Necessary but not Sufficient

In my latest article for Libertarianism.org, I argue that the existence of a “market failure” is a necessary but not sufficient condition for government intervention in the economy.  A slice:

As with all economic questions, the answer is “compared to what?” Externalities, compared on an idealized hypothetical world where all information is known and transactions are costless, appear easy to solve via government regulation. However, when we compare a world of externalities to the real world, where costs and benefits are subjective and ultimately judgement calls must be made by analysts, we see that externalities are necessary but not sufficient justification for government intervention.

 

The Metric Fallacy

We often hear some proclamation, usually in support of subsidizing some activity, that some activity is desirable because it leads to success (for example: “Education is an investment in the future”).  But this is what I will henceforth call the “Metric Fallacy,” which is a specific form of the “ad hoc ergo propter hoc” fallacy.

The fallacy goes like this:

Some desirable outcome, X, is highly correlated with broad category Y.

Therefore, to achieve X, one should increase Y.

The first statement is true (X and Y are correlated).  The second statement, however, is fallacious.  A practical example will help:

It is true that higher education is correlated with higher levels of income.  According to the College Board, a person with even just some college education earns approximately 13% more than someone with just a high school degree.  Higher levels of education are correlated with higher levels of income.

But it is fallacious to, therefore, say that education itself is the cause here.  We need far more information.  The type of education matters a whole lot more.  A person in theology earns considerably less than a person in chemical engineering.  Ceteris paribus, a doctoral degree in a STEM field will earn a lot more than a doctoral degree in religion.

Thus, the Metric Fallacy is: to increase income, we need to increase education.

We see the Metric Fallacy all over the place and in high-ranking areas (Education and Economic Growth Theory and subsequently foreign investment, just to name a few).  Many government policies are based off this fallacy, including minimum wage, subsidized college loans, foreign aid plans that involve capital donations, and the like.  Indeed, probably the greatest lie I heard as a child was “if you want a good job, you have to go to college.”

My colleague and professor Chris Coyne writes a lot about this in his excellent book “Doing Bad by Doing Good,” and it is the main thesis of Bill Easterly’s book “The Tyranny of Experts.”

The other day, I wrote about discovering prices vs imposing prices.  Discovering prices means that we see what prices emerge from the price system, people acting in response to relative scarcity.  When prices emerge, they provide information.  A person in a profession who earns a high salary means there is a relative scarcity of that profession.  He is indeed made better off by this, but it also signals that we need more of that profession.  Prices allow us to discover this information.  But it is a fallacy to conclude that his higher wage is in some way desirable for anything other than this purpose (eg, the protectionist who might argue if he is made “worse” off because of competition, we all are made worse off).

Costs and Benefits are Culturally Dependent

futurama culture

The above screenshot is taken from Futurama.  Lrrr and his wife, Ndnd, rulers of the planet Omicron Persei 8, are aliens from a warlike race.  Violence permeates their culture.  While Lrrr himself is not particularly warlike (he half-heartedly invades Earth in one episode just to stop his wife from nagging him), the culture still is ingrained in him and much of his confusion regarding Earth is why it is not more warlike (another quote I could have chosen is when he is watching an episode of the in-show spoof of Ally McBeal called Jenny McNeil, he asks “if McNeil wants to be taken seriously, why does she not simply tear the judge’s head off?”).

Lrrr’s confusion stems from the two different cultures of Earth and Omicron Persei 8.  What is “foolish” behavior for him is normal behavior for the people of “ancient” Earth (Futurama takes place in the opening decades of the 3,000’s, so “ancient Earth” to him is the 90’s and 2000’s for us).  For Lrrr, there is a benefit to demonstrating strength before (or to) friends.  For the people of Earth, it is a cost.

This simple fact makes the job of the economist difficult when it comes to regulation.  The typical Econ 101 story for regulation is to do a cost-benefit analysis and, if the costs are less than the benefits, then regulation may be justified.  But this seemingly straightforward process is, as we can see above, actually quite complex.  What counts as a cost and benefit, as well as the relative values of those costs and benefits, are subjective.  It depends on the person observing the situation.  For us, Ross’ behavior is normal and praiseworthy.  For Lrrr, the exact same behavior is confusing and foolish.  And Earth observer might propose a regulation that rewards people who act like Ross.  And Omicron Persei 8 observer might propose legislation that punishes people who act like Ross.

Ultimately, the determination of regulatory behavior comes down to the subjectivity of the observer.  What this means is “optimal” regulation (such as a tariff, tax, wage, etc), while possible in theory, is practically impossible.  What may be an optimal tax for one observer may be too high/low for another and may be a subsidy for a third.

This subjectivity is why I adhere to a status quo bias and a presumption of liberty.  Legislative and legal changes should not be done casually, and even with great thought and analysis, should be undertaken only very carefully.

Today’s Quote of the Day…

…comes from pages 86-87 of Bruno Leoni’s 1961 work Freedom and the Law (3rd Edition, emphasis added):

Common citizens were the real actors in this respect [the formation of common law], just as they still are the real actors in the formation of the language and, at least partially, in economic transactions in the countries of the West.  The grammarians who epitomize the rules of a language or the statisticians who make records of prices or of quantities of goods exchanged in the market of a country could better be described as simple spectators of what is happening around them than as rulers of their fellow citizens as far as language or the economy is concerned.

JMM: The economist as a scientist is one who observes, records, and explains phenomena.  Our models and metrics work best when they are describing these outcomes.  To use them to be prescriptive fundamentally changes the nature of the being.  For example, to try to manipulate the price system to get higher wages (eg, a minimum wage) causes distortions: less labor is purchased, overall wages may drop, etc.  Tariffs, as a means to produce more profit for firms, lead to overall poverty.  It’s easy to boost some metric merely by monkeying about with its components.  But do not fall into the mistake of thinking that now higher metric is comparable to the metric one observed before.  GDP manipulated is not the same as GDP arisen from market transactions even though they superficially look the same.

The good economist, like the good jurist or the good grammarian or the good scientist, observes the world.  He does not try to impose his own viewpoints onto the data.  He is a discoverer of economic relations (or legal relations or grammatical relations etc), not a creator of one.

Somewhere along the line, this simple fact was lost.  Economists are all about “policy recommendations” now.  Optimal tariff this and carbon tax that.  They have ceased being economists and have become applied mathematicians.  Likewise, judges, lawyers, and legislators have ceased trying to discover the law (that the law is) and have moved toward telling us what the law should be.  As such, they have ceased being judges, lawyers, and legislators and moved into being commanders of humanity.  What they do can no longer be called law; it is a farce wearing the guise of law.

Today’s Quote of the Day…

…is from page 15 of Bruno Leoni’s excellent 1961 work Freedom and the Law: (emphasis in original)


It seems to be unquestionable that we should, on this basis, reject the resort to legislation whenever it is used merely as a means of subjecting minorities in order to treat them as losers in the field. It seems also unquestionable that we should reject the legislative process whenever it is possible for the individuals involved to attain their objectives without depending upon the decision of a group and without actually constraining any other people to do what they would never do without constraint. Finally, it seems simply obvious that whenever any doubt arises about the advisability of the legislative process as compared with some other kind of process having for its object the determination of the rules of our behavior, the adoption of the legislative process ought to be the result of a very accurate assessment.

JMM: So often in the field of economic policymaking, little thought is given toward whether an action should be taken.  It’s trivially easy to come up with models that show, under certain circumstances, this or that policy can be enacted and it will resolve a market failure.  But little thought is given to whether these policy prescriptions are prudent.  There are no general maxims of economic policymaking that stand to guide actions; economists rarely discuss these matters deferring them to legislators, lawyers, or philosophers.  

But economists are in a unique position to advise precisely on those general maxims.  We built the models after all.  Our job is to explore the kinds of processes that lead to rules of our behavior, and they are more than just the legislative.  The economist who designs models without consideration to their prudence does a disservice to himself, his profession, and science as a whole.

Where’s Mine?

In my Econ 385 class on Tuesday (International Economic Policy), an excellent discussion on student loan debt came up.  One of my students asked the probing question: “Student debt is approaching $1.8 trillion.  Everyone seems to recognize this is a bubble.  Why is there so much resistance to student debt forgiveness?” 

I opened the discussion up to the class.  Lots of excellent, well-reasoned opinions were expressed.  Some argued that the schools have no incentives to keep their expenditures in check since the government is subsidizing the loans.  Some argued that the politicians do not bear the full costs of these loans, nor a default, so they have little incentive to address the issue.  Others noted that the banks would keep giving loans so long as they are backed by the government.  All of these are excellent points, which I’ll not rehash here (I wish I could take credit for teaching these students, but they were already smart before they came to my class).  

There is a larger issue I wanted to discuss, one which was not discussed in class (we were acting under the assumption, for the sake of the discussion, that forgiveness was the best option).  This issue is: who gets forgiven?

What is it about student loan debt that makes it worthy of being forgiven, but other forms of debt are not?  There’s credit card debt, housing debt, business debt, auto debt, etc.  All this debt can have the same effect as student loan debt.  True, student loan debt is larger than these other sources, but if that’s the case, that’s just an argument either for partial forgiveness, or for people to mount up other forms of debt.

If student loan debt is forgiven, the holders of the other forms of debt will wonder “why not me?  Where is mine?”  Indeed, recently a friend used exactly this line of reasoning when justifying tariffs for his own industry: “My competitors and suppliers get protection.  Why not me?”

This is the problem with most government handout programs.  Those that are designed to help a certain and arbitrary group can compel members of the out-group to seek their own rents.  If student loan debt is forgiven, business owners might lobby to have their debt forgiven (“I’m creating jobs!  if my debt is forgiven, then I can create more jobs!”).  Or automobile owners (“My car lets me get to my job!”).  Anyone could come up with various excuses.  

This rent seeking, of course, then results in wasted resources.  Resources that could have gone to productive uses are now trying to capture rents.  And there are other issues as well that I’ll not touch on here: the sanctity of contracts (will it become harder for people to get loans since the value of a loan contract will be reduced?), moral hazard problems (will former debtors seek even more debt since their previous amount was forgiven?).  These are all important issues to consider.

Expert Failure to Communicate

On Friday, Roger Koppl of Syracuse University presented his book Expert Failure at the Invisible Hand Seminar co-sponsored by George Mason University and the Institute for Humane Studies.  

The thrust of Dr. Koppl’s book is that, similar to market and government failure, experts can fail in their task as well.  Experts can give poor advice, he influenced by known or unknown biases, and react to incentives just like the rest of us.  An expert, for the purposes of this discussion, is anyone paid for their opinion (this is how Koppl defines expert in his book).

There is another aspect of expert failure which plays into the problem and that is a failure to communicate.*  Even if an expert does everything perfectly, if s/he cannot adequately communicate their message to the decision-maker, then expert failure can still result.  

This expert failure to communicate is a major issue in law & economics.  Economists are trained in statistics and empirical methods.  Lawyers and judges may not and juries almost certainly are not. In his 2009 textbook, Basic Concepts of Probability and Statistics in the Law, Columbia law professor Michael Finkelstein gives two examples were ambiguous wording by experts and misinterpretation of probabilities by juries led to false convictions (see pages 3-5).  These failures can lead to pro-prosecution bias in juries (or, alternatively, pro-defendant bias if other statistical fallacies are made).  In the two legal cases above, the convictions were overturned on appeal, but one has to worry about the error rate given the already confusing nature of statistical wording and hypothesis testing. 

In Expert Failure, Koppl discusses increased competition among experts as a means for solving expert failure.  A good expert can explain his argument in common-language and not necessarily hide behind jargon.  Competition between experts may indeed reduce this expert failure to communicate, but it ultimately rests on the head of the decision maker.  And indeed the more complicated a topic is, the more the reliance on expert opinion is needed, which increases the likelihood of expert failure to communicate.  

Ultimately, I think this all adds up to a rather strong presumption of liberty.  The more control experts have over our lives, the more likely it is for expert failure to occur.  Indeed, some of these highly complex functions, like contract issues or tort issues, may be best left to arbitrators rather than judges.  The more complex an issue is, the less one would want to centralize it.  

*Full disclosure: this point may come up in the book.  I have not read it, having ordered it shortly after the seminar