Category Archives: institutional economics

Why I would be inclined to replace the FCC and the FDA

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Francis Fukuyama writes,

Institutions are created to meet the demands of specific circumstances, but then circumstances change and institutions fail to adapt. One reason is cognitive: people develop mental models of how the world works and tend to stick to them, even in the face of contradictory evidence. Another reason is group interest: institutions create favored classes of insiders who develop a stake in the status quo and resist pressures to reform.

Pointer from Tyler Cowen.

The same holds true in business. Business organizations develop group-think biases and constituencies that resist change. However, if this gets to the point where the organization becomes dysfunctional, the market weeds out the organization. Government agencies lack such a weeding-out mechanism.

Overall, I found Fukuyama’s views did not correspond well with mine. I am concerned with the fundamental knowledge gaps that plague government policymakers. I think that the difference between market competition and government monopoly is significant. I also think that there are diseconomies of scale and scope in government.

Niall Ferguson on Networks and Hierarchies

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He writes,

European history in the 17th, 18th, and 19th centuries was characterized by a succession of network-driven waves of innovation: the Scientific Revolution, the Enlightenment, and the Industrial Revolution. In each case, the sharing of novel ideas within networks of scholars and tinkerers produced powerful and mainly positive externalities, culminating in the decisive improvements in economic efficiency and then life expectancy experienced in the British Isles, Western Europe, and North America from the late 18th century. The network effects of trade and migration were especially powerful, as European merchants and settlers exploited falling transportation costs to export their ideas, as well as their techniques and goods, to the rest of the world. Thanks to those ideas, this was also an era of political revolutions. Ideas about liberty, equality, and fraternity crossed the Atlantic as rapidly as pirated technology from the cotton mills of Lancashire. Kings were toppled, aristocracies abolished, and churches dissolved or made to compete without the support of a state.

Yet the 19th century saw the triumph of hierarchies over the new networks. This was partly because hierarchical corporations—which began, let us remember, as state-sponsored monopolies like the East India Company—were as important in the spread of industrial capitalism as horizontally structured markets. Firms could reduce the transaction costs of the market as well as exploit economies of scale and scope. The railways, steamships, and telegraph cables that made possible the first age of globalization had owners.

He argues that networks once again have gained an advantage, but he backs away from forecasting the demise of hierarchical corporations and states.

The Market is a Process, not a Decision Mechanism

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Veronique de Rugy testified,

But unlike in the marketplace, the incentives for good management in government are very weak. For instance, even though lawmakers are expected to pursue the “public interest,” they make decisions that use other people’s money rather than their own. This means that their exposure to the risk of a bad decision is fairly limited, and there is little to no reward for spending taxpayers’ money wisely or providing a service effectively or efficiently

This is standard public choice theory, and it is not wrong. But it is not persuasive to those who believe that moral authority is or ought to be sufficient to overcome such problems.

I think that many commentators contrast the market and government as mechanisms for making decisions. In this contrast, the market sometimes has an efficiency advantage, but government is presumed to have a moral-authority advantage.

Instead, think of the market as a process for testing hypotheses. The process is brutally empirical, winnowing out losing strategies and poor execution. In contrast, elections are a much weaker testing mechanism. Elections are unable to winnow out sugar subsidies, improvident loan guarantees, schools that produce bad outcomes, etc.

It is a lack of understanding of this dynamic that leads some people to surprised that healthcare.gov does not work as well as one of the leading commercial web sites. I keep trying to reiterate, as I do on this podcast, that something like Amazon is a rare survivor of a tournament. The private sector produced plenty of business ideas and software systems that were as bad as Obamacare and healthcare.gov, but those get winnowed out.

Cosmos and Taxis

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A new journal that looks interesting.

emergent orders are unplanned and exhibit orderly development trajectories, but only some of them are spontaneous orders in the sense of providing easily interpreted feedback to order participants. Examples of emergent orders that are not spontaneous in the sense of Hayek or Polanyi are civil society, the ecosystem, and human cultures.

That is from the editorial introduction by David Emanuel Andersson. Pointer from Jason Collins.

Clever Policies, Hard to Execute

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Timothy Taylor writes,

But the EITC is a program that involves complex rules for eligibility and size of payments, much more complex than Social Security. The EITC is aimed at low-income people, many of whom have economic and personal lives that are in considerable flux and many of whom have limited ability to deal with detailed paperwork, unlike the health care providers who receive Medicare and Medicaid payments. The envisioned health insurance exchanges are likely to end up serving many more people than the EITC. The complexity of decisions about buying health insurance is greater than the complexity of qualifying for cash payments from the EITC. When people’s eligibility for subsidies is moving and changing each year, as it is for the EITC and will also be for the health insurance exchanges, it will be difficult for the federal government to sort out eligibility. And as the complexity of the rules rises, it will spawn a network of people to help in filling out the forms, most of whom will be honest and forthright, but some of whom will focused on making people eligible for the largest possible subsidies, with little concern for legal qualifications.

Read the whole thing. Wonks should keep in mind that complex approaches that attempt to fine-tune incentives tend to be difficult to execute.

Exit, Voice, and Knowledge

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Samuel DeCanio writes,

democratic politics creates difficult knowledge problems for modern societies. By granting political parties exclusive authority over the production of goods and services, by preventing voters from comparing the effects of parties’ policies, and by requiring voters to evaluate the consequences of policies without a common metric for comparing disparate goods, democratic politics exacerbates the effects of ignorance on human affairs.

Pointer from Peter Boettke. This is an issue on which progressives and libertarians talk past one another. I think that for progressives what is important is that the political process has the potential to work well, while we know that markets fail to realize the potential of perfect competition under perfect information. For example, I read Steven Teles as saying that the problem with democracy is not that it inherently faces knowledge problems but that certain institutional characteristics, such as the Senate cloture rule, are at fault.

When the issue is government vs. the market, frankly, I have a hard time giving a good account of the progressive point of view. I keep hearing it as “markets fail, therefore government works,” and I know that is an uncharitable interpretation.

Narrative Wars on the State of the Economy.

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John B. Taylor and Lee Ohanian write,

why is the current recovery so weak? It is not because of the aftermath of the 2007-08 financial crisis. U.S. Financial markets began to recover in late 2008, more than four and a half years ago.

I am just starting to write in my book about the aftermath of the financial crisis (which means I am on the home stretch, although I am not sure that I might not try one more major re-write of the whole book). Like Ohanian and Taylor, I find it striking that he employment/population ratio today is actually lower than it was during the official “recession.” (See also Stephen Bronars on a careful calculation that adjusts the employment/population ratio for demographic trend factors. Bottom line: it still looks awful.)

My take on that is that the NBER dating of the end of the recession is a distortion of reality. Yes, GDP started to rise in the middle of 2009, but otherwise, things do not look very good.

Why is the economy not doing well? I would suggest the the latest Economic Freedom indexes might have part of the answer. Since the year 2000, we have fallen on a 10-point scale from 8.65 to 7.74.

The left’s counter-narrative is that the financial crisis blew a deep hole in the economy, and we needed bailouts and Keynesian stimulus do dig us out. We had about the right amount of bailouts, but not enough stimulus. And anyone who believes anything different is anti-science and defiant of the facts.

Big Gods

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That is the title of a new book by Ara Norenzayan. I have just started it. It appears to be an account of religion that is based on evolutionary psychology. He argues that the religions that thrived are those with (p. 6-7)

beliefs and practices that reflect credible displays of commitment to supernatural beings with policing powers.

This facilitates trust in strangers, which is otherwise difficult for humans (or any other species) to achieve.

I found the book very persuasive–perhaps too persuasive. I worry that so many of the psychology experiments that provide support for his propositions use “priming” techniques, and I wonder how well they replicate. I also worry that the idea that fasting and other painful rituals help to signal commitment makes for a “just-so” story.

Here is a question to think about. If religions help to create social capital by allowing people to signal conscientiousness, conformity, and trustworthiness, how does this relate to Bryan Caplan’s view that obtaining a college degree performs that function?

Institutions-Intensive Economy

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My latest essay:

Over the course of Coase’s lifetime, the locus of economic activity has been shifting, from the farm to the factory floor to the office and even to “the cloud.” With each step, the concept of property has become more difficult to define, the economic entities have become more difficult to locate in time and place, the proportion of wealth that is intangible has risen, and earnings have become increasingly contingent on social constructs rather than on individual attributes.

Some of the themes circle back to the book that Nick Schulz and I wrote.