Monday, April 3, 2023

fielding questions on equilibrium and efficiency in Econ

Question: I asked about equilibrium because I was wondering if there's a theory of market equilibria and if a free market would be optimal in a mathematical sense. Free markets are blamed for bank failures, etc. But would free markets be better for reducing poverty (as opposed to leading to concentration of wealth and power), or efficiency (avoiding what you blame government for: cronyism, lack of innovation, etc)--are these subject to mathematical modeling?

  • OK, thanks for re-engaging in what is a really interesting question/discussion. (When you said "equilibria", I thought you were referring to "market processes"-- how markets work and the tendency of mkts to move toward equilibrium. The popular/famous D&S graphs are a useful/powerful way to depict this in a reductionistic manner. But it looks like you were going a different direction with your question.)
    Yes, these things (and many more in Econ) are subjected to mathematical modeling-- for better/worse. The math in Econ theory can be quite heavy; having a Math undergrad was quite helpful to me and we don't recommend grad work without math up through Diff.Eq., Matrix Algebra, Stats, and Econometrics/Linear Regression.
    Often, the math is helpful; but often, it is misleading, distracting, etc. In Micro, we're trying to model human behavior within complex systems-- challenging. In Macro, they're trying to model human behavior and complex systems-- good luck. One of the inferences from Austrian Economics (and what's called the knowledge problem) is that efforts to reduce the economy to equations is somewhere between ridiculous and not worth it overall. (I share sympathies with this but see it as a baby/bathwater thing and don't think we should avoid it entirely.)
    Since the 1960s and 1970s, Econ has become much more mathematical-- and often, much less "economic", with economists ironically/perversely understanding less and less econ. (With the specialization of subfields in Econ, an "applied micro" like me is likely to have wide knowledge, but a Micro theory or Macro may not know much outside of their sub-field. I suspect that the math ability leads to hubris in many folks, leading them to talk too much outside their field.) So, generally: publishing in the top-tier journals is impossible without a ton of math and sophisticated empirical models. And one can be successful in the field with little or no understanding of markets, economics, etc. When we were in grad school, a student with a PhD in Physics and no background in Econ joined us and was so good at the math, that he had more refereed journal articles in grad school than I will have in my career (and I'm probably in the Top 10-20%)-- without knowing any econ.
  • Eric Schansberg
    A smaller, separate comment on "mkt failure" in general. This is a specific term in Econ and likely not how you're using it. "Mkt failure" is when the mkt takes us to outcomes that are *inefficient*. (There are other criteria by which one might be *dissatisfied* with mkt outcomes: "equity" [fairness concerns about process and/or outcomes] and "paternalism" [questioning people's decision-making ability AND wanting to use govt to remedy it].) There are five areas where mkts can be inefficient: "public goods" (again, jargon: "nonexcludable/nonrival" and the "free rider problem"; e.g., asteroid abatement); "externalities" (e.g., pollution, vaccines); asymmetric information; natural monopoly power; and macro business cycles.
    "Failure" is no longer seen as the best word, since
    a.) the level of inefficiency can vary where a 0/1 category is misleading (e.g., the difference between the externalities of pollution and me not cutting my grass often enough);
    b.) mkts tend to "struggle" in these areas, but often don't have much trouble and find workarounds (broadcast radio is a pure public good, but mkts handle it well);
    c.) failure implies....well, failure-- and so, it begs for govt intervention, which itself "fails" (or really, struggles) to do better. So, the question is whether govt will actually do better in practice vs. naive theories.
    Hopefully, you can see how Econ interacts with my Libertarianism. As a Libertarian, I'm ethically bothered by much govt activism, finding little room for using the force of govt to intervene in terms of equity or paternalism. But as a Libertarian and an economist, I find some role for govt on efficiency grounds, but (quite) worried (given theory and data) about how well they will do this in practice.
  • Finally, a few thoughts on "bank failures" as an example.
  • Finally, a few thoughts on bank failures: 
  • 1.) These are not "market failures" in the sense defined above. Businesses open and close all the time; this is largely a feature of markets rather than a failure. In competition, if firms do a poor job or demand decreases, then resources move elsewhere, resulting in massive losses for owners (and modest losses for those connected to them). Likewise, technological advances can stir markets in various ways that can lead to firms closing. If you don't think this is a feature, imagine a world where businesses can't close and the consequences of the resulting monopoly power. (Well, actually, you can do that by thinking about various govt-sponsored or govt-run monopolies!)
    2.) Most activity in an economy is regulated, but some (much) more than others. As regulation increases, one has to increasingly talk about "govt failure/struggle" and decreasingly blame mkts for outcomes. Key examples: the amazing levels of govt intervention in health care/insurance and the Great Depression imply that mkts generally get far too much blame and govt gets far too little blame in these contexts.
    3.) Because the govt intervenes so heavily in banking, it has to bear some/much responsibility for outcomes we don't like. Many times, it's straightforward-- e.g., govt's bank regulators failed to regulate well. Many times, it's more complex and subject to trade-offs-- e.g., the short-term and long-term implications of "Too Big to Fail". Even the expansion of FDIC insurance for deposits is a mixed bag: good news for depositors and more trust in "the system", but less concern and therefore less mkt regulation by investors and especially depositors about the quality of their bank.
  • Eric Schansberg
    One more thing: "avoiding what you blame government for: cronyism..." I'm not sure why this misperception continues, but let me try again. Cronyism requires a demand (by labor unions and certain businesses & non-profits) and a supply (by bureaucrats and politicians). If you don't like a market outcome, you "blame" demand and supply. (No demand = no cronyism; no supply = no cronyism.) But it does starts with demand. (If you don't like Taylor Swift, the underlying problem is the preferences of TS fans.) But I do have a big problem with cronies who pretend that they're not cronies and are self-righteous about it to boot (as are many in govt and their partisans).


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