Thursday, March 8, 2007

#4 - Markets

Consider a word one hears often in discussions of economics and the economy – “the market”. Markets, meaning a physical place where sellers and buyers congregate and transact, have been around for millennia. Virtually every town of any consequence has had a market for livestock, grain, fresh produce, wool, whatever was produced or trafficked in the area. These are the kinds of markets Adam Smith had in mind in his Wealth of Nations.
As economic activity and economic thinking evolved, the word “market” has become applied to more abstract “products”. The first “stock market” started out beneath a tree in Amsterdam. Lloyds of London was originally a coffee house where those interested in buying and selling insurance contracts congregated. In some respects, these nascent markets resemble the boys playing football in the park I mentioned in an earlier blog (#3). People gathered at the tree or in the coffee shop because they were interested in what happened there and they also wanted to “play”. However, and like the boys, they were not strangers to each other; they lived within the same society, probably went to the same churches and schools, knew each other’s family background and friends etc. In addition, they understood the same technical language of joint stock companies or of insurance. And, as with the boys, it is easy to underestimate how important this social fabric is for their market to function smoothly.
A market needs more than just willing buyers and sellers. It needs a shared ethic, some kind of collective code of conduct. It needs a language to give precision and mutual understanding about what exactly is being bought and sold and what precisely are the terms of the transaction. The market needs a means to identify and qualify would-be participants, so that different trading parties know with some confidence whom they are negotiating with. Finally, and perhaps most tendentious, every market needs an effective enforcement mechanism, to demand respect for the code of conduct, to clarify and settle differences over terms and conditions, to require specific performance, to verify the bona-fides of the participants: in short, to keep the market running smoothly.
This is what a market economy is about – smoothly functioning, transparent and open markets, with sensible and reasonable regulations firmly and consistently imposed. But this is often not what we hear in the public dialogue. Under ideological banners of “Free Markets” and “Free Enterprise” we hear calls for what is really de-regulation, which is something rather different and deserves its own analysis.
As a concluding point, it seems worthwhile clarifying just what a market is supposed to do for the society, as distinct from what it does for its participants. One often hears that markets “allocate resources”. In fact, this is not correct. The function of a market is to “clear”, to bring supply and demand into harmony. When all the various markets of a society are “cleared” then the society itself (or at least its economic aspects) are “in equilibrium”. Whether or not this “equilibrium” is also the “most efficient allocation of resources” is, like de-regulation, also another question deserving its own examination.

Tuesday, March 6, 2007

#3 - Social Consensus as a Precondition for Economic Activity

When I was a boy, I often went to the park to play “sand-lot” football. Soon after school had restarted and the Fall season settled into its rythm, a number of us kids would gather after school on a big grassy field in a nearby park and play football. About fifteen to twenty boys aged roughly eight to twelve; only boys, never girls! Weather permitting (never something assumed lightly in Seattle), we would gather about 4 o’clock and play till dark or dinner time, which ever came first.
There were no grown-ups around to be "in charge”. The “field” was simply an open grassy part of the park, no lines or markers, no “permission” to be sought or granted. There were no regular “teams”. The sidelines and goal lines would be marked out with strategically place jackets or sweaters or bikes. Since there were no goal posts, we simply did away with field goals. We didn’t even have referees. Any one who wanted to just came; the sides were made up of whoever showed; and everybody played.
There were, of course, a full measure of bruises and bloody noses; but nobody ever got really hurt. There were also occasional scuffles and even sometimes real fights, with blows. But only between two; and if the combatants themselves didn’t cool down after the first furious exchange, then the others would pull them apart, and we would all get on with the game. And we all had a great time.
How to explain such a Normal Rockwell scene? The observer of libertarian or free-market bent might say, “See! Get government out of the way and things work themselves out.” A more dirigiste observer might say, “Just imagine how much better we could make it by getting the boys a proper field, nice uniforms, organizing teams and practice sesseions , etc.” Each would be wrong; and not only because they miss our basic objective, to have fun by playing football, not to play football and hopefully have fun. Playing football was the only activity, but not the only objective, not the only benefit. They would also be wrong because each seriously underappreciates HOW we kids were able to have fun and play football.
We shared quite a lot in common besides a love of football. We knew each other. We lived in the same neighborhood. Some went to the Catholic school; some went to the public school. We all lived within a few minute’s walk or short bike ride of the park. Family incomes certainly differed, probably significantly, but nobody was crushingly poor or flagrantly rich. Many of us knew each other’s families, where he lived, his brothers and sisters, what his father did. We also shared attitudes and assumptions about things like fair play, unacceptable or inappropriate conduct, minimum standards of mutual respect. And, of course, each of us understood that you can’t play football alone. It is more fun for me when every one enjoys the game; if other kids don’t also have fun, they will stop coming; and then it will stop being fun for me as well. In short, we certainly all liked to play football, but we also shared a general consensus about what kind of conduct was acceptable and what was not.
That social consensus formed a sort of base platform for the football. It was never articulated or discussed or even thought about. It was simply there. But because it was there, we were able to enjoy those autum afternoons in the park.
I think there is a similar kind of social platform necessary for economic activity. It takes place within, and in a sense “upon”, an underlying social consensus. Large portions of this consensus are outside what we usually think of as “economics”, both the activity as well as the science. And so, as disciplined “experts”, we put them outside our “terms of reference”.
This practice leads to several pitfalls. First, we drift into talking about “the economy” as though it were a sort of insulated domain, with its own separate dynamics largely independent of other forces within the society. Then we start counting and measuring economic variables without much regard to other things, rather like an army not counting “collateral damage” among civilians as casualties. But the real damage starts when we start intervening and proposing with our eye on the “economic” indicators but not also on these other “extraneous” dimensions. And we are soon deep in the Sorcerer’s Apprentice problem.

Sunday, March 4, 2007

#2 - Positive Economics – a Sorcerer’s Apprentice

Economics is concerned with the production and distribution of goods and services within a society, that is, with the material dimension of society as distinct from its cultural or religious or aesthetic or political or other dimension. An easily overlooked part of this definition is the “as distinct from”. This is very different from “as separate from”. Economics looks at life; and life is whole, fluid, dynamic, fragile. But life is bigger than theory - any theory, indeed all theory. No scientific discipline, nor even all of them combined, can grasp life fully. Yet each can provide some insights from its specific optic.
This presents us with a rather serious problem. The “expert” in our world plays a prominent role. By definition, an expert is someone who knows the cannon of theory in whatever field he or she is “expert” – an economist economics, a sociologist sociology, a lawyer the law, a doctor medicine, etc. etc. etc. Once a “problem” is identified, we like to isolate it, call in the appropriate “expert’, and say, “Fix it.”
Warning, however! Experts are people too. We can hardly them to be immune to the temptations of self-interest and self-aggrandizement. This plus the fact that any real life problem has dimensions beyond the particular cluster of concepts and theories any expert can muster to address it, and we can easily find ourselves with a Sorcerer’s Apprentice situation. The expert tinkers with things only partially understood at best, and may easily destabilize an equilibrium of forces entirely outside his or her understanding or even perception. But you and I – We the People – get left with the consequences.
I find this problem acute in contemporary economics. The rigorous focus on observable economic phenomena, an obsession for quantification and measurement, and an inclination to prefer mathematics as the language of choice for expressing and debating concepts: these propensities have undoubtedly brought much clarity onto economic activity that had hitherto been only sensed intuitively.
There has, however, been a cost. Economic debate, especially discussions on issues of public policy, has drifted either into arcane exchanges between “experts” or the preaching of simplistic platitudes by those with specific agendas. Meanwhile the economic aspects of our lives, about which We the People are expected to make sensible concrete decisions, have become increasingly complex and intertwined both within themselves and with respect to other aspects.
Economics is supposed to provide useful conceptual tools for improving real life, not just “economic life”. If crime is high, if literacy is declining, if domestic violence is endemic, ... these issues have economic dimensions on both the cause side and the effect side, even though economics may not be the principal discipline for understanding them. Similarly, a comparative analysis of labor markets which looks only at employment statistics and turns a blind eye to these other indicators of a society’s health is necessarily seriously flawed. When it comes to real life situations, the ceteris paribus axiom (“all other things being equal”) of which positive economics is so fond, is not simply inappropriate (because it is not true, other things are never the same); it is dangerous. It leads to policy prescriptions which are quite likely NOT to achieve their objectives and also have unintended and unforeseen side effects
Economists have a lot of normative work to do on their own cannon, and some humble pie to eat with respect to other social sciences.

Friday, March 2, 2007

#1 - Why consider normative economics?

Economics sets out to describe the economic aspects of the real world. That is, economic theory is supposed to provide a coherent, usable and more or less complete package of conceptual tools for analyzing, understanding, explaining, and especially for improving the world in which we live – well, the economic aspects at least.
Does it succeed? Personally, I think there is room for improvement. Economic theory could be significantly more user friendly, and thereby more useful. Part of the reason for this current situation is a traditional distinction within the profession between so-called positive and normative economics. At the very beginning of his or her studies, the would-be economist is trained to make a sharp distinction between what “is’ and what he or she or others may think what “ought to be”. Statements about what “is” can be tested empirically, and their rightness or wrongness can be objectively determined. They are “positive” statements. On the other hand, statements about what “ought to be” are by their nature not empirically verifiable; they are value judgments; they are normative. The “science” part of economics, therefore, is taken to lie in the positive domain, since only what can be empirically verified (or unambiguously refuted) can be “true”. Thus, only positive economics is really “scientific”.
I think this distinction has been overplayed, to the detriment of both the profession and its potential users. Verification through quantification is not the only path to truth, nor are personal judgments beyond improvement through honest discussion, nor are intrinsic values inappropriate for collective analysis. In short, the economic tool kit will be both more relevant and more useable if normative analysis is also added in.
Hence this blog site. In a more or less logical manner I will offer views on several distinct but still related aspects of contemporary economics. First is a series of “corrections”, or nuancing of positive economic principles, with a view to enhancing and enriching their real world applicability. The second are some normative economic principles needed, I think, to complement the arsenal of currently available concepts and tools of positive economics.
Warning: this is not a site for the profession, although other economists are most certainly welcome. This site might be called, with a tip of the hat to George Bernard Shaw, “the intelligent person’s guide to useful economics”. The focus is utility; the target is the non-professional; the standard is, albeit often abstract, sensibleness and relevance and practicabillity. Good economics should be useful to ordinary people making real decisions.