The gut instinct…is to apply a simple supply-demand framework to the question at hand. In this world, every tax has an economic deadweight loss, every restriction on individual behavior reduces the size of the economic pie, distribution and efficiency can be neatly separated, market failures are presumed non-existent unless proved otherwise (and to be addressed only by the appropriate Pigovian tax or subsidy), people are rational and forward-looking to the first order of approximation, demand curves always slope down (and supply curves up), and general-equilibrium interactions do not overturn partial-equilibrium logic.  The First Fundamental Theorem of Welfare Economics is proof that unfettered markets work best.  No matter how technical, complex, and full of surprises these economists’ own research might be, their take on the issues of the day are driven by a straightforward, almost knee-jerk logic.

The second group — "second best" economists — is Akerlof, Stiglitz, Shiller, Krugman, and Rodrik himself; I believe you know their approach.

I think of myself as a better-than-first-best economist.  On average market solutions have positive Pareto-relevant externalities, if only through supplying experimentation and strengthening social norms in favor of commerce.  That’s true even for the market in thumbtacks, if you consider it as feeding into a broader social stream.  Externalities are virtually everywhere and often I prefer to think in terms of Hayek’s theory of spontaneous order.  Where markets should be allowed to operate, markets are usually too weak in their reach and scope.  Yes there is a continuum of social returns but only rarely are we close to an optimum. 

But I don’t mean this as a plea for laissez-faire.  Governments must produce public goods, maintain social order, and of course support markets.  At the margin, those activities, such as imposing accountability under the law, are also largely underprovided.  For the appropriate selection of policies, government is also better-than-first-best, despite its apparent static inefficiencies.

An oversimplified version of my view is that anything good is underprovided at the margin.  This follows from a belief in strong network and peer effects, and a belief in the relevance of basic sociology.

I favor much less government than Akerlof or Stiglitz or Rodrik himself; yes I view them as "second best" when it comes to government just as they are second best when it comes to markets.  But I’m often 4th or 5th best when it comes to what government does.

Who’s really the utopian?  And how did government ever work itself up to that number two?

1. Random number generators

2. Do you need a pre-arranged ring on your cell phone?

3. A vasectomy for an iPhone?

4. Matt writes in:

There are companies that register domain names for you,  companies that register domains and then sell them to you, and now companies that come up with unregistered domain names that you can register: http://www.inventmydomain.com and http://www.pickydomains.com.

In a survey Robert Frank finds that people say they would rather live in a 3000 square foot home when their neighbors have 2,000-square-foot bungalows than live in a 4000 square foot home in a neighborhood of McMansions.  Greg Mankiw asks:

Do people really behave as reflected in this survey? I bet the 4,000 square foot
house surrounded by McMansions would sell for more than the 3,000 square foot house
surrounded by bungalows.

Let’s take it to the data.   I regressed the sales price of about 12,000 houses in Northern Virginia on a bunch of housing characteristics including number of bathrooms, bedrooms, levels, age of the house and so forth.  I also included the average sales price of homes in the same neighborhood.  The result?  Houses in neighborhoods with high average prices sell for more than similar houses in neighborhoods with lower average prices.  Thus the prima facie evidence is that the same house is worth more if it is surrounded by more expensive houses – the opposite of Frank’s hypothesis.

Now it could be that the high average price of other homes in the neighborhood is controlling for unobservables of "your" home so here is a more precise test.  I defined a variable (sqft-avgsqft) where sqft is the lot size of your house and avgsqft is the neighborhood average.  I then split this into a positive difference, when your house is bigger than your average neighbor’s house and a negative difference when it is smaller.  Bigger houses ought to sell for more everywhere but if Frank is right then square footage is more valuable when other people’s square footage is low (lording it over your neighbors).  Similarly, if Frank is right people should be especially averse to living in small houses in big neighborhoods thus a negative difference should result in much lower prices.

Below you can find the relevant part of the regression.  The bottom line is that houses with bigger lots sell for more (the positive coefficient on lotsqft) but the increase in price is less when your lot size is bigger than the average lot size.  In other words, people do not want to own the biggest house in the neighborhood.

What about when your house is smaller than average?  Here there is no penalty.  Contra Frank, people do not mind having a small house in a neighborhood of McMansions.

Although the data are inconsistent with Frank’s argument that the rich make the middle class worse off they are consistent with an alternative status effect in which people dislike lording it over their neighbors or in an alternative interpretation, the poor make the rich worse off.