“When markets fail, use markets.” The above is a quote from Arnold Kling, the person who started this blog. I thought of that when reading Sally Satel, “Rethink Crisis Response,” Reason, October 2020. The whole October issue, by the way, is focused on fixing the police, and it’s excellent. Here are the first 3 paragraphs from Satel’s article. “Please just send one police car, please don’t have your weapons drawn, please take him to the hospital.” These are the words that many families with a mentally ill loved one have learned to say when crisis strikes. Sabah Muhammad and her siblings have spoken them several times since 2007, the year her brother was diagnosed with paranoid schizophrenia. He had been a standout student and star running back at his high school near Atlanta, but everything changed around his 18th birthday. “He would become catatonic, barely moving, just staring into space,” Sabah explains. “Sometimes he locked himself in his room for weeks, refusing food, except to come out of his room at 3 a.m. to make toast that he blackened to carbon ‘to get the poison out.'” Mute and malnourished, he would not allow family to take him to a psychiatrist—but he desperately needed help. The only option in the Muhammads’ Atlanta jurisdiction was a 911 call to report a psychiatric emergency, which tended to bring the police, multiple squad cars with lights flashing, and the ominous specter of armed agents encountering a young black man in a delusional state. So Sabah and her family would call the police, and pray. The data justify their dread. Between 25 and 50 percent of all people killed annually by police are in the midst of a mental health crisis when they’re slain, according to a report by the Treatment Advocacy Center (TAC), a Virginia-based nonprofit dedicated to improving treatment for people with serious mental illnesses. Satel goes on to discuss why there should be other models: why it would make sense to call emergency responders who are skilled at dealing with people who have mental health problems. I agree. Implicit, though, in her article seems to be the idea that the emergency responder should be a government official. But why? Even economists with more trust in government than I have tend to think that governments should provide public goods. But when someone has mental health problems, treating that person is a private good. The treatment is rival in consumption (the resources to treat one person can’t be used to treat another person at the exact same time) and excludable (it’s easy to withhold the service from someone who doesn’t pay. It’s true that such private provision does not seem to exist now. My guess is that that’s due in large part to the fact that we are so used to calling 911 in an emergency and to the fact that the government doesn’t charge for the service. But if people, as Satel writes, “dread” having the government come with guns, people might not think that service that they pay zero on the margin for is so great. That’s where Arnold Kling’s line comes in. Private provision doesn’t exist; start providing privately.   (0 COMMENTS)

Have you ever been on a roll- like a Steph Curry at Madison Square Garden roll? If so, you may have experienced the “hot hand.” Or maybe you played roulette at a casino, and you just knew which color would come up next. Are those “rolls” the same? Are they even real? In this episode, host Russ Roberts welcomes Ben Cohen to talk about his new book titled, of course, The Hot Hand. When someone is “on fire,” what part of our nature does this phenomenon appeal to? Do we see “streaks” more because we are story-telling animals, or are we just “fooled by randomness?” Let’s see what you think. Consider the prompts below and help us continue the conversation. As always, we love to hear from you.     1- Referencing another sports-focused episode, Roberts asks Cohen if the idea of the “hot hand” is really just the flip side of “Money Ball“. What does he mean by this? How is basketball any different than coin flipping or roulette in terms of “streaks”? Why do we come to different conclusions about Curry’s shots and the roulette wheel?   2- Why was Shakespeare on a roll in 1605? How is the story of his streak similar to that of Steph Curry? How is it different?   3- Is it better to think like a farmer or a basketball player? (Hint: think about “playing defense.”) Explain.   4- Why might “the fundamental question of investing and stock-picking” is whether the hot hand exists? How can someone like David Booth believe in the hot hand when it comes to basketball, but behave as if it doesn’t in his profession?   5- When have YOU found yourself “in the zone.” Cohen and Roberts talk a lot about their writing (and some personal sports examples). What were you doing? What do you think  enables you to get into “the zone”? Can you teach someone how to find “the zone?”     (0 COMMENTS)

Between March and July 1933, FDR’s policy of devaluing the dollar pushed industrial production up by an incredible 57% in just 4 months. Then FDR’s National Recovery Administration instituted a policy of mandating sharply higher wages. Hourly wage rates rose by roughly 20% in just two months. This immediately ended the robust economic recovery then underway. When the Supreme Court ruled the NIRA to be unconstitutional in May 1935, there had been no growth in industrial production for 22 months. Immediately after the NIRA was declared unconstitutional, industrial production once again took off like a rocket, until this second recovery was derailed by tight money and another wage shock in 1937. You’d think that FDR would have thanked the Supreme Court for rejecting the disastrous NIRA and triggering a surge in the economy—a boom that allowed FDR to win a huge victory in November 1936. In fact, Roosevelt was so frustrated by the Supreme Court that he tried to enlarge the court at the beginning of his second term. The goal was to add a number of FDR loyalists to the court, effectively reducing America’s political system from three branches to two. You occasionally see similar moves in the modern world, but mostly in authoritarian regimes. BTW, FDR was a fan of Mussolini. In the 1937, the US still had pretty strong resistance to authoritarianism. Even though the Democrats held an overwhelming 74-17 margin over the GOP in the Senate, there was so much outrage at FDR’s power grab that the proposal was eventually dropped.  America narrowly avoided becoming an authoritarian state.  The checks and balances put in the Constitution held up. Today I’m seeing renewed calls for court packing.  I suspect that if proponents of this scheme understood more about the 1937 attempt at court packing, as well as the effects of court packing in various banana republics, they would reject this idea. PS.  It’s important to distinguish between court packing and court enlargement.  With legitimate court enlargement, as with the 22nd amendment to the Constitution limiting the president to two terms, the current occupant of the presidency is exempted.  I don’t have strong views either way on legitimate proposals for court enlargement, but allowing the same president who signed a court enlargement bill to also engage in court packing would be a mistake of epic proportions.  Checks and balances are an essential tool for preventing authoritarianism. (0 COMMENTS)

I teach the economics of discrimination every chance I get.  Why?  Because the analytical framework, launched by the great Gary Becker in 1957, mightily illuminates so many questions that we care so much about.  When you see that almost all garbage collectors are male, for example, what should you conclude?  Perhaps women and men are equally able and interested in collecting garbage, but employers in the industry dislike women.  Perhaps male garbage collectors don’t like working alongside women.  Or perhaps customers don’t want women to touch their trashcans.  Alternately, perhaps men are better at collecting garbage than women.  (Statistically!)  Or maybe women dislike this line of work more than men.  (Again, statistically!) One of these stories might be the whole truth; all five could have some merit; or anything in between.  The analytical framework can’t tell you the breakdown; you need empirics (and good judgment) for that.  Yet without Becker’s analytical framework, empirical researchers wouldn’t even know where to start. One of the main insights of this Beckerian framework is that discrimination creates profit opportunities.  That includes employer-on-worker discrimination, worker-on-worker discrimination, and consumer-on-worker discrimination.  If most employers dislike workers in group X, depressing their wages below their productivity, employers who feel differently can profit by hiring them.  If most workers dislike workers in group X, similarly, employers can profit by giving the disliked workers “a firm of their own.”  If most consumers dislike workers in group X, employers can profit by keeping disfavored workers out of the public eye.  This doesn’t mean that market forces transform bigots into models of tolerance, though perhaps they do that too.  What the Beckerian framework implies, rather, is that market forces help neutralize bigotry’s effects.  With the right incentives and strategies, intolerance can be both prevalent and impotent. Most research on the economics of discrimination focuses on race and gender, but Becker’s framework works equally well for political bigotry.  Which raises a series of awkward questions for anyone troubled by the rise of corporate-sponsored “social justice” in general, and “cancel culture” in particular.  In the current office climate, even many life-long left-wingers fear the career consequences of publicizing their doubts about evolving left-wing orthodoxy.  They’re afraid to share their views with co-workers, and afraid to express themselves on social media because their co-workers might find out.  Moderates and right-wingers feel an even stronger need to keep their political views to themselves.  Cutting-edge leftists, in contrast, now feel empowered.  When they speak out on the job, employers seem attentive and responsive. This is not what the economics of discrimination would make you expect.  After all, the labor market is full of right-wing workers.  If left-wing employers don’t want to hire them, you would expect both pragmatic and right-wing employers to pick up the slack.  If left-wing workers don’t want to toil alongside right-wing workers, similarly, you would expect both pragmatic and right-wing employers to tacitly create politically segregated workplaces.  If left-wing consumers don’t want to buy products from right-wing firms, finally, you would expect both pragmatic and right-wing employers to keep politically disfavored workers out of the public eye. In the real world, however, it seems very hard to find businesses that warmly cater to moderate and right-wing workers.  Sure, you can work for a right-wing think tank, a conservative church, Fox News, or Republican-allied lobbyists.  And I just visited a decidedly right-wing gift shop in West Virginia; it really stood out!  Yet all such establishments sum to a tiny sliver of GDP. I understand, of course, why few businesses warmly cater to libertarians, or theocrats, or monarchists.  There aren’t enough monarchist barbers to economically justify a monarchist barbershop.  Where, though, are the firms where Republicans don’t look over their shoulders before they say they’re pro-life?  Where are the firms where moderates don’t look over their shoulders before they declare that affirmative action has already gone far enough?  Where are the firms where males don’t look over their shoulders before they express solidarity with the latest target of #MeToo?  Billions of 360-degree glances look like a massive profit opportunity.  Why then are so few businesses trying to capitalize on said opportunity? Let’s name and ponder the leading explanations. Explanation #1. My summary of the political climate of American business could be flatly wrong. Tentative evaluation: I doubt it, but I freely admit that my data is poor. Explanation #2. Perhaps I’m missing geographic variance.  Maybe leftists bully the right in firms in the Northeast Corridor and California, while rightists bully the left in firms in the South and Texas. Tentative evaluation: There is probably some truth here.  There must be plenty of firms in the South and Texas with minimal left-wing propaganda.  Still, are there really many where the Human Resources Division hails meritocracy and condemns hypersensitivity? Explanation #3. Perhaps I’m missing occupational and/or industry-based variance.  Leftists rule academia, and dominate law and tech.  But the right rules a bunch of other prominent occupations and industries. Tentative evaluation: I struggle to convincingly name more than a handful of such occupations and industries.  In the past, you might say “doctors.”  Yet these days younger doctors seem like typical left-wing elites.  Engineers, similarly, seem more politically apathetic than right-wing. Explanation #4. Few moderates or right-wingers care enough to create a major profit opportunity.  While they don’t relish looking over their shoulders, they prefer their current job to an alternative where they can shoot their mouths off but earn a $1000 less per year.  In this story, the left proverbially just “wants it more.”  And as usual, the market takes the intensity of conflicting preferences into account. Tentative evaluation: Very plausible, especially considering how strong the age-ideology correlation has become.  When today’s conservatives encounter politics on the job, they don’t start polishing their resume to find a more politically hospitable home.  They tell themselves, “I’m too old for this @%!&!” and get back to work. Note: A slight variant is that left-wing consumers are more willing to boycott firms they dislike than right-wing consumers.  The media’s liberal bias could easily amplify this: The left is more likely to hear about corporate policies they find objectionable than the right.  (Though this in turn raises the question, “Why does a highly competitive media market lead to such pronounced left-wing bias?”) Explanation #5. Discrimination law covertly stymies the creation of right-wing firms.  Most obviously, any firm that openly and aggressively opposed #MeToo and #BLM would soon be sued into oblivion. Tentative evaluation: Even more plausible.  Imagine what would happen if a firm’s top brass loudly declared that, “Discrimination simply isn’t a problem here” – and routinely fired complainers for contradicting the party line.  Picture a firm blanketed in propaganda telling workers to “Be color-blind,” “Laugh it off,” and “No one likes a tattle-tale.”  A small business in a conservative area might get away with this for a few years, but a Fortune 500 company that stuck to its right-wing guns would go down in flames.  This does not prevent firms from promoting a mildly right-wing corporate culture, but you won’t attract many politically homeless workers with such marginal improvements. What’s the real story?  Any possibilities that I’ve missed?  I especially prize answers based on first-hand work experience outside of academia… (0 COMMENTS)

There have already been an extraordinary number of remembrances, celebrations, and criticisms written of Ruth Bader Ginsburg’s life and work in the days since her passing. I’m grateful for her contributions to advancing gender equality in law, but I have no assessment of her overall judicial legacy to add to the outpouring. Instead, I’ll offer just a few thoughts about her success and why it means so much to so many people. One question that fascinates me when I think about RBG is: what made her decide she could do it? When RBG started law school in 1956, women accounted for less than 3% of the legal profession (preface; this and all other page numbers refer to Ginsburg’s collection of writings, My Own Words). Further, she was a mother. At the time, being a woman in a demanding profession was unlikely enough, but being a mother and a professional was truly exceptional. Until the early 1950s, the majority of local school boards and clerical firms had “marriage bar” policies in place against the hiring and retention of married women, so heading off to law school with a family in tow was truly a venture into uncharted waters. This is around the same time when Elinor Ostrom—future Nobel Prize winner in economics—would have been splitting up with her first husband because he saw graduate coursework as incompatible with their life together (Tarko, p. 4). Ginsburg credits her mother and her undergraduate teachers with enabling her “to take part in the effort to free our daughters and sons to achieve whatever their talents equipped them to accomplish, with no artificial barriers blocking their way” (preface). She credits her mother with encouraging her to be a lady, meaning, to always be civil; to be independent; and to love libraries and books. Ginsburg mentions the ambitious, literary “Jo” from Louisa May Alcott’s Little Women as a favorite find from those early days in the library (p. 4). I suspect if you took a poll of women in academics today, you’d find an awful lot of “Jo”s. LOUISA M. ALCOTT / Public domain She also credits two of her undergraduate professors, novelist Vladimir Nabokov, and constitutional scholar Robert Cushman, with teaching her the value of choosing words carefully and taking a principled stance (p. 20-1).The latter was deeply concerned about the impact McCarthyism was having on civil liberties. RBG’s engagement with this cause was her first experience with the idea of the lawyer as a defender of constitutional rights, an influence which would carry through into her work with the ACLU’s Women’s Rights Project. The first brief RBG filed with the U.S. Supreme Court as a lawyer was in the 1971 case of Reed v. Reed, in which a mother had sued to be able to administer the estate of her deceased son. Idaho law had given explicit preference to the father since he was male, but the Supreme Court decided in favor of RBG’s argument that the Fourteenth Amendment did protect against gender discrimination in law (p. 115). RBG saw this work to advance equality as the “constitutional legacy” of our founding ideals: “The founding fathers rebelled against the patriarchal power of kings and the idea that political authority may legitimately rest on birth status. Their culture held them back from fully perceiving or acting upon ideals of human equality and dignity” (p. 231). Those interested in comparative economic systems may be interested to find Don Lavoie expressing a similar sentiment in his conclusion to National Economic Planning: What is Left?, in which he argues that it was the incompleteness of the founding father’s vision of a non-hierarchical liberal democracy that blinded them to the harm that slavery, inequality in rights, protectionism, and monopoly privileges would wind up causing to their government and their principles. Metaphors like “breaking a glass ceiling” don’t really fit lives like RBGs. They suggest that there was an obvious way up and out, and it was only a matter of time before someone broke through. RBG herself used the term “waypaver” when talking about the women who had broken down earlier legal and professional barriers. It doesn’t roll off the tongue as smoothly as other descriptors, but it fits reality well. History didn’t have to move the direction that it did. Waypavers are willing to be first in line to take chances that others around them are either not willing or not able to. In so doing, they forever alter the expectations of those who come after them. By deciding the path of professional constitutional law was possible for her, Ginsburg made it easier for others to decide they were capable as well. RBG was well aware of those who paved the way for her as well. For instance, she spoke on multiple occasions about Belva Lockwood, the first woman to gain admission to the U.S Supreme Court Bar, and the many obstacles she had overcome. Lockwood’s 1869 application to study law was rejected because she “would…distract the attention of the young men,” and then her degree was denied even after she successfully completed all coursework because it would “lessen the value of the men’s diplomas” (p. 66). Lockwood would go on to be the first woman to argue in front of the U.S. Supreme Court and the first woman to run for President. Without Lockwood, would RBG have been able to be RBG? Without RBG, what future leaps would not be taken? Overall, RBG’s life and success are a testament to the power of encouragement. The experiences and lessons we receive directly from parents and teachers matter, as do the lessons from history about those who paved the way before us. Waypavers like RBG feed that inkling of doubt: maybe what we thought was impossible is in fact possible.     Jayme Lemke is a Senior Research Fellow and Associate Director of Academic and Student Programs at the Mercatus Center at George Mason University and a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics.   As an Amazon Associate, Econlib earns from qualifying purchases. (0 COMMENTS)

With the recent resignation of Shinzo Abe, there have been a number of articles analyzing the record of Abenomics. There seems to be pretty general agreement on two points: 1. Japan’s economy improved after Abe took office at the beginning of 2013. Deflation came to an end, nominal GDP began rising, the public debt was brought under control, and unemployment fell to just over 2%. 2. The policy was not completely successful. Most notably, inflation continued to run well below the 2% target set by the Bank of Japan. I believe that summary is correct. Where I part company with other pundits is in the lessons that Abenomics offers for monetary and fiscal policy. The Economist is fairly typical: The first lesson is that central banks are not as powerful as hoped. Before Abenomics, many economists felt Japan’s persistent deflationary tendencies stemmed from a reversible mistake by the Bank of Japan (boj). It had combined fatalism with timidity, blaming deflation on forces outside its control, and easing monetary policy half-heartedly. In 1999 Ben Bernanke, later a Fed chairman, called on the boj to show the kind of “Rooseveltian resolve” that America’s 32nd president showed in fighting the Depression. . . . The central bank is doing everything it can to revive private spending. Until it succeeds, though, the government has to fill whatever gap in demand remains. The shortfall in private spending is what makes government deficits necessary. This seems to be the consensus as to the “lessons” of Abenomics.  Monetary stimulus is not enough; you also need fiscal stimulus.  And yet if you look at the actual record of Abenomics, there’s not a shred of evidence to support this claim, indeed the opposite seems to be the case. For nearly two decades before Abe took office, Japan ran perhaps the largest combined monetary/fiscal stimulus in human history, at least during peacetime.  Remember, combined fiscal/monetary stimulus is the new consensus, the policy that most pundits in academia and the media now favor.  And what was the result of this massive stimulus?  Basically zero growth in nominal aggregate demand for almost two decades, a record even worse than seen in slow growing Italy.  If you’d told economists in the early 1990s that over the following 20 years Japan would mostly hold interest rates close to zero and increase the national debt from less than 70% of GDP to roughly 230% of GDP, and still have virtually no growth in nominal GDP, they would have responded that we need to abandon the standard textbook model of economics, as what we are teaching our students is clearly wrong.  Instead, we responded to this amazing analytical failure by doubling down on the very same flawed theory. The massive fiscal stimulus came to an end with Prime Minister Abe.  Taxes were raised several times and the national debt leveled off at just over 230% of GDP.  Instead of a combined monetary fiscal stimulus, Abe relied on monetary stimulus and fiscal austerity.  And the Japanese economy actually improved! I must admit that I am perplexed as to how my fellow economists draw their “lessons” from this record.  When people question monetary stimulus by pointing to the fact that Japan fell short of its 2% inflation target under Abe, I respond, “so do more”.  This doesn’t seem to convince anyone.  People seem to think I’m cheating, coming up with a theory that’s unfalsifiable.  “Yeah, you can always say they didn’t do enough.” But when it comes to fiscal policy, this skepticism goes right out the window.  If I point out that the huge Japanese fiscal stimulus of 1992-2012 failed boost aggregate demand, they say the Japanese should have done even more fiscal stimulus, as if boosting the national debt from less than 70% to 230% of GDP is not enough.  When I point out that the Bush tax cuts of 2008 failed, they say the tax cuts should have been even bigger.  When I point out that the Obama stimulus of 2009 led to an unemployment rate that was far higher than proponents predicted even in the absence of stimulus, they say the stimulus should have been even bigger.  When I point out that the economy actually sped up in 2013, despite widespread Keynesian predictions that it would slow due to austerity, they say that without austerity it would have improved even more.  When I point out that the economy did not fall off the cliff at the end of July when Congress failed to renew the fiscal stimulus, they say it would have improved even more with additional stimulus (even though the fall in unemployment in August was the second largest in history.) Now it’s certainly possible that I’m wrong and the Keynesians are right about fiscal stimulus.  Counterfactuals are tricky.  Maybe in all of these cases if they had only done more the results would have been better.  But in that case I’m honestly confused as to why I’m not allowed to argue the BOJ should have done more monetary stimulus.  Especially since while fiscal stimulus might become costly in the future if interest rates rise above zero, monetary stimulus is actually profitable, as central banks earn income on the assets they purchase with zero interest base money.  It’s monetary policy that seems to have truly unlimited “ammunition”, not fiscal policy. Nonetheless, I’ve been beating my head against the wall for so long on this issue that I feel I need to change the argument.  Thus I’ve recently focused not so much on the claim that Japan needed to do more, rather that Japan needed to do different.  The ultra-low rates and massive QE are actually a symptom of previous tight money mistakes. For example, the yen was about 124 to the dollar in mid-2015.  Today it’s roughly 105 to the dollar.  If Japan had simply pegged the yen to the dollar at 124 back in 2015, Japanese interest rates actually would have been higher over the following 5 years, mirroring the rise in interest rates in the US during this period (due to interest parity).  Monetary policy would have looked tighter to the Keynesian skeptic who (wrongly) feels that the actual Japanese monetary policy was highly expansionary, and ineffective.  And yet because the yen would have been far weaker, Japan would have actually experienced higher inflation than otherwise.  Indeed Lars Svensson made essentially this argument back in 2003, when he described a “foolproof” way for Japan to escape a liquidity trap.  He also noted that the higher nominal interest rates would be nothing to worry about, as this policy would have reduced the real interest rate in Japan, due to higher inflation expectations. There are political difficulties with pegging the yen to the dollar, but Japan could have achieved a similar result by setting an aggressive price level target combined with a “whatever it takes” approach to QE. So today I say to Japan, “don’t do more, do different.” And I say to my fellow economists, “use the same criterion for drawing lessons from monetary policy as you use for drawing lessons from fiscal policy.” PS.  Some economists do econometric tests of fiscal policy efficacy.  Elsewhere, I’ve criticized those tests for ignoring monetary offset.     (0 COMMENTS)

I received the following email from Bill Drissel about my “Public Choice: The Normative Core.”  Reprinted with his permission. Dr. Caplan The data you seek for your “normative core” is readily available in one arena: public transportation.  I follow the Anti-Planner, Randal O’Toole.  The planned benefit is number of riders.  The planned cost is usually available in dollars(of a given vintage).  The subsequent cost-overruns and consequent ridership are also available.  So every cost/benefit ratio could easily be adjusted by a “normative core adjustment”. For example, if extensive research shows that, for public transportation, actual costs / planned costs average 2.1 and actual ridership / planned ridership average 0.40, then the normative core adjustment factor for public transportation = 5.25.  So for back-envelope calculations, the planned cost/benefit should be multiplied by 5 or so. I have considerable acquaintance with software estimates including many that ended up in proposals and contracts.  I don’t know of a single case of software under-run (costs less than planned).  I would guess the typical over-run for routine software development at 2:1.  For difficult stuff: 5:1.  Really hard stuff like voice, face, fingerprint recognition: much higher than 5.  Development of a capable word processor with fonts and embedded images like MS Word, a single lifetime wouldn’t be enough. I had a one-man consulting business for 45 years.  Whenever I asked a client about his over-run experience, I got a mournful story.  If I suggested he apply an experience-based multiplier, the response was always, “If we did that, we’d never get any business!”  I guess that’s the equivalent of, “Junior Professor: By that standard, government should never do anything.” I admire the work that you and Don Boudreaux do.  I’m 87 but if I had encountered the public choice body of knowledge while I was much younger, I might have given up engineering for economics. ===================== Warmest regards, Bill Drissel bill@drissel.us The Colony, TX (0 COMMENTS)

In the analysis of market processes, the concept of externalities has long invoked strong public policy implications among economists regarding the role of government in addressing their alleged presence, or lack thereof. It is for this reason that analyses of externalities have preoccupied economists, at least since A.C. Pigou. The more important question, however, is how do they matter for economics?   In an excellent and thought-provoking article recently written by Don Boudreaux and Roger Meiners (2019), they provide a comprehensive overview of the origins of the concept of externality, its evolution, and its classifications. Boudreaux and Meiners put forth a subtle though sophisticated argument that transcends how economists generally arrive at particular public policy implications regarding externalities. My goal here is not simply to summarize their point, but also to provide my own interpretation of their argument. To summarize the concept briefly, an externality refers to a spillover cost borne by third parties to an exchange. Externalities arise when the market price at which a good is exchanged fails to account for the full cost (in the case of a negative externality) or benefits (in the case of a positive externality) of producing a good. Such costs or benefits are, therefore, not only involuntary, but more importantly, unexpected by third parties to the exchange. Externalities are indicative of a deviation from the ideal of perfectly competitive equilibrium, in which all potential gains from trade have been exhausted. Thus, the resulting “market failure” associated with externalities arises from the fact that “there exists a reallocation of resources, such as a change in the structure of market activities that will enrich society” (Boudreaux and Meiners, 2019, p. 21). This restructuring not only includes an adjustment in market prices to more fully concentrate the costs and benefits of exchange upon the relevant trading partners, but also, more importantly, an adjustment in the assignment of property rights, the exchange of which gives rise to exchange ratios, or market prices, in the first place. I will return to this last point later.   The fundamental aspect on which Boudreaux and Meiners focus is not the involuntary nature of externalities, but the degree to which they are expected or not. As they put it, “Externalities exist only when another party’s actions create unexpected spillover effects” (emphasis in original, 2019, p. 29). Building on Alchian (1965) and Demsetz (1967), Boudreaux and Meiners make clear that property rights “are a bundle of expectations” (emphasis in original, Boudreaux and Meiners 2019, p. 31) about how individuals can choose to use, exclude, and exchange resources. The expectation in a market economy is that property rights allow “harm” to the exchange value of a good or service, but not to its physical characteristics. Consider a barber who sets up shop in midtown Manhattan, assuming well-defined and enforced property rights, physical impediments to his expected ability to utilize his physical and human capital for providing haircuts constitutes an externality. For example, theft or other physical damage to the barber’s property rights are assumed to be prohibited. But, under these assumptions, he also has – or, as a reasonable person, should have – the expectation that a competing barber may “steal” away his clientele by providing a better haircut, thus reducing his income and the resale value of the capital he employs. Here is where the concept of externality gets a bit tricky, and why “the term has become nearly meaningless due to its ubiquity,” according to Boudreaux and Meiners (2019, p. 3). Returning to the previous example, suppose that building construction is taking place on 5th Avenue, requiring the use of jackhammers. These jackhammers, no doubt, are a nuisance to the barber, and therefore might impede his ability to provide haircuts in a safe and productive manner. A bad haircut or the slip of a razor blade while shaving a client will result in a misallocation of resources in terms of “too much” building construction and “too few” haircuts and shaves than would otherwise be optimal. Is this indicative of a negative externality? Does this example prove that building construction should be taxed in order for contractors to take into account the noise pollution resulting from construction? Not necessarily. The key here is the role of expectations. No doubt, incurring the noise pollution from jackhammering was involuntary if the building contractors did not get the barber’s consent beforehand. However, we can reasonably conclude that when the barber chose to locate his shop in midtown Manhattan, one of the most densely populated islands on earth, he would have expected and anticipated such occurrences. The fact that he nevertheless located there implies that he expects the cost to him of this particular “externality” to be sufficiently low as to not overwhelm the prospect of greater expected monetary income derived from serving a larger and wealthier clientele than if he located in a less populated area outside the city.   What does this way of looking at externalities reveal about the welfare implications of the market process? The fundamental point that Boudreaux and Meiners raise, as I understand it, is twofold. First, market processes are imperfect, meaning always in disequilibrium, and therefore imply that the expectations of individuals will never fully mutually coincide. If economists start in a world of disequilibrium as their analytic point of departure, then expectations about the costs and benefits of individual decision-making are never perfect (see Hayek 1937), in which case the concept of externalities, in an abstract sense, means everything and nothing. This implies, I would argue, that if the concept of externalities is to have any meaning and tractability, it must be grounded in an analysis of the particular expectations that individuals have in time and place. In doing so, it will provide the economist with a richer understanding of the public policy implications that follow from his or her analysis. Secondly, to admit or to deny the presence of externalities is not analogous to admitting or denying the presence of market imperfection. Admitting the presence of externalities does not necessarily imply the necessity of government intervention. But, the absence of externalities does not necessarily imply Pareto efficiency in the allocation of resources either. It therefore does not follow that embracing one analytical point of departure or the other implies the dismissal of or appeal to government intervention as a corrective.   As I’ve written elsewhere, imperfect markets do not imply suboptimality or an inherent flaw as compared to the ideal of equilibrium. Rather, imperfection implies “incompleteness” and therefore that markets are processes incessantly moving towards completion. That completion process is facilitated by greater mutual coordination of expectations, requiring corrections in expectations, which makes market processes necessary to addresses misallocations of resources in the first place! As Boudreaux and Meiners make clear, “nothing said here suggests that the absence of spillovers implies a Pareto-optimal allocation of resources” (2019, p. 30). It simply implies the failure of the conditions of the market process to exist, not the existence of market failure (see Candela and Geloso 2020). “The problem, if one asserts there is a problem, is the structure of property rights” (Boudreaux and Meiners 2019, p. 30). If I have correctly interpreted Boudreaux and Meiners, the question is not whether or not externalities matter for economists, but when they matter for economics, and how they matter for our analysis.   As an example to illustrate and conclude this point, let’s take the example of the solution devised by Julian Simon to the problem of airline overbooking (see Simon 1968). Generally speaking, airlines tend to overbook flights on the expectation that there will be a certain number of cancellations. Airline overbooking can then be reframed as problem of assigning property rights, since it creates a situation in which more than one individual has a claim on an assigned seat. When an airline involuntarily “bumps” an individual to another flight, can we conclude that represents an externality? Again, we must take into the context of time and place. Indeed, the airline has generated a misallocation of resources through its decision-making. It exchanges a claim to a seat for money with a customer, but by assigning more than one customer to the same seat, there is a potential spillover cost on an individual bumped to a future flight, the full cost of which is not borne by the airline. However, we must conclude in this case that though bumping individuals to a future flight may be involuntary, it is not completely unexpected. Prior to the introduction of Simon’s auction proposal, an individual booking a flight could not rule out the possibility that a flight is overbooked. The anticipation of this possibility by individuals implies that this is not an example of an externality. However, to conclude this is not an externality does not imply this is a Pareto-optimal situation. There is indeed a misallocation of resources, since there are too many claimants to the available seats on a flight. Therefore, there is a profit opportunity to devise an institutional innovation to realize such potential Pareto improvements. The introduction of the auction solution to the problem of airline overbooking can be understood as private property right solution, and therefore introduces new expectations between the airline and its customers about allocation of property rights. Given the transaction costs associated with correctly estimating the number of cancellations by customers, the introduction of the auction system (whether through a voucher or cash payment) grants all existing claimants to airline seats the ability to exchange, in effect creating private property rights in seats (Alchian 1965). Customers, in effect, not only become buyers of seats, but the auction system allows them to become potential sellers back to the airline in the case of overbooking. This exemplifies the point made by Phillip Wicksteed, namely that the supply curve for a good or service (in this airline seats) is part of the total demand curve for a good or service (see Wicksteed 1914, p. 13). More importantly, the exchange process generated through the auction system not only reduces the transaction costs associated with discovering the individuals with the lowest opportunity cost of moving to another flight (at a particular price that reflects such opportunity cost), it also reduces the transaction cost of economically calculating the minimum price necessary to pay an individual to be moved to a future flight. Such knowledge only arises in the context of the exchange of property rights (see Mises 1920 [1975]), which creates more consistent dovetailing of expectations between individuals. Thus, the ability to assign private property rights in seats with the introduction of the auction system thereafter creates an expectation that individuals will be compensated if an airline mistakenly overbooks a flight. This brings me to the case of the United Airlines 3411 incident that took place on April 9, 2017, in which a passenger, Dr. Dao Duy Anh, was involuntarily dragged off the flight for refusal to give up his seat. This would seem to be a case of an externality, since the situation represents not only an involuntary cost borne unfortunately by the individual, but also because it was unexpected. Given the expectation that, through the auction system, an individual more willing to give up his or seat could likely have been discovered and paid a lower price than what Dr. Anh would have probably demanded as compensation for the airline’s error in overbooking.   Connecting this example back to Boudreaux and Meiners, the point here is that however one approaches this analysis, the existence or non-existence of externalities does not eliminate the fact that airline overbooking was representative of a misallocation of resources. And, the fact that this imperfection in the market process facilitated an institutional innovation to erode an existing inefficiency in the allocation of airline seats did not depend upon whether or not there existed an externality. And yet, the presence of an externality does not automatically presume a market failure, requiring government intervention, but a failure to secure the conditions of the market process, namely the voluntary exchange of property rights, due to government intervention. We can therefore conclude that the unfortunate circumstances that transpired during the United Airlines 3411 incident indicated the presence of a negative externality, but that this was a result of government failing to provide clear expectations about the security and enforcement property rights in airline seats, not a market failure.   The focus of analyses for economists, therefore, should not be to look backward at a presumed consistency or inconsistency in expectations between individuals, and then to pass normative judgment on it in terms of its conformity with Pareto-optimality or an efficient allocation of resources. Rather, the economist must always approach each analysis of any state of affairs as “nothing but a seething mass of unexploited maladjustments waiting to be corrected” (Kirzner 1979, p. 119), and focus on the constant adjustments that market processes facilitate in an open-ended world of uncertainty. Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and Associate Director of Academic and Student Programs  at the Mercatus Center at George Mason University   Further References Candela, Rosolino A., and Vincent J. Geloso. 2020. “The Lighthouse Debate and the Dynamics of Interventionism.” The Review of Austrian Economics 33(3): 289–314. Hayek, F.A. 1937. “Economics and Knowledge.” Economica 4(13): 33–54. Kirzner, Israel M. 1979. Perception, Opportunity, and Profit. Chicago, IL: University of Chicago Press. Mises, Ludwig von. 1920 [1975]. “Economic Calculation in the Socialist Commonwealth.” In F.A. Hayek, ed. Collectivist Economic Planning (pp. 87–130). Clifton, NJ: August M. Kelley.       (0 COMMENTS)

How much has racism held back the U.S. economy? What would the country look like today if Black entrepreneurs and inventors had been welcomed and encouraged over the past century and a half? Economist Lisa Cook of Michigan State University talks with EconTalk host Russ Roberts about her research into the impact of racism, lynching, […] The post Lisa Cook on Racism, Patents, and Black Entrepreneurship appeared first on Econlib.

  Don’t let us catch you eating what we don’t think is a meal. Bar owners have had a particularly tough go of it during the pandemic, with the governor completely shutting them down following a brief reopening early this summer, but they are getting creative as the lockdown continues. According to the state board of alcoholic beverage control, bars can open if — and only if — they offer “bona fide meals” in conjunction with their wine, beer and cocktails. If they do, they essentially function as restaurants and must follow the rules imposed on dining establishments, and as long as Monterey County remains in the most restrictive shutdown category, that means take-out and outdoor dining only. The ABC’s standards for what constitutes bona fide meals are fairly strict. They can’t be pre-packaged sandwiches and salads, or appetizers and side dishes like fries and chicken wings. Snacks such as bagged pretzels or popcorn aren’t meals,and neither are reheated refrigerated or frozen entrées. Just offering dessert won’t cut it, either. “In short, the primary focus of the licensed premises should be on meal service, with the service of alcoholic beverages only as a secondary service in support of that primary focus,” according to the state. Inspectors tasked with determining whether a bar’s food service suffices generally consider “the various menu offerings, availability during typical meal hours, and whether the food offered is served in a reasonable quantity and what a reasonable person might consider to be a meal consumed at breakfast, lunch or dinner.” This is from Mary Schley, “Bars strive to become restaurants in the social distancing era,” Carmel Pine Cone, September 18, 2020. Bar owners are trying to figure out ways to survive and the state government is making it harder. The issue is not whether patrons socially distance. Those rules are enforced. It’s not about whether people are allowed to eat and drink indoors. In Monterey County, where I live, they aren’t. The issue is that the California state government wants to enforce its view of what constitutes a meal. It’s almost as if the government officials don’t care about bar owners and patrons.     (1 COMMENTS)