If you have school-age children, you may be wondering if they’ll ever get an education. On Tuesday the American Federation of Teachers, the second-largest education union, threatened “safety strikes” if reopening plans aren’t to its liking. Some state and local governments are insisting that public K-12 schooling this fall be conducted online three to five days a week and…

The Fed is currently contemplating a set of monetary policy changes that might be viewed as “second best”. These include yield curve control and average inflation targeting. With yield curve control the central bank would peg the yield on longer-term Treasury bonds. This was Fed policy during the 1940s. Under average inflation targeting the central bank tries to make…

Last week, I was part of the Cato Institute’s book forum on Laurence Siegel’s Fewer, Richer, Greener: Prospects for Humanity in an Age of Abundance.  Here’s my commentary on the book. 1. Vast areas of agreement: a. Until March, the world was getting richer at a marvelous pace. Absolute poverty has been disappearing before our eyes after ten thousand…

This is the first of a series of responses by Mario Rizzo and Glen Whitman, authors of Escaping Paternalism, for my Book Club on their treatise. Present Bias and Time Preference We should begin by thanking Bryan for his many kind words about our book, and also for hosting this book club.  We appreciate his critiques almost as much as…

  Krystina Alarcon of Fox News interviewed me this morning about why the exchange rate of the dollar and the price of gold tend to move in opposite directions. I think she did a nice job of splicing together my answers to various questions. I loved the way she started it. I referred to the work of Lawrence H.

There is perhaps no greater goal than promoting safe behavior during a pandemic.  Policy makers need to know the correct proscriptive policy to encourage, or perhaps force, citizens to act in safer ways.  For citizens themselves, the calculus is different.  Safe behavior can fall on a continuum of greater or lesser risk, but that typically corresponds with costs.  Some behavior…

Summary In Chapter 6 of Escaping Paternalism, Rizzo and Whitman argue that paternalistic behavioral economists have recklessly rushed from laboratory experiments to real life.  Even if the experiments were above reproach, their external validity is questionable at best.  Sunstein, Thaler, and the rest have overpromised and underdelivered: A central claim of behavioral paternalists is that their approach is…

Israel Kirzner is a prominent member of the Austrian School of economics. His major contribution is his work on the meaning and importance of entrepreneurship. Kirzner’s view is that mainstream neo-classical economics omits the role of the entrepreneur. The standard neoclassical models of markets, whether perfect competition, monopolistic competition, or monopoly, argues Kirzner, are equilibrium models. They omit the crucial role of the entrepreneur, which is to bring markets to equilibrium. In Kirzner’s view, which he and others refer to as a distinct viewpoint of the Austrian school of economics, the main characteristic of the entrepreneur is alertness. The entrepreneur is alert to price differences that others have not noticed and makes a profit by acting on this alertness. So, for example, the entrepreneur notices that goods selling for $10 in one market are fetching $15 in another market. He also notices that the shipping, insurance, and interest costs of buying where it sells for $10 and selling where it sells for $15 are less than $5. So he buys in the cheaper market, sells in the dearer market, and makes a profit. As long as others are not aware of this difference, the entrepreneur continues to make money. But other entrepreneurs are also alert. When they notice the difference in prices, they seek to do what the first entrepreneur did. As they enter the market—buying in the cheaper market and selling in the dearer market—they drive the price of the good that they buy above $10 and drive the price where they are selling below $15. This continues until the price difference covers the shipping, insurance, and interest costs. In his 1973 book, Competition and Entrepreneurship, Kirzner finds similarities and differences between his view of entrepreneurship and that of Joseph Schumpeter. What they have in common is that the entrepreneur qua entrepreneur contributes “no factor services to production.” Kirzner elaborates, “What the entrepreneur contributes is merely the pure decision to direct these inputs into the process selected rather than into other processes.” The main difference between Kirzner’s entrepreneur and Schumpeter’s is that Schumpeter’s entrepreneur upsets an existing equilibrium by introducing a new product or a new production technique, while for Kirzner, the entrepreneur “has an equilibrating influence.” Kirzner writes, “For me the important feature of entrepreneurship is not so much the ability to break away from routine as the ability to perceive new opportunities which others have not yet noticed.” He elaborates: Entrepreneurship for me is not so much the introduction of new products or new techniques of production as the ability to see where new products have become unsuspectedly valuable to consumers and where new methods of production have, unknown to others, become feasible. For me the function of the entrepreneur consists not of shifting the curves of cost or revenue which face him, but of noticing that they have in fact shifted. (italics in original)[1] Kirzner’s entrepreneur, then, is essentially an arbitrageur, a point that Kirzner makes in comparing his view of the entrepreneur to that of his mentor Ludwig von Mises. He sees both the Misesian view and his own as “an ‘arbitrage’ theory of profit.” (italics in original) For Kirzner’s entrepreneur, something is sold at different prices in two different markets because of imperfect communication between participants in the two markets. But, Kirzner notes, it is not only arbitrage in the narrow sense of buying a good in one market and selling the identical good in the other market. It is also arbitrage in a wider sense: in the market for factors of production, “it appears as a bundle of inputs, and in the product market it appears as a consumption good.” Kirzner’s view is that entrepreneurship is an inherent aspect of the competitive process. The term “process” is important because Kirzner sees competition as a process rather than as an end state.  But in the neoclassical model of perfect competition, which came to dominate economics in the 1920s, there was no process. Kirzner writes: Competition, to the equilibrium price theorist, turned out to refer to a state of affairs into which so many competing participants have already entered that no room exists for additional entry (or other modification of existing market conditions). (italics in original)[2] Kirzner notes that this end-state view of competition is very far from the view of the non-economist. By viewing competition as a process, one can get a new perspective on various market phenomena that economists have commented on and analyzed for almost a century. Two that stand out are (1) the role of advertising and selling effort in general and (2) the alleged waste from competition. Consider advertising and selling effort. The alert entrepreneur must also alert potential buyers to the presence and, ideally, the attractiveness of the items he’s selling. Doing so uses resources, but those resources are not wasted. Kirzner writes that “selling effort (including advertising) that alters the opportunities perceived by consumers constitutes an entirely normal avenue of competitive-entrepreneurial activity.” But such activity, he notes, would be unnecessary in a state of equilibrium because in that state, consumers already know all they need to know. Again, those who focus on an equilibrium, and not on the competitive process that gets us closer to equilibrium, will miss the value of advertising and other selling costs. One criticism of free markets that has been made for many decades is that they result in wasteful duplication. When one firm already exists, according to this view, entry of another firm is wasteful. Kirzner answers: The truth is that until the newly competing entrepreneur has tested his hunch about the lowest cost at which he can produce, we simply do not know what organization of industry is “best.” To describe the competitive process as wasteful because it corrects mistakes only after they occur seems similar to ascribing the ailment to the medicine which heals it, or even to blaming the diagnostic procedure for the disease it identifies.[3] Although economists do not typically engage in moral philosophy, Kirzner has applied his theory of entrepreneurship to make a case for the justice of making profits. He writes: The finders-keepers rule asserts that an unowned object becomes the justly owned property of the first person who, discovering its availability and its potential value, takes possession of it.[4] Because the Kirznerian entrepreneur makes a profit by discovering a higher-valued use, argues Kirzner, the entrepreneur, by the finders-keepers rule, has a right to the profit he makes from acting on that discovery. For more on Kirzner’s life and work, see A Conversation with Israel Kirzner, an Intellectual Portrait at Econlib Videos. Kirzner was born in London, England. From 1947 to 1948, he attended the University of Cape Town in South Africa. From 1950 to 1951, he attended the University of London. He earned a B.A. at Brooklyn College, an M.B.A. from New York University (NYU), and a Ph.D. in economics from NYU in 1957. He was an assistant professor of economics at NYU from 1957 to 1961, an associate professor from 1961 to 1968, and a full professor from 1968 until he retired in 2001. In 1976, he founded a graduate study program in Austrian economics at NYU.   Selected Works   The Economic Point of View. Kansas City: Sheed and Ward. Competition and Entrepreneurship. Chicago: University of Chicago Press. Perception, Opportunity, and Profit. Chicago: University of Chicago Press. Discovery, Capitalism, and Distributive Justice. New York: Basil Blackwell.       Footnotes [1] Kirzner, Israel M., Competition and Entrepreneurship, Chicago: University of Chicago Press, 1973, p. 81. [2] Kirzner, Competition and Entrepreneurship, p. 28. [3] Kirzner, Competition and Entrepreneurship, p. 236. [4] Kirzner, Israel M, Discovery, Capitalism, and Distributive Justice, New York: Basil Blackwell, 1989, p. 98. (0 COMMENTS)

Harold Demsetz made major contributions to the economics of property rights and to the economics of industrial organization. He also coined the term “the Nirvana approach.” Economists have altered it slightly but use it widely. Demsetz was one of the few top economists of his era to communicate almost entirely in words and not math. Demsetz also defended both economic freedom and civil liberties. Drawing on anthropological research, Demsetz noted that, although the native Canadians (Canadians often call them First Nations people) in Labrador had property rights in the early 18th century, they did not have property rights in the mid-17th century. What changed? Demsetz argued that the advent of the fur trade in the late 17th century made it more valuable to establish property rights so that the beavers were not overtrapped. By contrast, native Americans on the southwestern plains of the United States did not establish property rights; Demsetz reasoned that it was because the animals they hunted wandered over wide tracts of land and, therefore, the cost of establishing property rights was prohibitive. One of Demsetz’s most important contributions was a 1967 article, “Toward a Theory of Property Rights.” In it, he argued that property rights tend to develop where the gains from defining and enforcing those rights exceed the costs. He found confirming evidence in the presence or absence of property rights among native Americans and native Canadians, and he dismissed the idea that they were primitive people who couldn’t understand or appreciate property rights. Instead, he argued, they developed property rights in areas of North America where the property was worth defending. In the 1960s, the dominant view in the area of economics called industrial organization was that concentration in industries was bad because it led to monopoly. In the 1970s, Demsetz challenged that view. He argued that the kind of monopoly to worry about is caused by government regulation that prohibits firms from entering an industry. He pointed to the Civil Aeronautics Board’s restrictions on entry by new airlines and the Federal Communication Commission’s hobbling of cable TV as examples. He wrote, “The legal route of monopoly runs through Washington and the state capitals.” But, he argued, if a few firms achieved a large market share through economies of scale or through superior performance, we should not worry, and the antitrust officials should not go after such firms. As long as the government doesn’t restrict new competitors, firms with a large market share will face competition in the future. In a 1969 article, “Information and Efficiency: Another Viewpoint,” Demsetz accused fellow economist Kenneth Arrow of taking the “Nirvana approach” and recommended instead a “comparative institutions approach.” He wrote, “[T]hose who adopt the nirvana viewpoint seek to discover discrepancies between the ideal and the real and if discrepancies are found, they deduce that the real is inefficient.” Specifically, Arrow showed ways in which the free market might provide too little innovation, but then simply assumed that government intervention would get the economy closer to the optimum. Demsetz conceded that ideal government intervention might improve things, but he noted that Arrow, like many economists, had failed to show that actual government intervention would do so. Economists have slightly changed the label on Demsetz’s insight: they now refer to it as the “Nirvana fallacy.” Another major Demsetz contribution was his thinking about natural monopoly, evidenced best in his 1968 article “Why Regulate Utilities?” In that article, Demsetz stated that the theory of natural monopoly “is deficient for it fails to reveal the logical steps that carry it from scale economies in production to monopoly price in the market place.” How so? Demsetz argued that competing providers could bid to be the single provider and that consumers, if well organized, could choose among competing providers. The competition among potential providers would prevent the winning provider from charging a monopoly price. Economists often use negative externalities as a justification for government regulation. One standard example is pollution; in their actions, polluters do not take into account the damage imposed on others. Demsetz pointed out that governments also impose negative externalities. In the above-mentioned 1967 article on property rights, Demsetz wrote, “Perhaps one of the most significant cases of externalities is the extensive use of the military draft. The taxpayer benefits by not paying the full cost of staffing the armed services.” He added, “It has always seemed incredible to me that so many economists can recognize an externality when they see smoke but not when they see the draft.” Demsetz was a strong opponent of the draft. One of Demsetz’s other contributions, co-authored with Armen A. Alchian, was his 1972 article “Production, Information Costs, and Economic Organization.” A 2011 article written by three Nobel Prize winners—Kenneth J. Arrow, Daniel L. McFadden, and Robert M. Solow—and three other economists—B. Douglas Bernheim, Martin S. Feldstein, and James M. Poterba, stated that this article was one of the top 20 articles publishes in the American Economic Review in the first 100 years of its existence. In it, Alchian and Demsetz proposed the idea that the reason to have firms is that team production is important and monitoring the productivity of team members is difficult. Therefore, they argued, firms, to be effective, must have people in the firm who monitor and who are residual claimants. These people, often, but not always, the owners, get some fraction of the profits of the firm and, therefore, have an incentive to monitor effectively. That helps solve the classic principal-agent problem. In a famous 1933 book titled The Modern Corporation and Private Property, Adolf A. Berle and Gardiner C. Means had argued that diffusion of ownership in modern corporations gave managers of large corporations more control, shifting it from the owners. These managers, they argued, would use that control to benefit themselves. Demsetz and co-author Kenneth Lehn questioned that reasoning. They argued that owners would not give up control without getting something in return. If Berle and Means were correct, they wrote, then one should observe a lower rate of profit in firms with highly diffused ownership. But if Demsetz and Lehn were correct, one should see no such relationship because diffused ownership would happen where there were profitable reasons for it to happen. They wrote: A decision by shareholders to alter the ownership structure of their firm from concentrated to diffuse should be a decision made in awareness of its consequences for loosening control over professional management. The higher cost and reduced profit that would be associated with this loosening in owner control should be offset by lower capital costs or other profit-enhancing aspects of diffuse ownership if shareholders choose to broaden ownership. Demsetz and Lehn found “no significant relationship between ownership concentration and accounting profit rate,” just as they expected. In a 2013 tribute to Demsetz’s co-author Alchian, economist Thomas Hubbard highlighted their 1972 article, writing: This paper may be the most influential paper in the economics of organization, catalyzing the development of the field as we know it. It is the most-cited paper published in the AER [American Economic Review] in the past 40 years. (If one takes away finance and econometrics methods papers, it is the most-cited ‘economics’ paper, period.) It is truly a spectacular piece. It is a theory not only of firms’ boundaries, but also the firm’s hierarchical and financial structure.[1] He was also an early defender of the rights of homosexuals. At the September 1978 Mont Pelerin Society meetings in Hong Kong, Demsetz criticized, on grounds of individual rights, the Briggs Initiative, on the November 1978 California ballot. This initiative would have banned homosexuals from teaching in public schools.  The initiative was defeated, helped by the opposition of Demsetz’s fellow Californian Ronald Reagan. For more on Demsetz’s life and work, see A Conversation with Harold Demsetz, an Intellectual Portrait at Econlib Videos. Demsetz, a native of Chicago, earned his undergraduate degree in economics at the University of Illinois in 1953 and his Ph.D. in economics at Northwestern University in 1959. He taught at the University of Michigan from 1958 to 1960, at UCLA from 1960 to 1963, at the University of Chicago from 1963 to 1971, and then again at UCLA from 1971 until his retirement. In 2013, he was made a Distinguished Fellow of the American Economic Association. In 1963, when Demsetz was on the UCLA faculty, a University of Chicago economist named Reuben Kessel asked him if he was happy there. Demsetz, sensing an offer in the works, answered, “Make me unhappy.” The University of Chicago did just that, and Demsetz moved to Chicago for eight productive years.     Selected Works 1965. “Minorities in the Marketplace.” North Carolina Law Review, Vol. 43, No. 2: 271-97. 1967. “Toward a Theory of Property Rights.” American Economic Review, Vol. 57, No. 2, (May, 1967): 347-59. 1968. “Why Regulate Utilities?” Journal of Law and Economics,Vol. 11, No. 1, (April, 1968): 55-65. 1972 (with Armen A. Alchian). “Production, Information Costs, and Economic Organization,” American Economic Review, Vol. 62, No. 5, (December 1972): 777-95. 1973. “Industry Structure, Market Rivalry, and Public Policy,” Journal of Law and Economics,Vol. 16, No. 1 (April, 1973): 1-9. 1974. ‘Two Systems of Belief about Monopoly,” in Industrial Concentration: The New Learning, edited by H. J. Goldschmid, H. M. Mann and J. F. Weston, Little, Brown. 1985 (with Kenneth Lehn). “The Structure of Corporate Ownership: Causes and Consequences,” Journal of Political Economy, Vol. 93, No. 6 (December, 1985): 1155-1177. 1989. Ownership, Control, and the Firm. Cambridge, MA: Basil Blackwell. 1990. Efficiency, Competition, and Policy. Cambridge, MA: Basil Blackwell. [1] Thomas N. Hubbard, “A Legend in Economics Passes,” Digitopoly, February 20, 2013. At: https://digitopoly.org/2013/02/20/a-legend-in-economics-passes/ (0 COMMENTS)

  Richard H. Thaler won the 2017 Nobel Prize in Economic Science for “his contributions to behavioral economics.” In most of his work, Thaler has challenged the standard economist’s model of rational human beings.  He showed some of the ways that people systematically depart from rationality and some of the decisions that resulted. He has used these insights to propose ways to help people save, and save more, for retirement. Thaler also advocates something called “libertarian paternalism.” Economists generally assume that more choices are better than fewer choices. But if that were so, argues Thaler, people would be upset, not happy, when the host at a dinner party removes the pre-dinner bowl of cashews. Yet many of us are happy that it’s gone. Purposely taking away our choice to eat more cashews, he argues, makes up for our lack of self-control. This simple contradiction between the economists’ model of rationality and actual human behavior, plus many more that Thaler has observed, leads him to divide the population into “Econs” and “Humans.” Econs, according to Thaler, are people who are economically rational and fit the model completely. Humans are the vast majority of people. Thaler (1980) noticed another anomaly in people’s thinking that is inconsistent with the idea that people are rational. He called it the “endowment effect.” People must be paid much more to give something up (their “endowment”) than they are willing to pay to acquire it. So, to take one of his examples from a survey, people, when asked how much they are willing to accept to take on an added mortality risk of one in one thousand, would give, as a typical response, the number $10,000. But a typical response by people, when asked how much they would pay to reduce an existing risk of death by one in one thousand, was $200. One of Thaler’s most-cited articles is Werner F. M. De Bondt and Richard Thaler (1985). In that paper they compared the stocks of “losers” and “winners.” They defined losers as stocks that had recently dropped in value and winners as stocks that had recently increased in value, and their hypothesis was that people overreact to news, driving the prices of winners too high and the prices of losers too low. Consistent with that hypothesis, they found that the portfolio of losers outperformed the portfolio of winners. One of the issues to which Thaler applied his thinking is that of saving for retirement. In his book Misbehaving, Thaler argues that if everyone were an Econ, it wouldn’t matter whether employers’ default option was not to sign up their employees for tax-advantaged retirement accounts and let them opt in or to sign them all up and let employees opt out. There are transactions costs associated with getting out of either default option, of course, but they are small relative to the stakes involved. For that reason, argued Thaler, either option should lead to about the same percentage of employees taking advantage of the program. Yet Brigitte G. Madrian and Dennis F. Shea found[1] that before a company they studied had tried automatic enrollment, only 49 percent of employees had joined the plan. When enrollment became the default, 84 percent of employees stayed enrolled. That is a large difference relative to what most economists would have expected. Thaler and economist Shlomo Benartzi, arguing that people tend to be myopic and heavily discount the future, helped design a private pension plan to enable people to save more. Called Save More Tomorrow, it automatically increases the percent of their gross pay that people save in 401(k) plans every time they get a pay raise. That way, people can save more without ever having to cut their current consumption expenditures. Many “Econs” were presumably already doing that, but this plan helps Humans, as well. When a midsize manufacturing firm implemented their plan, participants, at the end of four annual raises, had almost quadrupled their saving rate. In their book Nudge, Thaler, along with co-author Cass Sunstein, a law professor, used behavioral economics to argue for “nudging” people to make better decisions. In each person, they argued, are an impulsive Doer and a farsighted Planner. In the retirement saving example above, the Doer wants to spend now and the Planner wants to save for retirement. Which preferences should be taken account of in public policy? As noted earlier, Thaler believes in “libertarian paternalism.” In Nudge, he and Sunstein lay out the concept. The basic idea is to have the government set paternalist rules as defaults but let people choose to opt out at low cost. One example is laws requiring motorcyclists to wear helmets. That is paternalism. How to make it “libertarian paternalist?” They favorably cite New York Times columnist John Tierney’s proposal that motorcyclists who don’t want to wear helmets be required to take an extra driving course and show proof of health insurance. In a review of Nudge, Thomas Leonard writes: The irony is that behavioral economics, having attacked Homo Economicus as an empirically false description of human choice, now proposes, in the name of paternalism, to enshrine the very same fellow as the image of what people should want to be. Or, more precisely, what paternalists want people to be. For the consequence of dividing the self has been to undermine the very idea of true preferences. If true preferences don’t exist, the libertarian paternalist cannot help people get what they truly want. He can only make like an old fashioned paternalist, and give people what they should want.[2] In some areas, Thaler seems to have departed from the view that long-term considerations should guide economic policy. A standard view among economists is that after a flood or hurricane, a government should refrain from imposing price controls on crucial items such fresh water, food, or plywood. That way, goes the economic reasoning, suppliers in other parts of the country have an incentive to move goods to where they are needed most and buyers will be careful not to stock up as much immediately after the flood or hurricane. In 2012, when asked about a proposed anti-price-gouging law in Connecticut, Thaler answered succinctly, “Not needed. Big firms hold prices firm. ‘Entrepreneurs’ with trucks help meet supply. Are the latter covered? If so, [the proposed law is] bad.”[3] What he was getting at is that, to some extent, we get the best of both worlds. Companies like Wal-Mart, worried about their reputation with consumers, will refrain from price gouging but will stock up in advance; one-time entrepreneurs, not worried about their reputations, will supply high-priced items to people who want them badly. But in a Marketplace interview in September 2017,[4] Thaler said, “A time of crisis is a time for all of us to pitch in; it’s not a time for all of us to grab.” He seemed to have moved from the mainstream economists’ view to the popular view. One relatively unexplored area in Thaler’s work is how government officials show the same irrationality that many of us show and the implications of that fact for government policy. Thaler earned his Bachelor of Arts degree with a major in economics at Case Western Reserve University in 1965, his Masters degree in economics from the University of Rochester in 1970, and his Ph.D. in economics from the University of Rochester in 1974. He was a professor at the University of Rochester’s Graduate School of Management from 1974 to 1978 and a professor at Cornell University’s Johnson School of Management from 1978 to 1995. He has been a professor at the University of Chicago’s Booth School of Business since 1995.     Selected Works 1980. Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1, No. 1, pp. 39-60. 1985. (with Werner F.M. De Bondt.) “Does the Stock Market Overreact?,” Journal of Finance, Vol. 40, pp. 793-805. 1992. The Winner’s Curse: Paradoxes and Anomalies of Economic Life. Princeton University Press. 2003. (with Cass R. Sunstein.) “Libertarian Paternalism,” American Economic Review, Vol. 93, No. 2, pp. 175-179. 2004. (with Shlomo Benartzi.) “Save More TomorrowTM: Using Behavioral Economics to Increase Employee Saving,” Journal of Political Economy, Vol. 112, No. S1, pp. S164-87. 2008. (with Cass Sunstein.) Nudge: Improving Decisions About Health, Wealth, and Happiness, New Haven: Yale University Press. 2015. Misbehaving: The Making of Behavioral Economics, New York: W.W. Norton.       [1] Brigitte C. Madrian and Dennis F. Shea, “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior,” Quarterly Journal of Economics, Vol. CXVI, Issue 4, November 2001, pp. 1149-1187. At: https://www.ssc.wisc.edu/~scholz/Teaching_742/Madrian_Shea.pdf [2] Thomas Leonard, “Review of Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness.” Constitutional Political Economy 19(4): 356-360. [3] http://www.igmchicago.org/surveys/price-gouging [4] https://www.marketplace.org/shows/marketplace/09012017 (0 COMMENTS)