Coordination Problem

More Evidence that Governmental Error is Obvious Everywhere and that it is Coordination that is the Puzzle

|Peter Boettke|

It will not be news to anyone here that the roll out of the Affordable Care Act (aka Obamacare) has not gone smoothly.  I don't want to comment on the pros and cons of the policy per se, but instead simply use the "coordination failure" to highlight Hayek's basic insight that: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

When Hayek won the Nobel in 1974, his lecture was titled -- "The Pretense of Knowledge".  It was not directed at the comprehensive central planning of Soviet style socialism, but at the piecemeal economic management of Keynesian macroeconomics practiced throughout the democratic west.  Despite his popularity in the wake of this recognition, and the experience of stagflation, Hayek's warning was never really heeded by either the Reagan or Thatcher administrations.  Yes, a more "conservative" approach was followed, but the basic structure of public administration was not addressed.

As detailed by Vincent Ostrom in The Intellectual Crisis in American Public Administration, the Progressive Movement successfully transformed the administrative apparatus of government starting with Woodrow Wilson and continuing through WWI, the Great Depression and WWII.  This administrative apparatus is built on the "pretense of knowledge" and operates assuming that the "pretense" is not a pretense.  Trained experts will be able to effectively manage affairs to achieve the public interest.

But we see the track record of failure in all of these administrative efforts whenever and wherever we look.  If we didn't, jokes like "I am from the government, I am here to help" wouldn't produce a laugh (even if in many instances that is accompanied by tears).  In my office in Arlington I have this poster hanging:

Indeed the solutions are often worse than the problems.  My colleague Chris Coyne in discussing the hubris associated with our efforts at nation building likes to ask audiences --- how can it be that you understand how poorly run the US Post Office, yet you believe that the US can successfully rebuild nations?

It is human arrogance and human opportunism with guile that gets us all the time in our efforts to pursue idealized plans for public management of economic and social affairs with the purpose of human betterment.  And this isn't just a matter of slouching toward a solution.  Arrogance and opportunism have huge costs in terms of money and lives, and very few benefits in terms of devising better solutions.

Any governmental plan that exhibits the arrogance of the pretense of knowledge, and unleashes opportunities for the most opportunistic of us to benefit at the expense of others, must be resisted and ultimately rejected as an approach to public policy.  We need a stronger filter on policies within the given structure of government -- e.g., a generality norm -- but more importantly we need to make sure the structure of governance is such that we do not ask the government and its officers to do things that they are incapable of doing.  We need to address not only questions of the size of government, but more importantly the responsibilities of government.

What better time to start this conversation than now?  We going to have another round of budget talks, and we are in the middle of the roll out of a new major government initiative that all can see is suffering serious coordination failures.  If the government cannot run the Post Office in a cost effective manner, why do we think it can do all these other range of activities so effectively?

As Steve Horwitz likes to stress, 'ought' does not imply 'can' -- those may well be two very separate questions.  And I would add, therefore, it is also important to remember just because you 'can' pass a law doesn't mean you 'ought' to pass that law, nor does it follow that when you implement that law it will produce the results you intended.

 

'An Engine of Creativity Without a Clutch'

|Peter Boettke|

That is how my teacher Kenneth Boulding described his teacher Frank Knight.  I was simultaneously a student of 2 of Knight's students -- Boulding and James Buchanan -- one semester back in the mid-1980s.  Both spent a lot of time on Adam Smith's deer-beaver example, and what Buchanan referred to as the simple analytics of natural liberty.  I asked Boulding once while visiting with him at his townhouse for milk and cookies, why we were discussing the deer-beaver model so much in his and Buchanan's class, his answer ... Oh, Frank Knight did that, or he talked about world religion, so you are just being exposed to the long Knightian tradition of economic education.  He then laughed his wonderful laugh.  He paused, and then said with a smile on his face, 'Knight was an engine of creativity without a clutch.'

I have a strange intellectual relationship with Frank Knight.  See my paper with Karen Vaughn on Knight that was published in HOPE.  On the one hand, I often find him to be the most arrogant and frustrating major thinker in the history of economics, and on the other hand, I sometimes find him to be among the most philosophically deep, analytically penetrating, and brilliant economist and political economist to have ever worked in the field.  Which Knight I am encountering varies from piece to piece.  Risk, Uncertainty and Profit (1921) and Intelligence and Democratic Action (1960), as well as "'What is Truth' in Economics?" (1940), all fall in the deep, penetrating and brilliant category, whereas his book reviews, his critical essays on capital and on socialist calculation fall in the arrogant and frustrating category.

Today I stumbled upon his 1938 review from the JPE of Walter Lippmann's The Good Society.  This review, ironically, has both categories on display in full view for the reader.  Consider the following extended discussion of the shortcomings of the book after starting the review by stating "That Mr. Lippmann's book is brilliant goes without saying to any reader of serious current social and ethical discussion in the English language in the post-war years."  Two paragraphs later we read that Lippmann's "interpretation of recent and current history and his general thesis seem to the reviewer both entirely sound and fairly simple and obvious."

However, just a few pages into the review, Knight argues that: "The absence of analysis and of a scientific approach is noteworthy at every stage of the argument -- whatever that may or may not imply in the way of criticism, in view of the type of book the author was trying to write." There is, according to Knight, "no scientific inquiry" evident in the book as to why laissez faire capitalism fails nor why collectivism fails.  Instead, Knight insists we get treated to the plain dogma that "not merely that collectivism means tyranny but apparently that it is impossible, or at least theoretically incompatible with social life above the level of savagery."

And here things get 'interesting' --- Knight writes: "In another place reference is made to the 'discovery', by Professor Ludwig von Mises, that a collectivist economy in peace is incapable of planned and calculated organization of production.  It is true that Professor Mises argued for this 'impossibility', but the position is indefensible.  The essential fact is that government of a collectivist state would do anything it liked, within the limits of physical and human, i.e., political, possibility and its own competence.  It might 'theoretically' run economic society in substantially the way in which say, the United States of America is run today, as to the activities of men and their results, collective and individual. The establishment of governmental monopoly of enterprise with ownership of productive wealth would not necessarily change much, if any, of the concrete process.  Or, it might convert society into a model orphan asylum, or into a shambles."

Really?  Knight seems here to purposefully obfuscate the issue of economic cacluation under collectivism.  Will not rehash the Misesian position here -- see this essay for an overview -- but let us just say that an economists of Knight's knowledge and analytical skill should that prices without property are a 'grand illusion' and that prices and profit and loss are necessary guiding devices within the competitive order.  In other places throughout Knight's writings he provides brilliant and insightful economic analysis into the role of property, prices, and profit/loss so it is unclear why he is obscuring the issue here (and in other places as Vaughn and I discuss in the paper above -- though our point is to make it clear why he tied himself in such knots).  

There is, of course, another objection to collectivism strongly associated with Mises (read not only Socialism, but Omnipotent Government) and Hayek (read not only Collectivist Economic Planning but The Road to Serfdom) and that is the political consequences of collectivism.  Here Knight joins in -- "the view that collectivism means dictatorship is correct beyond reasonable doubt."  He continues, "The authorities of a collectivist state would have to have unlimited power, and security of tenure, and would have to exercise their power ruthlessly to keep the machinery of organized production and distribution running.  They would have to enforce orders ruthlessly and suppress all disputation and argument about politics; and as a condition of minimum efficiency, they would also have to do everything possible to remove grounds of differences of opinion, by giving the people the appropriate 'information' and conditioning of attitudes, i.e., 'propaganda.' They would have to do these things whether they wanted to or not; and the probability of the people in power being individuals who would dislike the possession and exercise of power is on a level with the probability that an extremely tender-hearted person would get the job of whipping-master on a slave plantation."

The review of Lippmann's The Good Society has both Knight's going on -- arrogant and frustrating in some passages, and deep, penetrating, and brilliant in others.  There is much to learn from such complex thinkers. Boulding, who actually was a lot like Knight in terms of being an engine of creativity without a clutch, used to say -- "The world is a muddle, it would be ashame if we were clear about it."  Followed, as all Bouldingisms were, with his characteristic laugh, smile and twinkle in his eye, as he invited your puzzled reaction.

What teachers of yours have sparked your curiosity and both enraged and enlightend you at the same time?  What thinkers do that for you when you read them?

 

Even Master Jugglers Fail Sometimes

|Peter Boettke|

In Capitalism and Freedom, Milton Friedman wrote that "Any system that gives so much power and so much discretion to a few men that mistakes -- whether excusable or not -- can have such far reaching effects is a bad system."  He was, of course, talking about the Federal Reserve System in the US, and in particular the policy errors that produced the Great Depression of the 1930s.   Friedman then developments his argument for rules rather than discretion in macroeconomic policy.

But despite the intellectual victory of Friedman -- starting with his 1968 AEA Presidental Address on The Role of Monetary Policy -- I would argue that this mainly led only to a change in rhetoric surrounding public policy.  The institutions and the choices made inside those institutions reflected that power and discretion remained vested in the hands of few decision makers such that their errors -- whether excusable or not -- continued to have such far reaching effects.  In other words, the problem is with the system.

Drawing on Adam Smith, I have been stressing since the financial crisis began the juggling trick that governments -- ancient as well as modern -- engage in as they attempt to hide the consequences of their mistakes in policy choices.  See here for example.

If even master jugglers fail sometimes, and their failure is catastrophic for the entire system, perhaps we shouldn't allow them to persist in their juggling tricks.

In my latest 'The Economic Way of Thinking' column for FEE, I use the example of the juggling trick to explore the difference between "good economics" and "bad economics".  This, of course, fits with my simple perspective on economics and public policy which is:

 

BAD IDEAS ==>BAD POLICIES ===> BAD OUTCOMES

 

We have to address dire economic conditions by identifying the culprit in bad policy choices, and then we need to expose the bad ideas that gave rise to those policy choices.  Of course, we then must also discover incentive compatible policies that will fix the problem, and incentive compatible strategies for implementing the fixing solution.

Ultimately, we have to remember that instituitonal problems require institutional solutions.

And, a good start would be to STOP THE JUGGLING TRICKS.

Institutional Diversity and Political Economy: The Ostroms and Beyond

|Peter Boettke|

That is the title of the fantastic book that has just been published by Oxford University Press written by my colleague Paul Dragos Aligica.  Paul studied with the Ostroms at Indiana University prior to joining our research group here at GMU.  Paul has a deep knowledge of philosophy, politics and economics, and that knowledge is on full display in this work.

The critical question in political economy is how do groups of individuals find the rules that enable them to live better together; to find those institutional arrangements that encourage peaceful social cooperation and productive specialization among diverse populations.  The problem of diversity isn't always treated seriously by political economists.  Consider the following from the locus classicus of public choice, The Calculus of Consent: “Therefore, our analysis of the constitution-­making process has little relevance for a society that is characterized by a sharp cleavage of the population into distinguishable social classes or separate racial, religious, or ethnic groupings sufficient to encourage the formation of predictable political coalitions and in which one of these coalitions has a clearly advantageous position at the constitutional stage.” (1999 [1962], 81)

From my perspective Buchanan and Tullock are underselling their contribution by steering clear of questions of how social cooperation can emerge out of social conflict through the adoption of various rules of social interaction.  That task was more or less left to Vincent and Elinor Ostrom and their work on polycentricity and constitution making from the bottom up.  Institutional experimentation, and thus institutional diversity, must be recognized as individuals and groups grope for solutions to the puzzle of social conflict.  Alexander Hamilton asked in Federalist #1, whether constitutions are a consequence of accident and force, or choice and reflection.  Both the Virgina School and the Bloomington School examine analytically and empirically the constitutional arrangements that emerge from choice and reflection so that rules that enable individuals to live better together are agreed upon and enforced.  But the vast institutional diversity that exists throughout the world that enable groups (small and large) to realize the gains from social cooperation was primarily the research task of the Bloomington School and their institutional analysis of development.

In this work, Algicia not only provides a thorough discussion of the Ostroms' work, but also provides a deep, original, and creative examination of institutional feedback, policy design, and democratic society.  Aligica treats seriously the issues of heterogeneity and institutional diversity.  Rather than evading, Aligica focuses on the constitution-making process among populations with sharp cleavages and threatened by social conflict, and explores how groups stumble and sometimes succeed in finding the institutional framework that turns diversity into advantages rather than the cause for disruption.  In doing so, Aligica marries Hayekian insights on knowledge with Buchananeque concern with the constitutional level of analysis, and the Ostromean analysis of polycentricism and institutional diversity.  It is a brilliant analysis of the comparative institutional analysis of democratic governance.

Economics Teaches Us Humility

|Peter Boettke|

 

The Economics Analysis of Financial Markets -- A Nobel Prize Long Expected

|Peter Boettke|

Three American's were awarded the Nobel Prize today.  Eugene Fama had long been an expectant Nobel Prize winner for his development of the efficient market theory in finance.  Lars Hansen's reputation for sophisticated techniques in empirical analysis and pure theory have been recognized for over 30 years.  Ironically, I just purchased a book of Hansen's (co-authored with Sargent) on Robustness, which is focused on estimation techniques as they related to decision making.  Fama and Hansen are both professors at the University of Chicago (have economists from the same university won in the same year before?).

Robert Shiller is the third Nobel Prize winner this year, and the one most comfortable with the media -- so expect to here a lot from him in the popular press.  My suspicion will be that Shiller's work on asset bubbles will be picked up by journalists and the focus will be on the irrationality of financial markets in opposition to the efficient market hypothesis.  I do hope that the journalists also read Shiller's recent essay which raises doubts about the economist as social engineer, and a demand for economists to be philosophically self-aware.  I also always really liked this paper on citizen attitudes toward markets in Moscow and NYC.

This is a very worthy Nobel by all three individuals.  I do think the popular media could potentially see more of a stark contrast between Fama's efficient markets and Shiller's asset bubbles than there actually is, but that is just the way economc ideas are often translated into popular discourse.  To see a discussion of (Fama vs Shiller) vs the Common-Sense Political Economy of Mainline Economics see my paper "What Happened to 'Efficient Markets'?"

Happy Birthday Walter Grinder

|Peter Boettke|

Kurt Schuler, John Hagel and Chuck Moulton organized an online tribute to honor Walter Grinder on his 75th birthday. As mentioned in several of the tributes, Walter played a vital role in shaping the intellectual personality and agenda of many young scholars in my generation.  To those of us interested in Austrian economics, Walter's influence wasn't just his personal coaching, but also his own writings.

The Society for Development of Austrian Economics (SDAE) recognized a few years ago Leonard Liggio for his role in promoting Austrian economics through his work as a scholar, teacher, and mentor.  The Institute for Humane Studies that I grew up with reflected the character and intellectual temperament of these two wonderful men.  I owe so much to both men for what they taught me, and for the opportunities to learn from others that they provided me.  While I was a Claude Lambe Fellow at the Center for the Study of Market Processes (rather than through IHS), I was a summer fellow for 2 summers in the mid-1980s, and attended several summer seminars.  Rosemary (my wife) worked at IHS for 2 years as well during this same time.

After receiving my PhD, IHS continued to support my efforts to build an academic career and arranged for me to give talks in Europe and at various college campuses.  IHS worked with me to improve my dissertation and shape it into an academic book, as well as pursue the journal publication strategy that is so vital to young academics. Wherever I turned, either Walter or Leonard were there with a word of encouragement, advice on how I could improve, and support to keep striving to achieve a leveraged academic position.

If you look at my academic cohort who worked closely with IHS through those years, many have gone on to have significant academic careers.  And many of these reflect research ideas that were given to them by Walter Grinder.  He always had suggestions for books to read, questions to ask, and puzzles to solve.  I can remember conversations with him in the Harper Library or the Tallwood House property about issues that I am still pursuing and encouraging the graduate students working with me to pursue.

Happy Birthday Walter, and thank you for everything you did for me and all the others that came under your influence at IHS.

New Working Paper on Hayek and Mainstream Microeconomics

|Peter Boettke|

In a new working paper Kyle O'Donnell and I argue that the mainstream literature in microeconomics engaged in a failed appropriation of Hayek's central insights on knowledge and the process of economic coordination.  We argue that:

Hayek argued that the central question of economics is the coordination problem: How does the spontaneous interaction of many purposeful individuals, each having dispersed bits of subjective knowledge, generate an order in which the actors’ subjective data are coordinated in a way that enables them to successfully dovetail their plans and activities? In attempting to solve this problem, Hayek outlined an approach to economic theorizing that takes seriously the limited, subjective nature of human knowledge. Despite purporting to have appropriated Hayek’s thought by acknowledging the information-transmitting role of prices, mainstream economists have missed Hayek’s point. The predominant tool of formal economics — equilibrium analysis — begins by assuming the data held by actors to have been pre-reconciled, and so evades the problem to be solved. Even the more advanced tools for modeling knowledge in economic analysis, such as the economics of information, assume away either the subjectivism of knowledge and expectations (rendering the coordination of beliefs and plans a trivial matter) or the frictions and “imperfections” of reality (rendering the coordination problem indeterminate).

 

 

World Interdisciplinary Network for Institutional Research

|Peter Boettke|

The announcement of the forming of a new international scholarly association -- World Interdisciplinary Network for Institutional Research (WINIR) -- has been circulating ---  Download WINIR.  

Readers of CP should be particularly excited about this development.  Coordination is the problem in economic analysis, and the entrepreneurial market process is the solution to that problem, but that solution is contingent upon the institutional setting.  Property, prices and profit/loss represent a specific context of choice, outside of that context of choice and entrepreneurial altertness may be directed in ways that do not solve the coordination problem and thus do not lead to realizing the gains from social cooperation under the division of labor.

As I argue in Living Economics, the mainline tradition of economics worked with the self-interest postulate and derived the invisible-hand theorem by way of institutional analysis.  The mainline of economics never strove for an institutionally antiseptic theory (as Samuelson did), but instead always was striving for (as Buchanan put it) a 'genuine institutional economics' that is a 'significant and an important part of fundamental economic theory.'

It is this integration of the institutional level of analysis with fundamental economic theory that also characterizes my book, Institutional Economics: Property, Competition, Policies, which I had the good fortunate to be invited to join as a co-author for the second edition by Wolfgang Kasper and Manfred Streit.  It is also ultimately the reason why Paul Dragos Aligica and I wrote our book on the Ostroms and the Bloomington research program.

Economists and political economists too often take the institutional framework within which economic activity takes place as fixed and given, rather than as a subject of study.  Treating institutions as exogenous works for many problems in economics, but for many others it actually leads to bedlam. As Buchanan put it: 'The economist should not be content with postulating models and then working within such models.  His task includes the derivation of the institutional order itself from the set of elementary behavioral hypotheses with which he commences.'

Economics is about exchange and the institutions within which exchange takes place.  This perspective was represented in the work of Adam Smith to Vernon Smith, and in-between by Hayek, Buchanan, Coase, North and Ostrom.  It is what good economics is all about.  As I said before, self-interest postulate is the elementary building block from which the invisible-hand theorem is derived via institutional analysis.  Perhaps the clearest methodological/analytical statement of this mainline approach can be found in Robert Nozick's Anarchy, State and Utopia and in the section on invisible-hand explanations.  The equilibrating tendencies of any social system are a consequence of the institutional filter through which self-interested action and interaction are directed.  Economics as a discipline provides the most articulate statements about the mechanisms generated by alternative institutional arrangements, but the historical and empirical details of particular institutions are often found in disciplines such as law, politics, sociology, and of course history.  WINIR promises to encourage this dialogue across the disciplines.

Please browse the website and consider joining this intellectual effort.  And if so inclined, download the announcement and circulate widely to faculty and students who may be interested.

Profit and LOSS System and the Analogy in the Republic of Science

|Peter Boettke|

We often talk about the marketplace of ideas to reflect the contestation of ideas that constitutes the scientific enterprise.  Science is hard work, and being wrong in science should, and often does, hurt.  Reputations are won and loss, job prospects either emerge or vanish, research funds flow or dry up, and bright graduate students are either attracted to work with you, or flock to others.

But the scientific process only works when error is exposed and the incentives are structured so that scientist learn from their errors and correct those errors.  Just as in a market economy when we privatize the profits, but socialize the losses we get dysfunction, in the marketplace of ideas if the discipline of science is prevented from impacting on scientific behavior we will have dysfunction.

Science magainze published the results of a study where online/open access journals did not fare as well as one would expect in catching error and demanding correction.  The study raises serious questions about the scientific process, and the answers are not as straightforward as Science might be implying.  For readers of a certain age, the Sokal affair will set off certain bells and that had nothing to do with online/open access, but on the intellectual standards of argument in scholarly affairs.