Have economists given up on the free market?

This is the thesis offered by Noah Smith. He argues that the rise of data and new theories has led to economists to move away from free market theories. Adverse selection, moral hazard, and game theory have shown how rational agents can lead to suboptimal results, while behavioral economics has cast doubt on the assumptions about human rationality.

It seems to me that he conflates two things. The first is how the public perceives economists. The second is the political preferences of economists themselves. The distinction is important because even if economists have become more liberal, they still might appear to be free market dogmatists if the public continues to not understand economic theory. Bryan Caplan has demonstrated there continue to exist biases in the public understanding of economics. While adverse selection is important, I think most economists agree comparative advantage is even more so. Paul Krugman at least used to agree.

Noah also falls prey to the nirvana fallacy. He compares supposed market failures with idealized solutions. These idealized solutions rarely happen, the reason being public choice, an innovation he failed to mention. Government actors are the same fallible humans as market actors.

Take behavioral economics for example. While it is often applied to market actors, the same logic also applies to the government actors making and enforcing the rules. Therefore, on net, it isn’t clear whether behavioral economics justifies government intervention. Applying behavioral economics to government might imply restricting state intervention.

However, Noah’s more central point is about the change in attitudes of the economic profession. David Henderson already responded about macroeconomics. My research has been on development economics and that field has become substantially more likely to favor open markets.

It is worth noting that the traditional dichotomy between liberal and conservative is misplaced. While I favor lower marginal tax rates and less government intervention, far more important is government recognition of property rights. The question is not, is Sweden a better model than the US, it is, why is Africa poor? The (relatively new) consensus among economists is that Africa is poor because of bad institutions.

This wasn’t always the case. Peter Bauer was for years a loner voice against state led planning. Though Douglass North won the Nobel Prize in 1993 for his work on institutions, the turning point didn’t occur until Acemoglu, Simon Johnson, and James Robinson published “Colonial Origins” in 2001. They were the first to causally show through econometrics that institutions caused economic performance and not vice versa.

While institutional economics cannot be described as entirely libertarian in its implications, it is substantially more so than previous development theories. Two recent books, Why Nations Fail and Violence and Social Orders offer similar frameworks. They differentiate between two types of governments; I will call them an open state and a predatory state.  Predatory states are defined by elite expropriation of wealth and monopoly privileges. Open states allow any person to enter the marketplace and encourage competition. These distinctions are comparable to indices of economic freedom.

Part of the reason Noah might have the impression he does is because economists used to assume the existence of strong stable property rights. The discussion was over government intervention given those property rights. Perhaps given that assumption he is correct, but the importance of institutional economics is abandoning that assumption.

As I tell my students, the reason there are poor countries is because their governments steal too much from the people and don’t respect their property rights. I do not think most economists would have agreed in the 1960’s or 1970’s, but I do think they would today.

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2 comments

  1. Thanks, Mark!

    Noah also falls prey to the nirvana fallacy. He compares supposed market failures with idealized solutions. These idealized solutions rarely happen, the reason being public choice, an innovation he failed to mention. Government actors are the same fallible humans as market actors.

    I don’t think I fell prey to a fallacy; what I think is that public choice, while important, is dramatically under-studied. Economists in general very rarely tackle the question of how government actually works, and this, I think, is a big deficiency within the field. So I don’t think I forgot about public choice; I think economics has!

    Applying behavioral economics to government might imply restricting state intervention.

    Indeed it might…but who the heck is studying that right now???

    See my point?

    As I tell my students, the reason there are poor countries is because their governments steal too much from the people and don’t respect their property rights. I do not think most economists would have agreed in the 1960’s or 1970’s, but I do think they would today.

    That’s an interesting point. I am kind of out of the loop with regards to development econ, and I don’t think all the sub-disciplines are “in phase”.

    Like

    1. “public choice, while important, is dramatically under-studied.”
      Fair enough, I think we come from different traditions. Attending GMU, I had lots of public choice and I think much of it has been integrated into institutional economics.

      “See my point?”
      Touche

      “That’s an interesting point.”
      I guess I should have drawn out that point more. I think development has become substantially more sympathetic to markets. Though it probably started out as less sympathetic than the profession as a whole. Institutional economics doesn’t have the same history as development, but I think has also pushed the profession more toward markets.

      I would also differentiate between naive market advocates, think Russian privatization in the early 90’s, and market advocates who understand the difficulty of institutional change. I read your post as detailing the fall of the former, I was trying to draw attention to the rise of the latter, though it seems I could have done a better job.

      Like

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