Learning Economics...

...with Arnold Kling.

I'm reading Learning Economics, an excellent collection of writings by Arnold Kling (Ph.D.!), the well-known Tech Central Station contributor, master of EconLog, and founder of the old Homefair.com site.

It's both an excellent primer on how markets work (and how sometimes they don't) and an in-depth analysis of things ranging from "nonlinear analysis" to "the great displacement" to "bleeding-heart libertarianism."

Learning Economics is available here.

Comments

Fred Gillette | December 14, 2004, 8:41am | #

I'm not going to read the book; too much engineering stuff to read. But "bleeding-heart libertarianism" sounds interesting. Can someone summarize what the author means by that?

Nick Gillespie | December 14, 2004, 8:53am | #

Go here for what Kling means: http://www.techcentralstation.com/092903A.html

Fred Gillette | December 14, 2004, 9:21am | #

Thanks, Nick. Got it bookmarked, I'll read it later.

Jeff Smith | December 14, 2004, 9:53am | #

This is just background reading before you
read all my papers, right? :)

Jeff

Fred Gillette | December 14, 2004, 10:00am | #

Well, Jeff, if you could use subtitles like this, "In Which Krugman Meets a Heffalump", I would.

fyodor | December 14, 2004, 10:23am | #

At the risk of sounding naive, can someone tell me what's supposed to be meant by markets "not working?" That kinda sounds to me like saying that sometimes the laws of physics don't work. Sure, there have been times they didn't do what scientists thought they would, which meant there was more to learn about them, not that they "didn't work." And sure, there's often greater variability when dealing with humans than with natural laws, but that only means one must account for that when describing how human interactions work, it still doesn't mean they simply don't.

Hmmm, just googled "market failure" and came up with "the price established in the market does not equal the marginal social benefit of a good and the marginal social cost of producing the good" as the obvious answer of some quiz. But then, what and who determines that?

Dude | December 14, 2004, 10:33am | #

I hate to wax arrogant here but why is Kling publishing the book through Xlibris (aka self-publishing)?

I had a friend in high school who published his work through Xlibris. I would not call him an "auteur."

Kling is a bright guy and has a gift for both economic thinking and lucid explanation. So I'm sorry to see him make what I think is a mistake that will cause this book--which is probably very good--to be taken less seriously.

Does Kling believe that signaling and academic prestige mean *nothing*?

Craig | December 14, 2004, 10:46am | #

Read the whole book online for free here:

http://arnoldkling.com/econ/book/contents.html

Highway | December 14, 2004, 11:20am | #

fyodor, I think the definition of a 'market failure' is 'people not paying me enough for my goods and services'. ;-)

Actually, I think that most people who use the term are benchmarking it against some goal they set beforehand, like the flu vaccines from this year. People in the US wanted 200 million cheap flu vaccines, but the only companies that could produce them for those prices included one with shaky quality control. Therefore, the batch was deemed unsafe, and the corresponding shortage is chalked up to a 'market failure' because the people deeming it so want it to be a government purchase, instead of a market issue. Generally, it seems that things termed 'market failures' are either interfered with by the government (California blackouts) or things with unrealistic expectations ('cheap' health care for everyone).

Jason Ligon | December 14, 2004, 11:44am | #

You guys have it all wrong. The market doesn't give people free cutting edge medicine. Old people are DYING in the streets! If that's not a failure, I don't know what is!!


Sorry, flashback to my last family gathering ...

Tim Higgins | December 14, 2004, 12:03pm | #

fyodor,

Perhaps "market failures" refer to what are also called "externalities." A classic example is industrial pollution - say a bunch of smokestacks move in next door. Without regulation, how will I be compensated for the cost of the pollution that the smokestacks are imposing on me?

David | December 14, 2004, 12:19pm | #

292 articles from Arnold Kling linked at:

http://arnoldkling.com/~arnoldsk/aimstindex.html

And here is a link to the good Dr. Kling bustin' a move. It is not pretty.

http://www.arnoldkling.com/pix/ohevet.mov

Rick Barton | December 14, 2004, 12:19pm | #

Concerning "markets not working"/"market failure", what fyodor said.

Concerning "bleeding-heart libertarianism." Years ago, I used the term to come to grips with the evidence that folks who the bleeding heart liberals claim to want to help are in fact helped by reducing government impediments to their prosperity such as taxes and regulations. I don't know about what Kling means, but I'm guessing the same.

thoreau | December 14, 2004, 12:44pm | #

Tim Higgins hit the nail on the head. A market failure occurs when a transaction forces costs onto other people who didn't consent (either implicitly or explicitly) to it.

Now, we can debate the best way to handle the externalities, but that's the meaning of the term.

fyodor | December 14, 2004, 12:50pm | #

Kudos to Highway and Jason Ligon, cause that's probably how a lot of people use the term!

But Tim Higgins is probably right that it's when externalities are involved that more knowledgeable people might use this terminology. I still think for semantic reasons that the existence of externalities is not tantamount to "market failure" per se but is rather more of a law enforcement failure. Ie, how does one address an infringement of rights that is spread out more or less equaly over an entire population or even the entire globe? And of course it only gets more complicated when the perceived infringement of rights is of an abstract or disputed nature, as opposed to the concrete nature of punching someone in the face or taking someone's purse away.

drf | December 14, 2004, 12:59pm | #

note to those who claim to be supply siders: dr. kling is not one of them. he and others are in the salt water (blanchard, mankiw) arena and are NOT supply siders.

this is kinda important when looking at policy implications for bush's plans - don't cross the streams and look for a supply side explanation while catering to a demand side action.

cheers,
drf

fyodor | December 14, 2004, 1:16pm | #

Plus, I think that the whole concept of externalities is flawed as such. If a factory is polluting the air I breathe, I think it makes most sense to look at this as between the factory and me (although lots of others might be on the side of "me"). That is, the concept of externality implies that the pollution is some sort of side effect of the market transaction between the factory owners and their customers, and this is supposedly what makes them special. While I think it's always worth considering for certain purposes that the factory owners are satisfying the desires of their customers and not just being gratuitously evil, I don't think it's accurate analysis to include the customers. Rather, the polluting is what the factory owners are doing, regardless of their motive. OTOH, the victims of the pollution may very well be among the very same people who benefit from the fruits of the factory, which is why these combination victims/customers may not want the factory closed down even while they may want the pollution addressed.

Again, I don't think any of this means markets have somehow failed, only that understanding and dealing with exactly what is going on may require more sophisticaed analysis than found in the first week of Econ 101 or a libertarian primer.

Lisa Casanova | December 14, 2004, 1:41pm | #

"A market failure occurs when a transaction forces costs onto other people who didn't consent (either implicitly or explicitly) to it." I'm glad to see an attempt to define it precisely. Many people seem to think "market failure" means "anything that happens in a market that I don't like." The debate over how externalities like pollution should be handled is a whole different (huge) one, but it's a start to remind people that it isn't a market failure anytime you don't get what you want when you want it for as cheap as you think you should get it.

Larry Edelstein | December 14, 2004, 2:28pm | #

When I was in college, the econ students referred to "external diseconomies", which I think is synonymous with "externalities".

MikeP | December 14, 2004, 2:49pm | #

Lisa Casanova writes:
it's a start to remind people that it isn't a market failure anytime you don't get what you want when you want it for as cheap as you think you should get it.

Very true. However, while market failure is an overused term by people who promote supposed government solutions to the problem, it is a very real concept and it does exist.

Essentially, market failure happens whenever rational actors acting freely fail to reach an economically efficient solution. Externalities are one form of market failure, where the harm caused by the externalities costs more than the benefits of the production. Another is the public goods problem where everyone would be better off with a particular good being produced (say national defense or roads), but the benefits are so widespread that there is no way to charge enough for it, so the good is not produced.

Market failure is an extremely useful concept for libertarians to understand because it is used as the excuse for so much government intervention. The principal argument against government "correction" for market failure is that there is no market more prone to failure than the political market. Those who wish to propose government remediation for a market failure can not simply say, "Market failure. We have to fix it with law and regulation." They must demonstrate that the public solution -- not, mind you, the perfect solution, but the solution that will actually result from the government interference -- will actually be better.

A good source for market concepts is David Friedman's price theory textbook, which is on line. The chapter on market failure.

A paragraph from that chapter that echoes what others have been saying:
In thinking about market failure, it is often tempting to interpret the problem in terms of fairness rather than efficiency. Externalities are then seen as wrong because they are unfair, because one person is suffering and another gaining, and public goods as a problem because some consumers get what others pay for. That is a mistake.

Friedman has also written a more approachable version of these microeconomic concepts in his book _Hidden Order_.

fyodor | December 14, 2004, 3:48pm | #

MikeP,

Thanks for the valuable refresher!

Interesting though that Friedman feels justified to categorically say that considering fairness is a mistake, whereas I think it's still a vital issue. If one's rights are being infringed at the hands of another, it seems like that's more important than the lack of economic efficiency that has resulted from one's suffering. And even if a society (theoretically) gains on net from coercing payment for a public good, does that necessarily justify the coercion? In other words, maximizing societal efficiency isn't everything (even granting the dubious proposition that we can definitely do that through coercion). Perhaps there's a deeper way to look at these notions philosophically that explain away my objections, but it would require that and not mere efficiency maximization to justify coercion when no rights have been violated or to block coercion when rights are being violated.

MikeP | December 14, 2004, 5:09pm | #

You're welcome, fyodor!

On your discomfort with market failure not equating with unfairness... Market failure, as such, is supposed to be value neutral. While free markets reach the wealth-and-happiness-maximizing solutions almost all the time, market failures represent those provable rare cases where an opportunity for mutual benefit does not happen. It doesn't say what the right or wrong action is, and you are fully correct to say that fixes to market failure need to be balanced, if not outright trumped, by arguments against coercion. In fact, rights of those concerned can often be fully incorporated directly into the discussion of market failure.

For example, a company plans to build a factory. If the costs of the pollution of the factory to those living near it exceed the benefit of the factory to society, the factory should not be built -- its construction and operation decreases the wealth of the world. If, however, the benefits of the factory to society exceed the costs to those living near it, it should be built, from the standpoint of economic efficiency. However -- and this is where your thoughts on avoiding coercion come in -- those living near the factory should be compensated out of the benefits of the factory. The people near the factory are then paid more than the pollution troubles them, the consumers of the factory product get something worth more to them than the price they paid for it, and the operators of the factory get a surplus for putting the whole deal together. Wealth is created, and all are better off.

Unfortunately, it is usually hard to properly pay off the scattered neighbors with their varying tolerances for the pollution. The factory does not get built. The world does not get the benefits the factory would produce. The market has failed.

Note that if just one of the neighbors can put no price on the pollution she would tolerate -- even millions of dollars won't satisfy her -- we are back to your coercion issue. By being a prior user of her resources but not having a price, her resistance outweighs all other considerations.

This is where the wealth maximizers and the rights defenders hit the mat.

Rick Barton | December 14, 2004, 6:22pm | #

Tim Higgins:

A classic example is industrial pollution - say a bunch of smokestacks move in next door. Without regulation, how will I be compensated for the cost of the pollution that the smokestacks are imposing on me?

Sue for violation of your property, including your person if applicable.

Jadagul | December 14, 2004, 7:16pm | #

The problem with suing for restitution in pollution cases lies in distributed costs. I may be able to sue the factory that sits right next to me and dumps toxic waste in my backyard. In that case the government isn't really necessary. On the other hand, suppose a million factories each do between five and thirty cents of damage to me. Is suing really a viable option?

I think that, in general, market failures can be treated as failures of the property rights system--that is, either failures to appropriately allocate property rights, or inabilities to enforce property rights people have. The problem with pollution is either that my right not to have my air quality damaged is unrecognized, or, more pertinently to America's case, that it's simply difficult or impossible to protect my property rights to clean air (how do I sue a million people for ten cents each? How do I prove that factory A did five cents of damage and factory B did fifteen? How do I prove which factories were involved at all? Since my interests aren't harmed until the level of pollution passes a certain point, do all factories polluting my air have to pay up? Do we only count a certain portion of each factory's pollution? Do the first factories to start polluting get a free pass, and we only dock the ones that pushed the pollutant level over the point where it's harmful?). In an ideal world, all these problems would be solved by negotiations between the polluter and the pollutee. In real life, logistics makes that difficult.

Similarly, public goods failures occur either when I don't have the rights to all the benefits of my action, or those rights can't be enforced. Roads are a public good because of the logistical problems, some of which are currently being solved, involved in charging everybody who uses a road without irritating the hell out of them. IP is another good example...the purpose of copyright and patent law is to give artists and inventors a property right in the ability to reproduce their art and inventions. But, as Kazaa illustrated rather effectively, the internet makes those rights much harder to enforce now than previously.

Interestingly, as Ronald Coase argued in "The Problems of Social Cost," less important--at least from an efficiency perspective--than who gets the property rights is the fact that the property rights have a clear owner and that negotiation is cheap and easy. If I have a right not to be polluted, factories can pay for the right to pollute. If the factories have the right to pollute, I can pay not to be polluted. One of these approaches, I believe, is much better from a moral and rights perspective, but both are similarly efficient economically--either way, if it's worth more to me not to be polluted than it is to the factory to pollute, the pollution won't occur. The difference is a moral and fairness issue.

As to how to deal with pollution...I don't really tend to trust the government (probably not a controversial statement). On some level it has to be involved, if nothing else to guarantee the property rights however they're allocated. But I'd like to see minimal involvement, if possible. One idea I've been playing around with is to take a cue from the music industry. Even before digital file sharing, composers' rights were hard to enforce: how do you keep track of every person who performs your song? The solution was the RIAA, which performed the job of keeping track of all songs performed, charging all artists, and giving all the composers their royalties. It seems like a similar model may work for distributed pollution...something to think about, anyway. There are inefficiencies there, but probably no more than there would be with government action.

Rick Barton | December 14, 2004, 9:52pm | #

Jadagul,

The scenario that you lay out, with many infringers would also likely be one of many infringed. So, market demand for less pollution would develop. It could manifest itself in the form of PR considerations on the part of the infringers as well. This process could have played a role in the dramatic reduction in pollution levels in the US.

Jadagul | December 14, 2004, 10:31pm | #

Maybe I'm a bit too cynical (though I've never yet found any amount of cynicism that failed to be matched by reality), but I highly doubt that a PR campaign makes much sense. There would be, of course, a demand for less pollution; but polluters (I think we can agree) don't pollute just because they feel like it, but because it's cheaper to do things that way. So it's not a choice between a good made by a polluter and a good made by a non-polluter, but a choice between a good made by a polluter and a significantly more expensive good made by a non-polluter. Here we have the same problem of concentrated benefits and distributed costs that forced the formation of private property in the first place: it's to everyone's benefit (in many cases) if no one buys from the polluter, but it's in my benefit to buy from the polluter. Just like in the tragedy of the commons example it's in everyone's interest that no one overgraze, but it's in each individual's interest to overgraze. In the classic commons example the solution is to create individual private property rights over the commons; the same solution has to apply to pollution.

The third-world-sweatshops affair is a good example of why/how Rick's strategy wouldn't work. Activists pitch fits about the conditions of workers in sweatshops--at my college we just had a meeting about knowing where your t-shirt comes from, and all the students got fliers about various fair-trade stores we can buy stuff from. There is a fair amount of consumer demand for not-having-kids-work-in-sweatshops. But as far as I know, this hasn't resulted in a significant increase in the amount of not-having-kids-work-in-sweatshops supplied. Of course, there's the occasional uproar where someone (Kathie Lee Gifford?) gets nailed in the press, and I assume in a system of no accountability for pollution, the occasional egregious offender would be punished in the press. But for the most part companies would go on dumping toxic waste all over the place, because it's just cheaper that way.

On a more...moral...level, my right not to have people dump crap all over my yard isn't something I should have to pay for. It's my yard, goddamnit. I think that's something most of us should be able to agree on. The fact that a million different people are each dumping a little bit of crap on my lawn doesn't change the essential character of the act, only the difficulty involved in fixing the problem.

it's too late | December 15, 2004, 3:23am | #

Not that any one is going to read this at this point, but what disappointed me about the critique of left liberterianism in this months issue was that it was a critique of some completely bizaren completely contradictory, and compleltely abstract version of left-liberterianism, and not a critique of, say, julian sanchez left-liberterianism.

Rick Barton | December 15, 2004, 3:44pm | #

I think that the evidence for the reality of the dynamic that I describe is the plummeting of pollution levels, not just automobile emissions, in the US. Amounts of pollution generated by manufactures fell both beyond and often before any regulatory mandates. Ron Bailey's books cover this.

Sure, increasing wealth makes this possible but still, although it might have been less costly to continue production at existing and higher levels of pollution emissions but the bottom line would have been adversely effected because of public concern. No doubt, not all competitors in a given sector decided to pollute less simultaneously, but when one led the way, others strove to keep up. There are many examples of this.