cannot be quantified for a single instance, and cannot quantified for comparison between people (the impossilbity of “interpersonal utility comparison”).

8. Transaction cost — the surrounding efforts required to make a transaction. Originally defined as searching, bargaining, and enforcement (of contracts, of product liability laws and so forth), but it can extended to risks of many kinds, such as risk to future retirement security. Estimated to be valued at about 1/2 of GDP.

9. Institution — a method of agreement in effect on both parties, in order to reduce a transaction cost. It is not a building or a physical organization. The institution could be simply that they use the same language, or that they trust each other, and thus reduce the cost of transacting. Or the institution could be a business entrepreneur who directs two workers toward certain transactions with each other, to save time or space. The institution could be a government that provides the law to enforce market contracts or enacts transfers to reduce risk or uncertainty in private outcomes. The market institutions are money, prices and private property.

10. Allocative efficiency — a state of the total economy in which all of the production is consumed by the people who want it, AND can pay for it. One of the two widely-used definitions of “efficiency” in any science which is not quantified; it is not a numerical ratio between two quantities. Note that allocative efficiency is independent of the distribution of income, so if the economy is producing little, and poor people want stuff but cannot pay for it, it may still be allocatively efficient.

11. Pareto efficiency or optimality — a state of the economy in which no one can be made better off, without making someone worse off. The other widely-used definition of “efficiency” in any science which is not quantified; it is not a numerical ratio between two quantities. Note that Pareto efficiency is independent of allocative efficiency. Note that Pareto efficiency is also independent of the distribution of income.

12. Market failure — that which prevents allocative efficiency. Names: monopoly & imperfect competition, externalities, public goods, asymmetric information. In each case, self-interested behavior does not lead to “allocative efficiency”, because of one or more of these conditions (which also may be called market failures): A–firms are not price-takers. B–there aren’t enough participants to form a competitive price. C–there is no free entry or exit for producers or consumers. D–immobility of factors of production. E–free riders. F–products are not homogenous. G–imperfect information of either buyer or seller. H–unassigned or unassignable property rights, therefore “missing” markets. Thus, market failure is pandemic, or rather we should say, there are very few markets which can approach proper functioning; examples are some agricultural commodities and some financial instruments. Note that market failure prevents allocative efficiency, by definition. Note that we cannot prove we have moved closer to allocative efficiency by any improvement in a market failure, due to LIpsey-Lancaster “second-best” theorem. Note also that the “unequal distribution of income” is not defined as a market failure, because allocative efficiency is defined as independent of the distribution of income. Isn’t that neat?

13. Government failure — should be enlarged to “institutional failure”, because the set of analogies to business management failure is complete. It all in the mistakes of direction from the center, due to information, lack of feedback, rent-seeking, etc. The difference is in the ultimate method of decisionmaking: by votes or prices.

14. Externality — a cost (negative externality) or benefit (positive externality) of a production or consumption, that affects something outside the parties to the transaction. Environmental pollution and social cost are examples of negative externality. Anything that makes the world a better place for others has a positive externality.

16. Social cost — a negative externality which affects many or all people.

17. Internal/external economies of scale — Internal: a firm’s advantage in cost-reduction in production, due to size, scale, or larger run of output. External: reductions in cost, due to the size of the whole industry, or due to placement in a geographic area where similar or related firms can transact more easily in ideas, product parts, labor market, etc. (Geographic economy of scale is also called agglomeration economy).

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John Quiggin 05.26.15 at 2:16 am

First, thanks to everyone for lots of helpful comments. I am paying attention, and rethinking as I go. I welcome everything from editorial nitpicks to fundamental critiques of the entire project.

Second responding to 76 and several previous comments, this will indeed be a book about mainstream (aka neoclassical, though that term is also used for a faction within the mainstream) economics. Here’s a statement of my views

http://crookedtimber.org/2007/06/01/heterodoxy-is-not-my-doxy/

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reason 05.26.15 at 8:30 am

It seems to me that Hazlitt really will have a hard sell with point 2. It doesn’t take much imagination, to imagine digging up the interstate highway system and selling the land for houses, or to see that such a policy would be a disaster. He must have really used some extraordinary arguments to try to get around that one.

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reason 05.27.15 at 9:43 am

Sebastian H. @41
“Ownership’s root is the idea of ‘mine’, which comes well before a toddler can credibly threaten force.”
This can only have been written by someone who has never dealt with a toddler.

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notsneaky 05.27.15 at 2:58 pm

@87 Not true. “Sharing” they have to learn. “Mine” they are pretty much born with.
(I don’t know if “I’ll cry and scream and drive parents crazy until I get what’s mine” can qualify as some kind of version of “credibly threatening force”)

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Anarcissie 05.27.15 at 3:35 pm

I don’t think an infant has a concept of mine, because then there would be also not-mine, whereas the infant simply wants what it wants at the moment and takes what it can grasp. After several months of interaction with others and their culture, it begins to develop concepts like the division of the world into various kinds of property. No doubt some psychologists of children have gotten into great detail on this.

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5566hh 05.28.15 at 2:49 am

“The first question was one that naturally occurred to me when Seth Ditchik, my publisher at Princeton University Press suggested this project”

This is extremely minor but personally I would put a comma after Press in that sentence. In fact I am just reading Zombie Economics and have noticed a couple of occasions where your comma usage does not seem intuitive to me. I’m not sure whether others would agree on this point or not.

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reason 05.28.15 at 8:39 am

notsqeaky
“(I don’t know if “I’ll cry and scream and drive parents crazy until I get what’s mine” can qualify as some kind of version of “credibly threatening force”)”
OK so you do get it.

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reason 05.28.15 at 8:43 am

notsqueaky
I’m not sure that toddlers have an innate idea of the difference between possession and ownership. Question – how do toddlers deal with someone else having something that they want? (Yeah – I know the answer is pretty much the same way the Koch brothers do, but that is another issue.)

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John Quiggin 05.28.15 at 8:47 am

As I’ve said before, the idea that words like “mine” relate closely to property rights is a linguistic confusion.

http://crookedtimber.org/2014/07/28/uncle-toms-cabin/

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mclaren 05.29.15 at 7:52 am

Quiggin remarks:

The simplicity of Hazlitt’s argument is his great strength.

Quite the contrary, it seems Hazlitt’s greatest weakness. Hazlitt arrogantly presumes that the (human) economist enjoys godlike powers of clairvoyage, able to see every detail and each minutiae of the possible outcomes of economic policies not takes — as well as compute them financially.

But it economics has taught us anything, surely it has taught us that the law of unintended consequences rules our economic life. I’m thinking here of the vast chorus of expert economists in 2007 who assured all and sundry that the subprime mortgage market could not possibly bring down the larger American economy, since it amounted only to a mere 5% of the U.S. GDP.

Presumably Quiggin will attack Hazlitt on this point, since Hazlitt’s stunning hubris certainly seems to make him uniquely vulnerable: but there seems no sign of it in the general tone of Quiggin’s discussion.

As anyone familiar with, say, even simple dynamical systems well knows, even the simplest physical-mathematical systems prove vulnerable to radically nonlinear behavior. Thus we get Rayleigh-Benet convection cells in non-equilibrium thermodynamical systems, near-earth asteroids shooting out from the asteroid belt unpredictably (Tertairy-Cretaceous extinction even, anyone?) and so on.

And human interacting economically en masse sure look to me like a more complex system than a relatively straightforward 3-body dynamical system, or nonlinear forced pendulum. So common sense would suggest that calculating opportunity costs is roughly akin to solving a million-body problem with dollars instead of momenta and velocities as the quantities involved. This sure looks like Hazlitt’s big weak point to me.

Will Quiggin point this out? Maybe he’s doing the Popper trick, building up the apparent case for his opponent only to knock it down by demolishing his opponent’s basic assumptions.

The presumption in Lesson 1, that market prices reflect anything much in the real world, seem highly suspect to me. C.f. the insane housing prices not only at the cusp of the bubble, but today on both coasts in America. Markets, contra Hayek, aren’t a mechanism for accurately valuing goods and service, but a method for the 1% to rape the rest of society. Likewise, prices aren’t a substitute for value, but indicators of the amount of control fraud and corruption in the system. Which is to say, to a non-economist, markets look more like the Black Plague, and prices more like buboes, than anything else.

Perhaps Quiggin plans on taking his argument in a different direction. Accepting Hazlitt’s presumptions seems unwise, given the utterly peurile nature of Hazlitt’s reasoning…

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JR Hulls 05.29.15 at 9:28 am

One of the best means of explaining various schools of thought are concrete historical examples of which the reader would be aware, as well as analogies that are accessible, such as Keynes burying money in old coal mines and paying people to dig it up. I might suggest the Hoover dam as an example of many of the issues one might deal with in debunking Hazlitt’s free market evangelism. (as you describe it because I have not read him yet) It also let me make a very bad pun in a piece entitled ‘Dam the Economists’ at http://somewhatlogically.com/?p=523
We amateurs from the pond water school of economics believe a sense of humor and history are vital.

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Anarcissie 05.29.15 at 2:07 pm

Hazlitt’s great strength is that he assumes or recites prejudices and myths which have already been accepted by his intended audience, just as once people justified Negro slavery and other practices now seen as absurd or abominable. The problem is not refuting his work rationally, it’s getting its victims to question the assumptions which to them are old, familiar friends and relatives.

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ZM 05.29.15 at 4:02 pm

John Quiggin,

“As I’ve said before, the idea that words like “mine” relate closely to property rights is a linguistic confusion.”

I think it is an interesting and very current topic the distinctions between ownership, use, property, etc. and maybe the interaction of these with other duties and obligations.

There was a meeting about indigenous land rights and economic development convened by Tim Wilson and Mick Gooda the other day, with Tim Wilson arguing property rights are part of human rights. This is historically inaccurate, because property rights came first via John Locke et al, and then human rights were developed later in the 20th C as a response after property rights took the common lands, made people work in poor conditions, and relied on colonisation and ended up in wars and world wars.

Tim Wilson said in the The Australian 20/5 “Property rights are actually the forgotten human right. Without property rights, you don’t get security, you don’t get people being able to materialise the efforts of their labour, and in the end, without property rights you simply don’t have economic development.
The feedback from indigenous leaders has been incredibly strong: they know the challenges they face, and they know the human experience or the consequences of what happens when you can’t use your property to its full legal extent.”

Noel Pearson said the meeting “brought a really fresh angle” “We’ve reached a stage where a couple of things are converging — we’re moving from a land rights claim phase to a land rights use phase where people are grappling with how do we make our land contribute to our development” Which is understandable given poverty and discrimination and other problems faced by indigenous people.

But Tim Wilson is not up to date, because this year the UN is meeting to discuss how to move to sustainable development even in wealthy countries like Australia. This is a good opportunity for indigenous people, hopefully their will be indigenous voices represented at the conference.

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