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On F.A. Hayek's "The Use of Knowledge in Society" (1945) and Amartya Sen's On Ethics and Economics (1987).
Is economics a pseudoscience? Certainly, trying to model a phenomenon mathematically and so predict, for example, the consequences of proposed legislation is better than acting blindly, but given the complexity of the system, are the simplifications required to create a model just too immense?
Hayek argues that the whole idea of sitting back and contemplating how to plan an optimal economy is misconceived, because the planners are not in a position to know all the relevant details about supply and demand. Instead, this information is spread among many people, and the price system communicates what people actually need to know to make local economic decisions.
Amartya Sen discusses the many simplifying assumptions of economics, such as the claim that individuals are rational welfare-maximizers, and that "welfare,"( i.e., "the good") is equivalent to pursuing one's desires or maximizing one's material gain.
Seth, Wes, and Mark are joined by economics guy Seth Benzell to try to figure out to what extent the two readings actually disagree, what the political upshot is, and whether philosophers can simply wander into the domain of this supposed science and say anything worth hearing. Before the conversation starts, Seth B. gives his "precognition," an introduction to lay out the facts of the readings. Read more information and get the texts.
End song: "People Who Throw Away Love" by Mark Lint.
Hayek picture by Sterling Bartlett.
Ah yes, central planning is not an efficient way to allocate goods since it would require perfect information on the part of the planner. The free market on the other hand is optimal, since it always lead to pareto efficient outcomes, provided all market participants have perfect information, there are no externalities, all markets are in full equilibrium, markets are perfectly competitive and transaction costs are negligible.
On the question of a “model” I understand now that the other sciences has it quite backwards, if their model does not model reality they change the model, in economics it seems that first you create the model, then you try to change reality to fit the model. I must say this approach is better. Questions becomes much easier to answer, take for example the question of helping the poor, how do you do it most efficiently? In the model? Lump sum transfer. In reality? First change reality to fit model, then lump sum transfer.
Hi K,
Helping the poor is a worthy goal. In the second half of this podcast we have more to say about the limitations of the model.
Certainly the Second Fundamental Welfare theorem suggests that the best way to help people is through transfers. But Economists know that the model does not perfectly match reality. To understand what really is best for the poor we conduct experiments or study natural experiments. “Poor Economics” by Banerjee and Duflo is a great example of this approach. Economists strive to use this information to eliminate bad models and replace them with better ones. Cash transfer programs such as “Give Directly” and the conditional cash transfer programs in Latin America (such as Bolsa Famillia and Oprotunidades) have had great success with this approach.
I will also point out that while asymmetric information can lead to failure for the FWT, the information requirements for the Central Planner who hopes to improve on the market outcome are absurdly greater. The central planner needs better information about everyone’s ever changing demand and production capabilities while the decentralized approach only requires that individuals have sufficient information about their own valuation of goods.
“the information requirements for the Central Planner who hopes to improve on the market outcome are absurdly greater.”
But there is no greater information requirement than the requirement to possess perfect information, are you saying that this is not a requirement in the case of free markets but only in the case of central planning?
You seem to be hinting at this when you use “can” and not “will” in the sentence:”while asymmetric information can lead to failure for the FWT”
If so in what way can the requirement of perfect information in free markets be relaxed and still lead to “FWT”?
For example which of the following pieces of information is not needed to be known to the consumers or producers:
price, utility, quality or production methods, and still lead to pareto efficient markets?
Then you go on to say that:
“The central planner needs better information about everyone’s ever changing demand and production capabilities while the decentralized approach only requires that individuals have sufficient information about their own valuation of goods.”
First of all, let me repeat the question, in order for the price of a goods to reflect the value of it, and in order for an individual to evaluate it or make a descision to buy it, in a free market, that indvidual requires perfect information. Otherwise, as an example, the flu-medicine that is super effective but kills you after a month would be valued very high, if no one knew it would kill you after a month.
Secondly, what is the definition of a “central planner” here? As an example is public schooling considered central planning? If it is it seems that the state is in a good position to know the demand on that service since it is given universally to a specific age group. Is “central planning” analogous with anything thats not the free market?
I’m seeing a non-binary aspect to the information in the readings. The degree to which the market systems achieve the objectives (satiating the desires of the participants) is a variable and the authors and the hosts were making comparative statements between the differing market philosophy’s.
By “failure”, I think they are referring to the market not being in a state of perfection. This is nearly impossible, due to our desires constantly changing (demand side) and resource availability changing (supply side). The bigger statement in the market shortcomings question is how the markets can deal with imperfect information since we are not completely rational or all-knowing beings. The answer is that, at best, the market can only satisfy the needs that are indicated by the participants actions (purchases). If everyone that purchased the new I-phone decided that it was a negative to their life (or did not live up to their expectation and left them with buyers remorse over the $1000 they spent on it), the sales would drop enormously, thus sending a clear signal to the manufacturer.
On the central planning question: I would say that you gave a reasonable definition. The choices of public schooling are largely not made by the consumers (children or their parents) but by politicians and school district employees. The central planning vs. free market classification isn’t a binary but is also a spectrum. In the case of public school, the consumers are occasionally given choices, but for the most part the subjects that are taught, who teaches them, the method that they are delivered, etc are decided with little to no regard to the consumers desires. Also included at this end of the spectrum is heath-care, financial, and construction/zoning industries. At the other end of the spectrum is industries with very little central planning input such as computers, software, electronics, clothing, etc.
Given a model of some system, and a set of assumptions under which the model holds I think it makes sense to ask, “but what if the assumptions don’t hold?” (Specially in a case when they in reality never actually hold).
It does not follow that a small change, in a constant say, necessary results in a small change in predicted outcome, infact a small change can possibly lead to a very large change in outcome.
But it may be the case that a somewhat free market, with say imperfect information among producers and consumers, somehow approximates or tends to pareto efficient outcomes. I find it hard to believe that this could be the case, however I don’t know it to be false, thats why I asked the questions.
I agree with questioning assumptions, not just if they can represent reality but if they are a necessary part of the model. In this example of markets: do free markets require rationality on the part of the participants or is the lack of coercive force sufficient to be free? If we are comparing economic systems, we should evaluate if rationality is encouraged (by rewarding that participant with an advantage) and if society is improved when rationality is increased (I think this would be an externality).
Can we conclude that participants will become more rational with this reward of better outcomes? I think this is generally true, but behavior psychologists can certainly find many cases where we fail in this respect. My opinion is that most of human development has been cause, in a large part, by our increase in ability to reason and act more rationally.
I would also conclude that society is better off with increasingly rational members as this is the driver toward parato efficiency. To this end, I would have to conclude that rational people have an incentive for the rest of society to be more rational, also (because it leads to increased parato efficiency). I would like to claim that this incentive is greater than the incentive to be more rational that the other participants (which can give an advantage in transactions), but I haven’t located a study to back this up. Maybe data related to migration patterns of people between regions of higher and lower rationality (however that is measured).
There’s that word equilibrium! Cue mandatory Steve Keen video.
Thanks for the share. The weather model discussion takes the lecture a bit off track in my opinion but I like him and the push on equilibrium.
I’m really glad that this is the first pod cast I’ve heard from you guys. I’ve been reading more about the possibilities of free market economies in the last 4 years and I’m more and more impressed.
The thing that I didn’t hear directly was that education is a key to Mark making the right decision. Mark has to know whats best for him, and self knowledge isn’t intuitive all the time. Does he really need to phone’s features or is he trying to fit in> He has to decide whether being self-fulfilled without an Iphone or maybe it just makes more sense to join the group. Maybe it will make his life easier and check all the other boxes. simultaneously.
I don’t think Marketing is unaccounted for. Advertising is talked about extensively. It’s persuading people to choose a product, an offer that can ultimately be declined. the alternative being force or coercion.
I much prefer the annoyance of Apple’s bombardment than police action dictating I can’t choose a cheaper, less stylish phone.
Thank you for this program.
http://www.cbc.ca/radio/ideas/it-s-the-economists-stupid-1.3219471
This was one of my favorite PEL episodes ever, although I’m sure I’m biased because I have a pretty big interest in economics. But in general I think it might be cool to do more episodes like this that take a philosophical look at other areas in social science, which aren’t philosophy per se, but which still have a lot of philosophical underpinnings. So maybe something on Sociology (e.g. Weber, Durkheim, Bourdieu), Political Science (Lindblom) or Anthropology (Geertz). if you can find a work that goes into to some of the philosophical work that helped to inspire many of these guys’ theories it might make a good discussion.
Hayek can be taken to be a meta(mega)-central economic planner in that he puts forth a massive theoretical framework that is supposed to encompass the economic whole. By claiming that price systems communicate what we need to know, and that markets will evolve to a mythical efficient state; he states how we ought to act (or at least how we ought not act economically). The fact that his grand theoretical planning says, in content, to abandon centralized planning, does not free him from a centralized, authoritative doctrine that drives his imagined perfect economy.
Question. Does Hayek advocate for any level of centralization of the economy? Does he throw it all to the ashes, or will he accept that some level of centralization can be helpful?
I’m more familiar with Mises than Hayek but I assume that their take on government is roughly the same. That is to say that they advocated for liberal democracies. Thus there is room for minimal governmental intervention, mainly in the form of defense of the commons as well as natural rights.
But I think you and everyone else on here is projecting the myth of utopia unto Hayek. If Hayek is like Mises then the goal is not prescriptive but descriptive. Free markets have been more efficient and the Austrians provide and explanation why. Austrian Economics is not a Utopian school of sociology.
The economics expert also uses the term ‘market failure’ in a very strange way; or at least in a way that no Austrian would use it. An example of a market failure is one where larger cars are safer for their drivers in that they have more momentum. Thus in a crash the larger car’s driver will be more likely to survive. But if everyone knows this then everyone will want bigger and bigger cars. This would be a case where everyone wishes to be safer but the collective actions of car buyers make no one safer. (Notice that this market failure is gradually being solved by greater safety technologies).
On the other hand, if someone wants a smartphone simply because it’s fancy this isn’t a market failure. Rather the person in question would rather buy positional goods than invest in capital. Envy isn’t an externality. To say this is to conflate economics and ethics.
This circles back to your original concern about Hayek and central planning. Austrian economics was largely developed in opposition to paternalism. Thus it fits nicely with libertarian politics; but make no mistake: it is, strictly speaking, not a branch of libertarian politics. Rather, Austrian economics makes pains to separate and distinguish ethical, political, psychological, and economic schools of thought.
Hi Lmcquaid,
I would argue that in certain circumstances smartphone envy can create an externality in the same sense that your car example is.
Suppose that everyone is perfectly happy to have no smartphones so long as no one has one. In other words, the first person to buy a smartphone gained exactly no value from it. However, suppose that first persons’ friends all were made upset by the fact that they personally did not have the smartphone (envy). Then we might end up in an equilibrium in which everyone goes and buys smartphones (so they don’t feel left out) even though the best situation would be for no one to have a smartphone.
Hi Seth B.,
I’m not sure I get what you’re saying so I’ll reformulate what you’re saying:
First I’d like to say that I”m not completely sold that market failures actually exist but the car example is a good example and I think we are on the same page with it.
We agree that in this hypothetical situation people are buying massive vehicles in order to be safer which is creating a new equilibrium of massive cars on the road, which causes inefficiencies (i.e., more fuel spent, more road repair etc.).
Now for Smartphones. Smartphones are not built in order to cause envy. Yet, perhaps in that massive vehicles are not intended to make you safer (yet do at the expensive of smaller cars) there is an analogy to be made.
Let’s say that instead of no one having a smartphone everyone has smartphone 1.0 and suddenly your buddy get’s smartphone 2.0. Everyone was content but now many people are jealous. In order to alleviate their jealousy they rush out and buy the new phone. They do this even though it’s not making their lives noticeably better other than they don’t feel jealous anymore. Furthermore they could have used that money for better uses. So we’ll say that the externality is a miss-allocation of resources.
The reason I need to rephrase your statement is because if people were “perfectly happy” without smartphones then no one would buy a smartphone. You’re begging the question by asserting that this state of perfect happiness is disrupted by your following scenario. You’re assuming that equilibrium is the desired state, thus disequilibrium needs to be avoided.
I’d also take issue with what appears to be you assuming that it is the smartphone which causes the envy. I don’t know if you are actually saying this but I interpret so. In Austrian economics, economic actors are assumed to be rational maximizers. Thus, it’s hard to see how phone-envy can be a rational reason for expending resources. Envy is a character failure, not a market failure. Which is why I say that I think you are conflating ethics and economics.
Again, I’m not convinced that there are any instances of true market failure but the car example is much more compelling. It’s hard to say that someone who isn’t concerned for their safety is a ‘rational-maximizer’. But before you or anyone jumps in to lecture about the problems with the term ‘rational-maximizer’ we need to understand that it is used here in the spirit of behavioralism.
Thanks for the reply,
Talk to you later.
Marc,
I don’t know exactly what Hayek would have said, but I can speak to a common view proposed by Ronald Coase in 1937. He proposes that a a large company is essentially a ‘no free trade zone’ in which all decisions can be directed by the CEO. He then argues that reason why some industries have big companies and some are mostly composed of small companies have to do with the relative benefits of central planning vs. free competition. In industries where it is useful to have lots of people fully controlled by a single vision/leader financial markets will naturally create larger businesses and vice versa.
Of course there are also perverse reasons we might get large firms, such as monopolies taking anti-competitive actions etc.
i love you guys and love the podcast, in theory.
in practice, less.
when you don’t understand something you defer to authority. which is normal but normal is the problem.
philosophers should do otherwise.
hayek is a propagandist for fascists or corporations.
people and life have no place of priority to those who paid for this propaganda.
saying that central control is impossible to be perfect is trivially obvious.
setting up the straw man caricature of stalinist russia and saying: see everyone hated it. it is the worst is what a 24 year old news reader on fox news with perfect hair does to us.
you should be better. unless you are also trying to please your corporate sponsors. congrats on making some money out of this, but please keep it real despite your success.
stalinist russia is a “freddy kruger” that is used to make people afraid to challenge the abysmal and violent status quo.
am i a marxist? no. do i think marx swam in the deep end of the clear pool of human reason and beauty? yes, so did adam smith.
they saw reality first and tried to explain it. you may have problems with the arguments they end up with.
but YOU must agree that reality is a good place to start a science from.
this was a disappointing podcast. but now let me try to return from the land of ad hominem to see if i can make a more compelling point for you all to begin to repent from…
central planning seems overwhelming? ok all agree. it so happens that in reality it would be trivially easy to have very good information with the internet on a global scale.
this reality undercuts hayek’s straw man position. i mean he is wrong: we could centrally plan now way more efficiently than he could have imagined.
but he was wrong even before the internet makes his straw man suddenly sturdy and formidable.
my intuition is that he is wrong.
i would just propose that yes: virtue is teachable. efficiency and quality of life could be prioritized. waste could be made to feel almost sinful as it is in third world countries, in native indigenous cultures. in traditional catholic , jewish, buddhist, muslim and every culture…
thanks to hayak’s bosses. we now in america all seem to waste as a matter of pride. in your texas i just rad about wind power being given away for free. hmmm, never heard of oil being so abundant we should give it way free. but let’s use central planning to waste renewable energy so we can keep saying how childish it is to prioritize a beautiful clean cheap not smelly world… let’s use central planning to take 50% of GDP and make an army. but let’s make sure not to centrally plan anything to make say a work-tax whereby the oil based pollution is cleaned by everyone , say one week a year you owe to clean up the mess…
maybe then we would clean up together… better not do that. better just tax poor people. don’t give anyone food, just give them addictive made up things like money and mcdonald’s “meat”…
anyway, i am clearly tipping my hand…. marx is better hayak is better as a female hollywood strlet named salma…
and you guys can do way better.
thanks
Hard to follow this.
But the profound philosophical idea in Hayek is that by ‘planning’ in the way you seem to suggest (and in the way the USSR took to insane levels leading to the deaths of millions) you make decisions that are bound to be based on ignorance.
More. You’re necessarily ruling out various categories of human creativity that have to be banned or be ignored by the state because the ‘planners’ can’t manage to prioritise and cope when it comes to inventiveness.
This leads to literally inhuman results. Stalin’s Russia and Ukraine were no F Kruger. They happened. The people presiding over this monstrosity all had the collected works of Marx on the shelves in their offices. They drew directly on those ideas, and used them to murder people.
Hayek drilled down deep into part of this insanity, and explained why exactly that very idea was doomed to fail, for reasons of epistemology itself.
For an example happening just now, see the gyrations in Venezuela as the state there drifts into ever-increasing folly as its very starting assumptions about cause and effect and knowledge itself are skewed:
https://www.americanthinker.com/blog/2018/03/hilarious_venezuela_to_eliminate_3_zeroes_from_currency_to_combat_economic_persecution.html