Compared to Heaven, Earth Looks Like Hell

Economists have many models that exist in highly stylized theoretical settings (this is just a fancy way of saying “perfect settings”).  When we compare real-world institutions and situations to these stylized models, the real world often looks awful in comparison.  There are externalities, corruption, misallocation, a general lack of equilibrium, asymmetric information, etc etc etc.  Thus the models compared to real life look ever more better.  It’s severely tempting to use the flaws of the real life outcomes to justify moving toward theoretical approaches (eg. using market failures to justify government intervention).

But, as was discussed the other day in the Alchian quote, alternative institutional arraignments have flaws, too.  To compare a flawed institution to an ideal alternative is what Harold Demsetz called the “Nirvana Fallacy” and can lead to mistaken conclusions.  We need to compare institutions using the same assumptions about each one.  For example,   market operations are subject to externalities because of information asymmetry among the participants?  Government intervention must also be subject to such information asymmetry.  Markets misallocate due to imperfect information its participants?  The same must be said for government operators in the market.  And so on.  This application of consistent assumptions when comparing alternative institutions is, ultimately, at the heart of economics in general and Public Choice Theory in particular.

It is also important to note these flaws as well as virtues of alternative institutions because the situation may change and warrant different approaches.  Take, for example, trade tariffs.  As a general rule, the lower the tariff the better (I will refrain from proving this at this time and we will proceed with the assumption it is true for the sake of discussion)*.  Let’s say that the current tariff on Good X is 25%.  The economist would argue for lower tariffs.  Now, let’s say that a new government comes in and declares that tariffs on Good X will rise to 35%.  The economist’s position will now change to maintain the current 25% tariff.  The situation has changed and the comparatively better option is to maintain the status quo.**  Compared to Heaven, Earth looks like Hell.  But compared to Hell, Earth looks like Heaven.

When looking at institutions and discussing institutional change, we need to compare like with like.  Comparing a market failure with a highly stylized government intervention is unfair (and, likewise, comparing highly stylized markets with government failure is also unfair).  The flaws in each must be recognized and honestly discussed.  The existence of flaws in any given institution is not a reason to abandon it.

*If you disagree with this assumption, it doesn’t change the discussion.  Simply reverse the signs of the discussion in the paragraph.

**Of course, this is not to say the economist won’t/shouldn’t advocate for even lower tariffs once the 25% is met.  We’re just looking at this one situation.

3 thoughts on “Compared to Heaven, Earth Looks Like Hell

  1. *If you disagree with this assumption, [ the lower the tariff the better] it doesn’t change the discussion. Simply reverse the signs of the discussion in the paragraph.

    Heh! Good one, Jon.

    Like

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