Coordination Problem

Sachs is at it again

Jeffrey Sachs, author of The End of Poverty, has obtained rock-star status for an economist.  This a status he achieved before he was 30 and it has continued.  In 1989, I saw hims speak to a packed house at the Detroit Economic Club where he was introduced as the most important economist since John Maynard Keynes and he did not blink at such a descriptions and in fact accepted such accolades in stride without even a  hint of self-deprecating humor.  But unlike Keynes or Milton Friedman, Sachs's status did not coincide with rising professional status as an economic scientist.  Rather, his case is more like John Kenneth Galbraith's --- the wider his appeal to the intellectual class the less he is viewed as a serious contributor to the debates within economic science.  In short, professional economists don't look to Jeffrey Sachs to understand why some nations are rich and others are poor.  This is not to say he did not have an influence in the professional conversation.

His work on free trade as a proxy measure for commitment to liberal economic policies and in turn the positive impact on economic growth --- published in the Brookings Papers in the mid-1990s --- did communicate to economists and policy makers in a simple and very clear way how important liberal economic policy was for economic growth.  However, almost as soon as he wrote that study, he started to switch gears and argue that the real determinant of the wealth and poverty of nations was geographic location.  In fact, some countries are so geographically disadvantaged that liberal policies are not effective and only massive amounts of government intervention from afar can fix the problem.  It is at this point that Sachs moves from economists as savior, to a global intellectual coordinating rock stars (Bono), movie stars (Sharon Stone) and politicians (Tony Blair) to address the interventionist plans to solve the problems of health and human services in Africa and elsewhere.

As a public policy economist, Sachs has moved from a mild New Keynesian, to Monetarist fighter against inflation, to advocate of shock therapy, to creator of 'Big Plans' to right the wrongs in the world and solve world poverty once and for all.  He refuses to admit the merit in any of his opponents argument (on each and every instance) yet his position has moved around.  He often is viewed as an advocate of the free market, but note that even in his most "shock therapy" days (as I pointed out in Why Perestrokia Failed) he wanted a market economy established so that the appropriate regulatory practices of the western social democratic states could be instituted in East and Central Europe.  Sachs in short is the quintessential interventionist economist of his generation and along with Paul Krugman (who had more scientific cache in his youth, though by now he has discredited himself with his op-eds which are so divorced from rational economic discourse that it is hard to imagine him ever coming back to the realm of sound economic discourse concerning public policy!) has emerged as the darling of the slightly left of center intelligentsia.  From a scientific point of view, Sachs's relevance is less than what the public estimates, but from a policy point of view Sachs's dreams to end world poverty could influence a generation of policy makers and the idealistic youth.  Unfortunately, the unintended and undesirable consequence of Sachs's policy prescriptions will be the impoverishing of the millions he hopes to help by not addressing the underlying causes of poverty.  In order to address that one would need to recognize that increases in real income only result from increases in real productivity and that increases in real productivity result from improvements in human capital, improvements in technology, and improvements in managerial capabilities.  And these in turn are most effectively brought to any society through the expansion and development of a market economy.

For a recent article on Sachs and his plans to fix world poverty continue reading

The Review of Austrian Economics - 19(1)

Be sure to check out the latest issue of The Review of Austrian Economics.

Highlights include Roger Garrison's 2004 Society for the Development of Austrian Economics Presidential Address, "From Keynes to Hayek: The marvel of thriving macroeconomics," and Michael Montgomery's, "Austrian persistence? Capital-based business cycle theory and the dynamics of investment spending."

The complete TOC can be viewed here.

Discounted subscription information available here.

James Buchanan the Great

Last week I attended the week-long seminar of Professor James Buchanan at The Center for the Study of Public Choice at George Mason University (see here). Buchanan does not teach on a regular basis anymore, but every year he still comes to give a week-long seminar where he freely discusses with the students his contributions to economic science. In addition to Buchanan, Geoffrey Brennan gave two lectures and participated in the debates. David Levy supervised the week and, along with Hartmut Kliemt, played a key role in the discussions. Gordon Tullock attended the second day. Pete Boettke showed up for the discussion on Afraid to Be Free.

In spite of his age—he is 87—James Buchanan is still intellectually alert and active. For a whole week, Buchanan discussed with us his life-long themes, as well as his most recent views and research. Buchanan is one of the few great classical liberals of the last 50 years. He has made seminal contributions to economic science. Spending a week discussing with this Southern gentleman was a true reward in itself.

As far as the discussions are concerned, Buchanan talked about constitutional political economy and the Wicksellian approach, his Nobel Prize, the influence of Hayek’s thought in his work, the survival of socialism (Afraid to Be Free), and his more recent work on increasing returns. Here are a few ideas that Buchanan mentioned during the seminar and that stuck with me:

Constitutional political economy teaches us that the rules of the game matter more to obtain socially desirable outcomes than the strategy the players may adopt within a given set of rules. Buchanan used the poker game analogy: if poker players agree on rules before dealing the cards, a different set of rules (and thereby outcomes) will be decided than if they agree on rules once they have the cards in their hands (and thus know where they stand and which rules would favor each of them separately but not all of them as a social group).

“I am an optimist if I look backward, and I am a pessimist if I look forward.” Buchanan here means that he has often been happily surprised by the way things turned out in the past. For instance in the 1970s, no one could have predicted then that in less than a decade, the UK, the US, and New Zealand, among others, would have started radical policy changes. However, as he looks into the future, he sees the decline of classical liberal ideas.

In the 19th century, socialism offered the State as an alternative to God (and the family). Classical liberalism was not able to offer a viable alternative to the socialist ideal. Economists are, in large part, responsible for this state of affairs. They were not able to convince the general population that capitalism, as the embodiment of the principles of classical liberalism, is the only system that delivers the goods (the league tables are important in this respect).

On the distinction between law and legislation (dear to Hayek), Buchanan believes that judges should be finding the law, not “making” it. The analogy Buchanan likes to use is that of tennis players on a clay court. After hours of play, the lines become harder  and harder to see. However, in spite of this, the judge must act as if the lines were still there, he can’t move them around; he must act as if the lines were truly visible.

Buchanan sees himself neither as a relativist nor as an absolutist (in ethics and epistemology). He uses the famous Knightian position of the “relative absolute absolute.” This means that we can challenge the basic values that we operate on, but not all values are relative. While I don’t agree with this critical rationalist position, I was struck by the influence of Frank Knight on Buchanan.

Finally, my favorite is the idea of the market as the ultimate frontier. As long as there is freedom of entry and exit, anyone can always go and start his own business and engage in new trading activities. In this sense, the market is a virtual frontier. The analogy with the American West is here present. While he did not explicitly recognize the open-endedness of his view, I believe this is where the Misesian (and Kirznerian) influence in Buchanan’s work is most acute.

I wish James Buchanan many more years of fruitful research and discussions with his colleagues and students.

Stupid in Africa!

One of my favorite books in recent years is Richard Epstein's IEA Free Markets Under Siege: Cartels, Politics and Social Welfare.  Epstein's draws on his deep knowledge of politics, history, law and economics to make a very simple point --- in the realm of public policy if economists and social theorists focused their energies on the "low hanging fruit" of policy debates and employed basic economic reasoning much of the really stupid policies in the world may be reversed and the lives of millions would be improved drastically.  Candidates for the truly stupid public polices would include legislation mandating minimum wages, rent control, and occupational liscensing.

Part of the professional work that I cherish the most at George Mason University is the opportunity I have with the Mercatus Center to give lectures and engage key public policy decision makers on Capitol Hill and at other international governmental agencies, such as USAID or MCC.  Testifying in front of congressional committees is not something I ever thought I would have the opportunity to do when I set off to attend graduate school and become a college professor.

My message in these venues is usually very simple.

#1: Intentions do not equal results.

Intending to do good is not the same thing as achieving good in public policy.  As public policy decision makers focus on doing good, not feeling good. And learning the difference between those two is one of the major contributions that the economic way of thinking has to offer in public policy discourse.

#2: Incentives Matter, and Information is necessary to act on those incentives.

In trying to "do the right thing" individuals in society much first face incentives that are capable with doing the right thing, and even if incentives are so aligned these individuals must also have some mechanism by which they find out what the right thing to do would actually be in the given situation.  Market mechanisms of property, prices and profit and loss are tremendous at providing both the rewards and penalities to align incentives, but also the requisite information about what would be the most appropriate action.  Anytime decision making is to be done outside of the market context, the question must be raised as to what mechanisms will serve as a proxy for the functions provided by property, prices and profit and loss.  Has does the political process, for example, align incentives, provide the relevant information to decision makers, and generate a feedback system for learning and selection?

Now, the most drastic illustrations of these two basic points can be found in the former communist countries and in the less developed countries of Latin America and Africa.

Tim Harford has a wonderful essay on Reason On-Line, which is adapted from his brilliant book, The Undercover Economist, on "Why Poor Countries are Poor."  His answer is stated in a more measured and eloquent fashion, but the basic upshot is that poor countries are poor because political leaders in these countries follow economically stupid and corrupt policies which provide perverse incentives and distorted information and as a result rob their citizens of the chance for a better life.  Given the stakes, this is a crime of drastic proportions against humanity, and perhaps one of the best reasons why the young and idealistic among our students must study economics seriously and correct the fallacies that exist among their peers with regard to markets, globalization and the plight of the poorest of the poor.

Is the Entrepreneur Really Returning?

As Chris Coyne pointed out (here), The Economist has an article this week on the return of the entrepreneur. I like the article’s title—Searching for the Invisible Man—not only because it conveys the idea of absence of entrepreneurship in economics, but also because it is, as the work of Israel Kirzner shows, the entrepreneurial process which generates the properties of the market system—properties which were described by Adam Smith using the invisible hand metaphor.

However, The Economist’s article barely scratches the surface of the issue. Clearly, it is desirable to see economists discuss the notion of entrepreneurship. Yet, discussions of this sort have been going on for a few decades now, with always the same chorus: that entrepreneurship is too elusive to be used in microeconomic theory. (See for instance the special issue of the American Economic Review back in 1968. See also Hébert and Link’s book, The Entrepreneur, published in 1988.) The great Joseph Schumpeter provided many insights into the field and most economists, including William Baumol, have had a hard time figuring out how to deal with them. This said, however great Schumpeter’s insights were, his work remained, at the end of the day, within the walls of microeconomics (of the Walrasian type to be exact, as Rothbard explained—see here). Even the neo-Schumpeterian literature suffers from the same problem: it is good neo-classical modeling with an emphasis on an agent who has a special utility function (see for instance the work of Kenneth Carlaw).

The other way entrepreneurship usually shows up in the literature is with reference to business start ups. The Global Entrepreneurship Monitor is a major instance of this approach (see here). Business start ups are usually related to innovation. However innovation, like many other notions such as dynamic efficiency, fascinates many economists because they don’t know what to do with it, i.e. how to model it.

Baumol is right when he says that economics should not ignore the phenomenon of entrepreneurship, because many important issues derive from it (see here Pete Boettke on Baumol). However, Baumol understates the case. The truth is that one cannot ultimately explain the market process without a deep understanding of the role and function of entrepreneurship. Entrepreneurial activity is the driving force of the catalactic order.

It is pretty obvious that the author of the article in The Economist doesn’t know much about Kirzner’s work (which is why he describes alertness as unrelated to innovation). This is also why he doesn’t say that economics is likely to remain in this entrepreneurless state for many more decades. Indeed, it would need a change of paradigm, an acceptation of the open-endedness of economic phenomena to fully incorporate entrepreneurship. I do not know if this will ever take place. It is true that many (non-Austrian) economists have taken notice of the work of Kirzner (for instance James Buchanan, Terry Anderson, and P.J. Hill). Business schools are also becoming more and more interested. The historian Jonathan Hughes has referred to Kirzner’s work as the most relevant work in economics to explain the history of American capitalism.

My hope is to be wrong and that this current resurgence is a real one. Kirzner’s work deserves to be recognized, understood, and acclaimed (and above that of Baumol’s). Let’s hope that the article in The Economist and the FSF-Nutek Award that Kirzner recently received are premises to the greater recognition of entrepreneurship (in the Austrian way) that is to come.

"Stupid in America"

John Stossel's latest investigative report, "Stupid in America," is available online.  The piece highlights many of the problems with America's public school system including government restrictions on choice and the role of unions in resisting reform and change.

I watched the show earlier and I highly recommend it.  My favorite segment is when Stossel discusses what is required to fire a teacher belonging to the union.  The number of steps is captured on several sheets of paper, taped together, that are as tall as Stossel.

Thanks to Craig Depken at Division of Labour. 

The Return of the Entrepreneur

This week's Economist has a short piece, "Searching for the invisible man: Economics rediscovers the entrepreneur."  Kirzner gets a passing mention but the main focus of the piece is on the work of William Baumol.  The main gist: 

Microeconomics instead gives pride of place to prices. Guided by the wages and interest rates they must pay, businessmen choose among different techniques of production (labour-intensive when workers are cheap, capital-intensive when they are scarce) but they do not reinvent or revolutionise them. Guided by the price their wares will fetch, they decide to make more goods or fewer. But they do not conjure up new products that no one had previously thought of.

Some quick thoughts:

1. I am pleased that the entrepreneur is getting some well-deserved attention.  However, given Kirzner's large body of work on this topic it is a shame he is not the focus of this piece.

2. We shouldn't forget the importance of prices for economic calculation.  It is prices and profit/loss that serve as a disciplinary mechanism regarding the activities of entrepreneurs.

3. Perhaps obviously, the institutional environment that provides incentives to engage in productive innovation and reallocation of resources is key.  Both Baumol and Kirzner recognize the role of institutions in the entrepreneurial process in their work. 

The Failings of Legal Centralism in Transition Economies

Ed Stringham and I have a new paper out published in the Czech journal, Politická ekonomie 1/2006.

THE FAILINGS OF LEGAL CENTRALISM FOR HELPING STOCK MARKETS IN TRANSITION

Edward STRINGHAM, Department of Economics, San Jose State University, San Jose, CA 95192 (e-mail: edward.stringham@gmail.com); Peter BOETTKE, Department of Economics, George Mason University, Fairfax, VA 22030 (e-mail: pboettke@gmu.edu)

After Czech voucher privatization many companies simply ignored the interests of their shareholders. The government has since increased the amount of regulation, but they have failed to establish significant investor confidence. This article offers some explanations of why their legal centric approach remains unlikely to create good corporate governance. Mandating that companies maximize shareholder value is easier said than done because it requires government to assess whether companies are making optimal business decisions. In former communist countries especially, government officials are ill suited to make such judgments because they lack the knowledge of how businesses should be properly run. Increased bureaucratic oversight in the Czech Republic has simply burdened markets without any noticeable positive results. This article discusses how good corporate governance can only be a byproduct of markets where managers compete for investors rather than something that can be created by law.

Blog Searching

Let's face it, when one is a colleague of Tyler Cowen and Alex Tabarrok it is awful difficult to uncover a new link on the internet that they haven't already discovered.  And the internet makes everyone who is a reader of Marginal Revolution a colleague in a certain fundamental sense.  Thanks to their excellent pointers I have learned of:

1. Jeff Miron's new blog -- The Case for Small Government.  Miron is an outstanding economist, whose work is first-rate and yet addresses fundamental policy questions from a libertarian perspective.  Several years ago I lost out on a chair professorship at Boston University (what in many ways I still consider would have been a dream job working in an interdisciplinary center headed by the great Peter Berger).  Jeff was the chair of the economics department that eventually voted me down after I received the unanimous support at the Institute, college and even provost level and my wife and I were already working with a real estate agent that the university had put us in contact with in anticipation of a move from NYC to Boston.  But I possesses no ill will toward Jeff or his colleagues at BU--- instead I recognize his intellectual integrity and commitment to academic excellence.  Jeff is a hard core libertarian, but he also is a very standard neoclassical economist and he has severe doubts about the scientific legitimacy of Austrian economics.  In short, the assessment on me at BU was not malicious, but an honest assessment based on the judgement of the scientific worth of the work of others.  I obviously disagree with the assessment made of me, but I value the abilty of people to make those judgements and free of any ideological precommitment to shared policy passions.  I value their freedom in making those standard judgment just as I value my own ability to make those judgements from my perspective!  Jeff's blog promises to be a great addition to the blogosphere and I do expect to learn much from his straightforward analysis of policy issues.  He is already not disappointing to his reader.

2. Amartya Sen has reviewed Bill Easterly's new book.  Of course Sen will object as overdrawn Easterly's distinction between 'planners' and 'searchers', but what is most surprising is how much Sen has come to believe he agrees with the critique of big planning schemes.  Actually he agrees less than he actually communicates at times (you have to read between the lines).  A few years ago I was at a conference at Princeton on P T Bauer and Sen was asked to comment on what the biggest difference between was in development economics between 1964 and 2004. Sen answered that the biggest difference is that in 1964 everyone saw markets as a negative sum or at best a negative sum game, whereas today the dominate proposition is that markets are positive sum games.  Sen's review reflects that the change in thinking from 64 to 04, while not complete, has made consider inroads into his own thinking as well.

3. That Malcolm Gladwell, author of Tipping Point and Blink, is a huge sports fan and uses a discussion of whether he could outperform the GM of a sports franchise such as the Knicks in picking a roster.

4. That the Richmond Fed did a wonderful interview with Tyler, including pictures.

These are just a sampling, but Tyler and Alex rarely disappoint.  And at GMU, the amazing thing is that we have so many colleague that are fascinating economists and political economists.

Is Blogging a Waste of Time?

Trevor Butterworth at the Financial Times, thinks maybe so ... read more.