Grappling with the Market

Arguing with free-market enthusiasts can be tedious, but somebody’s got to do it. In his most recent book, social-democratic economist John Quiggin examines the case for markets and where it goes wrong.

A bust of economist Adam Smith. (Caitriana Nicholson / flickr)

The right-wing classic Economics in One Lesson, by Henry Hazlitt, was originally published in 1946. Hazlitt was a libertarian journalist influenced by the so-called “Austrian school” of economics. His book proved quite popular in its time. At first glance, it’s a polemic against the emerging economics of John Maynard Keynes, which had crossed the Atlantic from Britain and begun to exert strong influence in the United States. Hazlitt wrote for a popular audience and grounded his arguments in reductionism and bad faith. I would not recommend his book.

However, John Quiggin of the University of Queensland, in Brisbane, Australia, takes Hazlitt seriously as an exemplar of how conservatives understand economics today. In this book, he supplies us with a “second lesson” that addresses the myriad deficiencies in Hazlitt’s survey. Quiggin is as good a green, social-democratic economist as one can find, so his book is a showcase for the progressive use of “mainstream” economic theory. It is left to the reader to judge whether there is a case for a third lesson.

Hazlitt reduces his own message to:

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

You could be forgiven for thinking, “Well, no shit, Sherlock.” Quiggin recapitulates Hazlitt’s argument sympathetically, the better to take it apart subsequently. The core of that argument is more clearly advanced by Quiggin than by Hazlitt himself. It follows from the economic concept of opportunity cost.

The simplest summary of opportunity cost, which you were given if you ever set foot in an economics classroom, is that it arises when, in order to get something, you must give up something else. The value of that “something else” is the opportunity cost of the “something.” On the surface this will sound trivial, but in the minds of economists there are layers and more layers.

There was an amusing flap some years ago when somebody initiated a survey of professional economists, offering up a quiz to test their understanding of the concept of opportunity cost. The failure rate was high — I would say for two reasons. First, the test question hinged on a relatively arcane technical point, and second, at that level, there is something flaky about the concept itself. (Full disclosure, I answered the question correctly. Honest!) But here, the simple and obvious definition will serve our purposes.

It may not be obvious, but the idea of opportunity cost supports the idea of gains from free exchange between individuals or nations. The reason is, you would never consent to a trade unless your well-being was improved. In other words, if you engage in a transaction with informed consent, what you receive must more than compensate you for what you gave up — your opportunity cost.

The shoemaker exchanges the shoes he makes for candles he cannot make. He can always make more shoes, so an extra pair is worth less to him than what he can obtain in candles. And he will keep making and trading shoes for candles, until the point where the value of candles he receives exactly offsets the cost to him of making an additional pair of shoes.

This blissful outcome is also known as “competitive equilibrium.” It is efficient because all resources are employed — both the shoemaker and the candlemaker are hard at work — and the resulting distribution of output cannot be improved upon, at least in the sense that nobody can be made better off without somebody else’s ox being gored. In this particular style of economic thinking, no such redistribution can be scored as improvement, because the well-being of different persons is not comparable in any overarching, social respect.

The setting for free exchange is the market, so markets are good. “But, but, but!” you might say. Yes, we are ignoring all the things outside the simple act of exchange that could render this situation less benign. Quiggin is a professor, so he follows the usual pedagogical practice of laying the foundation before digging it up, using the concept in a variety of practical applications. His book would be a useful supplement to a principles of economics course, with the advantage of avoiding resort to any graphs or equations.

Free Lunches

In offering a critical recapitulation of Hazlitt’s account, Quiggin hints at the critique to come. His “Lesson Two” opens with a bang-up quote from the philosopher David Hume’s Essays, Moral, Political and Literary:

There is no property in durable objects, such as lands or houses, when carefully examined in passing from hand to hand, but must, in some period, have been founded on fraud and injustice.

Well! Now that we have your attention, Quiggin explains how the foundation of efficient exchange in markets is the sand of an arbitrary distribution of wealth, indeed “founded on fraud and injustice.” In other words, the state of affairs left by markets has no normative standing, no ethical basis.

Hazlitt meant to go on the warpath against Keynes and his followers, who rejected the traditional economist’s view that there are no free lunches. If there are idle resources, such as unemployed labor, the opportunity cost of additional output is zero. (We are talking about cost in terms of physical resources — land, labor, and capital.) The implication is that, unless it is employed, labor’s productive output is nil. Employing it is costless. Quiggin brings Keynesian theory to the center of this question.

The big potato of free lunches is the boost to economic well-being brought about by full employment, made possible by activist fiscal and monetary policy. There is a big free lunch available if the economy is failing to reach its potential output. Quiggin suggests that the economy fails in this sense much more often than is usually supposed. A more radical take would be that it fails almost all the time.

Either way, as Keynes himself acknowledged, such a condition can persist almost indefinitely. Today a buzz surrounds the old idea of “secular stagnation,” originally proposed by Keynes’s early followers in the United States, such as Alvin Hansen. The idea was that, absent a large boost from fiscal activism — meaning deficit spending and monetary expansion — the economy would crawl along at an unsatisfactory rate. This proved not to be the case after World War II. The US economy in the 1950s and ’60s grew like mad, and the idea of secular stagnation was discredited. But more recently, in the aftermath of the great meltdown of 2008, we’ve seen a slower than expected rate of employment recovery and very little wage growth. Today, even centrist economists suggest that this betokens a new era of secular stagnation.

Failing Markets

As Quiggin demonstrates, even confined to the “micro” level of individual markets, Hazlitt leaves much to be desired, since he is innocent of any appreciation that markets can fail absent interference by government. These failures were concisely enumerated in one of my favorite economics articles ever (also cited in Quiggin’s book), a 1958 piece by Francis Bator of Harvard entitled “The Anatomy of Market Failure.” Quiggin elaborates them for a popular audience.

The most well-known type is monopoly. Here we have markets in a superficial sense — people buying and selling — but there are only one or a few sellers. The implication is that output will be restricted because the seller is able to charge higher prices. (The extra revenue from the higher price more than offsets the loss in revenue to the seller from reduced sales.)

The flip side of monopoly is monopsony, most salient in the labor market, where the existence of only a few buyers (the employer) reduces the incomes of sellers of labor power.

Another type of market failure is the existence of externalities — fallout from a market exchange that affects third parties. It could be positive or negative, but in either case it signifies an inefficient outcome. There is either too much output, in the negative case, or not enough, in the positive. An extreme, albeit common, case of externality is a public good, whose nature is that its provision benefits a broad portion of the population.

These days, the varieties of market failure (there are others) will be conveyed by any competent economics instructor not deranged by animosity toward the public sector. A more radical perspective would acknowledge the logic of market failure but would worry about it leading to the mistaken inference that the well-functioning market is in some way the “normal” state of affairs, while the failures are exceptions.

To the contrary, the economy is replete with badly functioning markets, and markets that are missing altogether. (For instance, there is little more than a rudimentary market for carbon emissions.) The well-functioning market is more the exception than the rule, not to say an utter myth. And even if we had efficient markets, as noted above, the moral foundation for these markets is lacking.

Quiggin brings to bear the tools of what is sometimes disparaged as “mainstream economics” on all the shortcomings of markets. In this respect, it is essential reading for anyone interested in the practical side of economic policymaking.


Economics for Socialists

Why should a socialist read it?

First off, if you’re a Bernie Sanders–type socialist, you’re no different from Quiggin himself. His book is right up your alley.

If you look forward to socialization of a greater share of the economy (such as postal savings banks, or public broadband), the standard theory of public goods, interpreted in a properly sympathetic manner and upheld by Quiggin, is also on point.

Quiggin’s deconstruction of Hazlitt’s “Lesson One” provides a lesson in “know your enemy” for anyone left of center. If your only instruction in economics was a principles course, this book provides an essential completion of the basic story. You will be empowered to see the fundamental flaws in economic reasoning broadcast by all the big-time, know-nothing, right-wing outlets and pundits.

If your hostility to markets runs more deeply, then the mainstream theory elaborated by Quiggin provides a useful challenge. As suggested above, the canonical theory is susceptible to critique for its grounding in the isolated, rational satisfaction-seeking of atomistic persons (known in the trade as utility theory). As a sociologist friend once told me, “You people (economists) individualize everything.” (Quiggin, in his academic research, has examined utility theory critically.)

What becomes deemphasized, when it is not glossed over entirely, is, on the one hand, the proliferation of “externalities” that bind together the interests of ostensibly disparate individuals, and on the other, our capacity (historically demonstrated) to respond effectively on a cooperative, collective level.

Economics as practiced by progressives pursues these insights, but, as I think Quiggin would agree, it has further to go. His “second lesson” is a crucial step in this journey.