Category: Economics

Elizabeth Anderson and other commentators misunderstand Hayek and in the process they fail to understand the sense in which market outcomes may be said to be just (Tyler comments also).

Hayek argued that the concept of social or distributive justice was "empty and meaningless."  Anderson tries to use this argument, which she explains well, to suggest that any idea of libertarian or free market justice must also be empty and meaningless.  Hayek, however, did not argue against rules of just conduct, "those end-independent rules which serve the formation of a spontaneous order."  Among such rules may be Nozickian or Lockean rules of voluntary exchange.

It’s quite possible, for example, to be a good Hayekian and also to say that I deserve my income because it was acquired by just conduct, e.g. by production and trade.

True, it is an accidental fact that I live in a time and place where my skills are highly prized.  In this sense, I do not deserve my income (i.e. my income is in part a function of things beyond my control).  But I do deserve my income in the sense that it was acquired justly and to take justly acquired earnings may be an injustice.

Here is part of Anderson’s argument:

Let’s consider first Hayek’s claim that prices in free market capitalism do not give people what they morally deserve. Hayek’s deepest economic insight was that the basic function of free market prices is informational. Free market prices send signals to producers as to where their products are most in demand (and to consumers as to the opportunity costs of their options). They reflect the sum total of the inherently dispersed information about the supply and demand of millions of distinct individuals for each product. Free market prices give us our only access to this information, and then only in aggregate form. This is why centralized economic planning is doomed to failure: there is no way to collect individualized supply and demand information in a single mind or planning agency, to use as a basis for setting prices. Free markets alone can effectively respond to this information.

It’s a short step from this core insight about prices to their failure to track any coherent notion of moral desert. Claims of desert are essentially backward-looking. They aim to reward people for virtuous conduct that they undertook in the past. Free market prices are essentially forward-looking. Current prices send signals to producers as to where the demand is now, not where the demand was when individual producers decided on their production plans. Capitalism is an inherently dynamic economic system. It responds rapidly to changes in tastes, to new sources of supply, to new substitutes for old products. This is one of capitalism’s great virtues. But this responsiveness leads to volatile prices. Consequently, capitalism is constantly pulling the rug out from underneath even the most thoughtful, foresightful, and prudent production plans of individual agents. However virtuous they were, by whatever standard of virtue one can name, individuals cannot count on their virtue being rewarded in the free market. For the function of the market isn’t to reward people for past good behavior. It’s to direct them toward producing for current demand, regardless of what they did in the past.

Now, I am torn between "strict philosopher" and "common sense morality" views.  In the former, I am a metaphysical determinist who doesn’t think much of desert arguments — whether pro-market or not — in any context. 

But for purposes of argumentation, let’s put on the common sense hat.  I then think that most voluntary transactions — at least in democratic market economies — are in fact reasonably just.  The biggest problem is fraud — Enron and the like — and that cannot be blamed on Hayek.  The share price of Enron — when it counted as the seventh largest firm in terms of capitalization — was a Hayekian obscenity if judged as an information aggregator.  The problem was that prices were tricked by inflated earnings estimates and did not perform their Hayekian duties properly. 

Another fairness problem is that some people are born into terrible neighborhoods and face unfair odds in life.  But the information aggregation function of prices is again far from the leading culprit in those cases.  In fact price floors and ceilings usually make poverty worse and less fair.

The complex concept of merit encompasses many values.  One of those values — but not the only one — is how much other people are willing to pay for what you have to offer.  Let’s start with that as a workable concept, and modify it whenever deviations will serve the general welfare.  Nozick goes wrong in thinking that no other notion of merit can override a prescription for laissez-faire, but consenting acts between capitalist adults should serve as the proper default.  If I buy a wonderful stinky cheese for $10, barring fraud, most likely all is well in the moral universe in this case.

Now the critiques are well-known.  Marginal products are determined in a broader social and economic context, plus the distribution of wealth may be unfair.  But the American public comes close to having the correct view here.  On one hand, it is widely recognized that taxation to finance public goods, including some degree of social insurance, is morally legitimate.  At the same time, people are seen as deserving what they earn, again fraud aside.  We ought to think twice before treating earned incomes as a "social pie" purely up for grabs.

But those judgments are piecemeal rather than foundationalist.  Few people agree with Robert Nozick in treating property rights as absolute.  More generally, we cannot justify all distributions, prices, and incomes from some set of first principles.  Rather we start with what we have and go from there.  And then the $10 for the cheese does in fact represent justice.  Furthermore we can believe this while admitting that the child born in the South Bronx does not receive a fair shake.

Anderson also confuses the manner in which prices are forward-looking.  A measured price for a consummated transaction reflects supply and demand from the past.  To the extent that a person’s merit was reflected by what she can get others to pay, this is OK.  There is no contradiction between backward-looking and forward-looking perspectives.  It remains true that such prices will not reflect, say, the purity of a person’s heart.  But this point stands without worrying about time frames.  Anderson writes as if "information aggregation" is some independent, ex ante functional purpose which causes prices to move in morally undesirable directions.  In reality information aggregation is an ex post property of a competitive bidding process, it does not on its own drive prices away from some pre-existing benchmark of moral merit.

Some of Anderson’s statements are hard to parse:

"the function of the market isn’t to reward people for past good behavior. It’s to direct them toward producing for current demand, regardless of what they did in the past."

OK, but past rewards will have come from efficacious past behavior in satisfying consumer demands.

Anderson also argues that even a productive and meritorious person cannot insure adequately against all possible future disasters.  It is well-known that markets do not produce many kinds of long-term insurance and indeed this remains a puzzle.  But here a dose of more Hayek — not less – would seem to be in order. 

The bottom line: A coherent notion of moral merit includes more than just your ability to serve others through the marketplace.  So market returns won’t coincide with personal merit, even putting aside the dilemmas of determinism.  But voluntary transactions — in many settings — provide a rough but non-absolute starting point for what is fair.  And if we are looking for causes of unfairness, the Hayekian informational role of prices is simply not a major culprit. 

Stephen Moore writes:

The central idea behind the Freedom to Choose Flat Tax is to create an optional post card flat tax, which would be offered to tax filers as an alternative to — rather than a replacement of — the current tax code.  There would be no deductions whatsoever, except for a generous personal deduction and child deduction.

The flat rate would, of course, be somewhat higher.  Might many people prefer to pay a little more to avoid the hassles of the current system?

I can think of some problems:

1. Many people might fill out two tax returns and pay the lower one, thereby raising tax filing costs.  That being said, the new and second return won’t take much time.

2. Let’s say everyone paid the higher flat rate.  How long will it stay flat for?  Won’t Congress auction off privileges and deductions as they have done in the past?  In the meantime our taxes have gone up, and in the long run we might return to tax complexity.  We are addressing symptoms rather than underlying causes of the problem.

3. The benefits of having a flat tax are often overrated.

Still, the idea has its virtues.  Transition costs would be low.  The relevant legislation would be relatively simple, and easy to explain to the public.  And it might lower tax filing costs significantly.

The quotation is from The Wall Street Journal Op-Ed page, 27 January 2005.  Here is more information.

How about monkeys buying monkey porn?

Bill Gates and Warren Buffett are short the dollar.

“I’m short the dollar,” Gates, chairman of Microsoft Corp., told
Charlie Rose in an interview late yesterday at the World Economic
Forum in Davos, Switzerland. “The ol’ dollar, it’s gonna go down.”

Gates’s concern that widening U.S. budget and trade deficits are
undermining the dollar was echoed in Davos by policymakers including
European Central Bank President Jean-Claude Trichet and German
Chancellor Gerhard Schroeder.

The dollar fell 21 percent against a basket of six major currencies
from the start of 2002 to the end of last year. The trade deficit
swelled to a record $609.3 billion last year and total U.S.
government debt rose 8.7 percent to $7.62 trillion in the past 12
months.

“It is a bit scary,” Gates said. “We’re in uncharted territory
when the world’s reserve currency has so much outstanding debt.’…

Gates reflected the views of his friend Warren Buffett, the
billionaire investor who has bet against the dollar since 2002.
Buffett said last week that the U.S. trade gap will probably further
weaken the currency.

“Unless we have a major change in trade policies, I don’t see how
the dollar avoids going down,” Buffett said in an interview with
CNBC Jan. 19.

Thanks to David Theroux for the pointer.

Black life expectancy is lower than white life expectancy.  On this basis, President Bush argues that social security is a worse deal for blacks than whites.  Paul Krugman says this is a lie but his primary counter-argument is shockingly weak:

Mr. Bush’s remarks on African-Americans perpetuate a crude misunderstanding about what life expectancy means. It’s true that the
current life expectancy for black males at birth is only 68.8 years –
but that doesn’t mean that a black man who has worked all his life can
expect to die after collecting only a few years’ worth of Social
Security benefits. Blacks’ low life expectancy is largely due to high
death rates in childhood and young adulthood. African-American men who
make it to age 65 can expect to live, and collect benefits, for an
additional 14.6 years – not that far short of the 16.6-year figure for
white men.

True, life expectancy at birth isn’t the right statistic but neither is life-expectancy at 65.  Consider the following simple example: suppose that 95 percent of blacks die before the age of 65 but that the 5% who survive to 65 have the same life expectancy as whites.  Krugman would then claim that social security isn’t discriminatory, but that would be absurd – 95 percent of blacks would be paying payroll taxes for all of their working lives and in return they would receive nothing.

As HedgeFundGuy points out a more relevant measure of life expectancy for social security is life expectancy at 20, when working-life begins, and at this age black life-expectancy is still a significant 6 years less than that of whites.

Life expectancy isn’t the only thing that affects social security redistribution, however, marriage rates, number of dependents, disability, income and even the time pattern of income matter also.  It may be that when all of these considerations are taken into account that on average social security is no worse a deal for blacks than for whites but this will be true only because social security is a hash of redistributionist tendencies few of which are well understood let alone well justified.

Addendum: See also Heritage’s rebuttal which makes a number of other good points especially the fact that lumping in the disability program with social security is not appropriate.  Although the programs are connected historically they can, are, and should be treated as independent for purposes of reform and analysis.

I am sometimes in environments with large numbers of attractive women. Other times I am in environments where attractive women are rare. In the former case, I do not become desensitized to all the hot young women, (or at least, only a little bit.) I still react differently to the different crowd. Male brains are programmed to react to certain signals of beauty. We are attracted to women who appear fertile…, and [anatomy is] part of that (although perhaps for foolish reasons, ie the equivalent of peacock tails). Having more of those signals does not make the signals meaningless. If what we are attracted to is fertility, then if everyone looks fertile we will be attracted to everyone.

…Is all beauty relative? Hell, no! A man in a crowd of 22 year-olds will do more ogling than a man in a crowd of 60-year olds, even if he is in those crowds long enough to adjust his beauty scale. He may become choosier about which 22-year olds he finds attractive, but he will still find a higher proportion of the women attractive.

Read more here, and yes it is safe for the workplace.

My question: When do we find that purely voluntary games are zero-sum?  If my neighbor resents my excellent music collection my gain still probably exceeds his loss.  Or if I compete more effectively for a spouse, my spouse gains; the net gain is usually positive even if other men lose out.

Since status is almost everywhere, virtually all marketplace transactions have both positive-sum and negative-sum elements.  But the average expected return on these games still has to exceed what is available from purely private pleasures, otherwise drop out from the game.  So few of these games create zero or negative value, all things considered.  Nor do we have a good idea which voluntary games should be taxed at the margin for a relative excess of negative-sum status competition.

Robert Shiller has a new edition of Irrational Exuberance coming out, this one will feature a chapter on real estate.  Shiller, of course, predicted the stock market collapse and now believes that we are near the peak of housing prices. He is also involved in establishing a futures market that would allow people to hedge against movements in housing prices (see also my post on The New Financial Order). Here is a short interview with him on these subjects.

I too think that housing prices are inflated.  It is certain that prices cannot continue to rise as they have in recent years and when interest rates increase, as they surely will as budget deficits continue to balloon and Asian central banks grow weary of taking losses on their portfolios, prices will fall both because of the rise in interest rates per se and because the increase will prick the bubble.  Yes, Tyler has outed me as well as Brad De Long and Brad Setser.

Jane Galt asks:

Why hasn’t labour successfully colonised the non-manufacturing world, outside of the public sector?

Read the comments to her post, but I see a few major hypotheses:

1. It is now easier to fire people who try to organize unions.  Remember Reagan and the air traffic controllers?

2. Marginal products are easier to measure and markets are more competitive than in times past.  This lowers the scope for unions as a means of increasing the bargaining power of labor.

3. Physical capital — especially in service sectors — is less fixed than in previous times.  If workers organize, the capital will move to another sector or nation.  In contrast an auto plant is hard to move out of Michigan.

4. Government regulations, and superior market institutions for risk-sharing, render unions less necessary.

5. In the service sector the distinction between "management" and "labor" is more blurred than in traditional manufacturing firms.  Yes you have lawyers and secretaries, but the class of manual laborers who spend their lives with a single firm is smaller than in times past.

It remains a puzzle to me why unions are so strong in Hollywood, suggestions are welcome, I have turned on the comments if you have any ideas on this.

The new Liberty Fund edition of Gordon Tullock’s The Organization of Inquiry is out:

In this book, Tullock focuses attention on the organization of science, raising important questions about scientific inquiry and specifically about the problems of science as a social system. Tullock poses such questions as: how do scientists engage in apparently cooperative contributions in the absence of hierarchic organization and why are scientific contributions worthy, for the most part, of the public’s trust?

If you are fed up with publication lags, Gordon had the answer for that one too, circa 1980:

"Professor Gordon Tullock referees submissions to Public Choice himself and usually has a response in the mail within 48 hours."

See also Brad DeLong’s appreciation of Gordon. And here is a list of forthcoming volumes in the series.

Traditional game theory assumes that individuals choose strategies.  Evolutionary game theory assumes that individuals are strategies.

Our colleague, Dan Houser, has just published an important new paper (co-authored with Robert Kurzban) that supports the assumption of evolutionary game theory. (The paper is also featured in the Economist.)  In a public goods game, Kurzban and Houser are able to identify three systematic strategies; cooperate, free ride and reciprocate (cooperate more when others do so).  The first surprising result of their paper is that these strategies can be tied to specific individuals.  Some individuals cooperate, others free ride and others reciprocate and the strategies that these individuals "choose" are stable.  (This doesn’t mean that individuals play strategies robotically regardless of context a better analogy may be to think of strategies like personalities – even a quiet person can yell sometimes.)

Strategy choice is so stable that Kurzban and Houser can create very cooperative groups simply by weeding out the free riders.  What is even more surprising, however, is that when individuals are randomly assigned to groups each strategy type earns about the same payoff.  Even though the strategies are very different, no strategy dominates the others in a randomly assigned group – this is exactly what one would predict if individuals are strategies in an evolutionary game. 

Kurzban and Houser’s paper raises a number of interesting questions.  First, if they can pick out free riders why can’t the group members do so – in which case the baseline set of strategies won’t be an ESS.  How much does it take to push people away from their natural strategies?  Is the proportion of the population that plays each strategy the same in different cultures?  And what do the proportions (13% co-operators, 20% free-riders and 63% reciprocators) tell us about conditions in the evolutionary era when such strategies first solidified?  I will take these up with Dan.

1. An independent Fed works because the American public fears inflation.  If anything, the data suggest that people are too afraid of inflation.  American voters do not have similar instincts about an independent investing trust.

2. It is harder to maintain political independence when large amounts of money are being allocated or invested.  Note that seigniorage is no longer a significant source of revenue; central bank performance has improved accordingly.

3. If we reform social security, it will lose its status as a "sacred cow."  This is not objectionable per se.  But it will make it harder to treat an independent investment board as a sacred cow.

4. It took long periods of experimentation and meddling to establish the independence of most central banks.  What is the learning process for these investment boards?

5. Most state pension funds (Calpers is one notable exception) are not big enough to influence corporations as the federal government could.  Furthermore state pension funds are much less visible than is social security.  That being said, state pension funds are starting to meddle.

6. What if Brad DeLong is right that the Bush Administration manages to politicize everything?  What if the Democrats learn the same?

A core question is why we don’t run our entire government by independent experts, insulated from political pressure.  The answer, in short, is twofold.  We both require some degree of accountability, plus our government (and yes I include voters under that designation, not just "evil politicians") cannot precommit to leaving things alone.  The Fed works because of a relatively high coincidence of interests in its topic areas, namely monetary policy and bank regulation.

When it comes to the investment board, the greatest danger is simply that voters will get upset if returns are low for a ten or fifteen-year period.  They will demand a change — any change — and I fear how this pressure will work its way through the political process. 

The bottom line: There is nonetheless a good chance that the independent panel idea could work.  Maybe a fifty percent chance.  But still I would not do it, as the downside is higher than the upside.

My general perspective is simple.  Social security will bring some form of big government, whether we like it or not.  Let us do our best to keep private capital markets free to outrace the size of that government.  I am confident that markets are up to the task, and afraid of tinkering with this basic fact about our world.