It depends.  But I will argue that the thing it depends on is probably different from the thing that most people believe is important. When I was young, I looked at this issue in partisan terms.  Divided government is good (I thought) if the party I oppose holds the presidency, and united government is good if my preferred party holds the presidency.  I suspect that this is a fairly widely held view, especially among better educated voters.  But I now think this is wrong. I have come around to the view that the decisive factor is not “which party holds the presidency”, rather the optimal outcome depends on the answer to this question: Is this an era of relatively good governance, or an era of relatively bad governance? If we are operating in an era where governments are engaged in useful reforms, such a deregulation, privatization, freer trade, fiscal responsibility and tax reform, then a more powerful central government may (and I emphasize may) be a good thing.  If we are operating in an era of socialism and nationalism, then more government power is usually a bad thing. Because most of this blog’s readers live in the US, I won’t use an American example to make this point.  It’s too hard to look beyond our own personal political biases.  Instead, I’d ask you to look across the pond and contemplate recent British history. They’ve had three relatively long periods of mostly one party rule.  The Conservatives ruled from 1979-1997, then Labour from 1997-2010, and then the Conservatives ruled again until this past summer’s election.  What do we notice about these eras? 1. Governments often do better in their early stages.  They come into office with a plan to fix the failures of the previous administration, and often do some useful things during the early portion of their tenure.  Then they run out of gas, and policymaking quality deteriorates. 2. Governments tend to do better policymaking when the global zeitgeist is moving in a “neoliberal” direction (say up until 2007), and less effective policymaking when the world is moving in an illiberal direction. I certainly won’t tell people how to vote, and indeed in a presidential year one cannot know for certain whether one’s vote would lead to unified or divided government.  (In midterm elections, voters do know.)  But one thing to consider might be whether we are in an era of good governance or bad governance.  Is the political zeitgeist moving in the direction of balanced budgets and supply side reforms, or is it moving in the opposite direction? How much trust do you have in the policymaking process of today’s America? One final point.  I would not rule out the possibility that divided government is good more often than it is bad.  That largely depends on the question of how much “activism” you favor.  My own view is somewhat hostile to government activism, thus my bias is toward divided government.  In this post, I’m merely trying to describe when each outcome is relatively more important, not necessarily which is best in an absolute sense.  If I favored government activism, I might lean toward the view that unified government is usually best.  Even so, I think people tend to underestimate the importance of the zeitgeist, the importance of whether we are in an era of relatively good governance, or an era of relatively bad governance.   (0 COMMENTS)

When should the government intervene? In introductory economics classes, we introduce market failures. In intermediate economics classes, we discuss them in greater detail. In advanced and field courses, we get into the nuts and bolts of different ways pure exchange doesn’t get the job done and how, theoretically, a government could improve things. Theoretically. The assumptions most textbooks make about governments, their capacities, and their motivations. A perfectly benevolent, omnipotent, all-knowing government would set a tax equal to the marginal external cost upon observing an externality. That’s a pretty heroic assumption, and it’s important not to mistake the model for reality and its assumptions for plausible descriptions of the world as it is. To this end, a presentation from the philosopher Jason Brennan inspired a paper I’m contributing to a symposium in the Journal of Private Enterprise on the contributions of my late friend and Liberty Fund contributor Steven G. Horwitz. Brennan and his coauthor Christopher Freiman explained how all the arguments for regulating consumer choices apply equally to political choices. Sure, we’re irrational and weak-willed at the supermarket. The problem is worse in the voting booth because our incentives are even worse.  Brennan and Freiman explain that there are, therefore, a few conditions the government has to meet before it can override people’s choices. I summarize them here. First, we should ask whether or not the problem we want the government to solve is an unintended consequence of another government policy. Are you worried about the environment and insufficient urban density? Let’s examine how government policies discourage urbanization and density (single-family zoning, for example). Second, the private sector has already fixed a lot of market failures. Are you worried about externalities from secondhand smoke in restaurants and bars? That’s already capitalized into wages and prices–and one unintended consequence of urban smoking bans was that people drove to the suburbs to drink–and then killed people driving home. Third, it’s not always clear the governments we actually have run by the people we actually elect who face the incentives they actually face will improve things. “Affordable housing” could be fixed tomorrow if we got rid of rent control and the layers of red tape preventing new construction. Telling people you support policies that reduce their property values or challenge their most cherished beliefs is a pretty nifty way to ensure you don’t get reelected. Fourth and fifth, it’s incumbent upon us to ask whether or not the policy passes a cost-benefit analysis and how it changes people’s incentives. The Transportation Security Administration, for example, is a monumental waste of resources with a cost per life vastly above the cost per life saved by other policies and initiatives. The TSA also made flying less convenient and induced more driving–which meant more highway deaths. Finally, even if policies pass all these tests, people might have rights that trump the proposed policies. Even if eugenic forced sterilization policies passed all the other tests–which they almost surely wouldn’t–they violate people’s bodily autonomy and are therefore disqualified. How should we decide when and where to intervene? As Steven Horwitz and I argued a long time ago, market failures are necessary but not sufficient conditions. Before trying to cure this or that ill, we must make sure the cure isn’t worse than the disease.   Art Carden is Professor of Economics & Medical Properties Trust Fellow at Samford University. (0 COMMENTS)

One of the differences in how people analyze the world I’ve found most interesting has been called high decoupling vs low decoupling. What is decoupling? In this context, it means an ability to consider ideas in isolation, disconnecting them from other variables and influences. Low decouplers think of ideas as embedded in a social context, and thus think analyzing ideas in abstract, isolated terms rather than placing those ideas in a social narrative is misguided. A very long essay you can check out describing this divide and applying it to modern debates can be found here, but here are some snippets outlining some of the key ideas: High-decouplers isolate ideas from each other and the surrounding context. This is a necessary practice in science which works by isolating variables, teasing out causality and formalizing and operationalizing claims into carefully delineated hypotheses. Cognitive decoupling is what scientists do… While science and engineering disciplines (and analytic philosophy) are populated by people with a knack for decoupling who learn to take this norm for granted, other intellectual disciplines are not. Instead they’re largely composed of what’s opposite the scientist in the gallery of brainy archetypes: the literary or artistic intellectual. This crowd doesn’t live in a world where decoupling is standard practice. On the contrary, coupling is what makes what they do work. Novelists, poets, artists and other storytellers like journalists, politicians and PR people rely on thick, rich and ambiguous meanings, associations, implications and allusions to evoke feelings, impressions and ideas in their audience. The words “artistic” and “literary” refers to using idea couplings well to subtly and indirectly push the audience’s meaning-buttons. To a low-decoupler, high-decouplers’ ability to fence off any threatening implications looks like a lack of empathy for those threatened, while to a high-decoupler the low-decouplers insistence that this isn’t possible looks like naked bias and an inability to think straight. I tend to lean much more into the high-decoupler mindset. One aspect of high-decoupling I find beneficial is the ability to separate things that are often practically related but still logically distinct. As the author of the above-linked essay notes, “Even when issues don’t belong together logically and/or causally they’re often structurally, socially and emotionally similar and that makes them feel like a single thing — with a single positive or negative valence that ‘informs’ our reactions to single instances.” But even if different things emotionally feel the same, nonetheless, different things are different. (That’s right, I’m not afraid to make such bold, controversial statements as “different things are different.” Stay tuned for further hot takes!) And I find it very useful and clarifying to separate these things when trying to think about the world. As one example, Dan Moller, in his book Governing Least, decouples the ideas of desert (not the tasty kind, the philosophical kind of “desert” that indicates deservingness) from entitlement. In ordinary, day-to-day life, what you deserve and what you are entitled to tend to go together frequently enough that it “makes them feel like a single thing – with a single positive or negative valence that ‘informs’ our reaction to single instances.” Thus, many philosophers who advocate redistribution argue that the well-off lack desert for what they’ve accumulated, even if they accumulated their wealth in the most morally pristine ways possible. If you accumulated your wealth honestly because you were intelligent, hard working, and driven – well, they say, you didn’t deserve to be born an intelligent and hard-working person. You didn’t earn your natural capacities, nor did you earn the environment you grew up in and the mentors you encountered to help you develop those capacities. Thus, you don’t deserve the wealth you accumulate through those capacities. Moller, however, points out that what one deserves is logically distinct from what they are entitled to. If you and I are hiking together and you just so happen to stumble across a massive diamond valued at a hundred thousand dollars, clearly you didn’t deserve this good fortune in some deep moral sense. Nonetheless, you entitled to it. Similarly, someone who wins the lottery or hits a jackpot on a slot machine doesn’t deserve their winnings, but they are still entitled to them. The fact that you didn’t “deserve” to find the diamond does no work at all for the case for redistribution. If I were to say to you “You didn’t deserve to find that diamond and it could just as easily have been me, so give me some of that money, it’s mine!” I’d be in the wrong. It simply doesn’t follow that because you didn’t deserve your good fortune that I therefore am deserving of it – or even that I’m entitled to take some of it from you. There are also discrepancies in the opposite direction – sometimes, you can deserve something yet not be entitled to it. Let’s say you’re an employee in my company. You work hard and produce great value, and a job opening is available that represents a significant promotion for you and for which you are clearly qualified. Nonetheless, because it’s my company, I decide to give the job to an old buddy of mind who has done none of the work you’ve done. Since this is my company, I can hire whomever I want into whatever role I want – you are not entitled to that job. However, it still seems reasonable to say that even though you were not entitled to that promotion, you still deserved it. Or suppose you are getting married and want your parents to come to your wedding, but they refuse. Perhaps you’re marrying someone of a different race and they disapprove, or maybe you’re gay and marrying someone of the same sex and they deeply oppose that. I think it’s fair to say that you deserve to have your parents there supporting you at your wedding, but nonetheless, you are still not entitled to it. Their refusal to be there and support you is wrong, but it would also be wrong to force their attendance and make them pretend to be supportive against their will. Thus, while desert and entitlement often (perhaps usually) overlap, they are still distinct and can be decoupled. You can deserve something but not be entitled to it, and you can be entitled to something even if you don’t deserve it. At the risk of taxing your patience, dear reader, all of the above has simply been me laying the ground for another decoupling I think is worth making – being responsible for your situation, and deserving your situation. If you are responsible for the situation you are in, does that equate to saying you deserve to be in that situation? This has some intuitive force behind it. If you tell someone “You’re responsible for the situation you’re in,” that seems almost synonymous with saying “this is your fault” or “you deserved it.” Unless, of course, the situation is good, in which case saying they’re responsible for being there sounds like a form of affirmation or congratulations. “What you are responsible for” and “what you deserve” also seem “like a single thing” at first glance. But reality is rarely able to be described in a single exceptionless statement, and these, too, can be decoupled. Picture the following situation. John Q. Example is wandering down the street, listening to music with his headphones on. Unfortunately for Mr. Example, he’s so engrossed in the jaunty tunes coming through his headphones that he loses all focus on where he is wandering – and he wanders into a crosswalk, where he is struck and killed by a car. It seems to me in this case, two things can be said. Mr. Example is responsible for what happened – his behavior was careless and directly lead to his death. At the same time, it also seems true to me that Mr. Example did not deserve to die. He was responsible for causing his own death, but he nonetheless did not deserve death. After all, imagine that he had absentmindedly wandered through the intersection but, through sheer luck, was missed by every car that drove past, making it safely to the other side. Suppose after witnessing this, I pull out my trusty handgun and shoot him dead. When the police are called, I try explaining to them that was I did was justified, because, after all, Mr. Example deserved to die because of his inattentive and careless behavior. That would obviously be an absurd statement, and I’d be a moral monster for making it. My aim here is not to provide some finely-tuned description for when being responsible means deserving it, and when it doesn’t. (Good luck trying to spell that out!) But I do think people’s difficulty decoupling the two ideas leads to problems. Someone who holds the “you’re responsible for X therefore you deserve X” principle very strongly is Bryan Caplan. For years he’s been referencing a book he’s been writing on poverty and blame (a book I’m impatiently awaiting!), and one key distinction he makes is between the deserving and undeserving poor. Part of what makes someone deserving or undeserving depends on how responsible they are for their situation, as Caplan argues here: A person deserves his problem if there are reasonable steps the he could have taken to avoid the problem.  Poverty is a problem, so a person deserves his poverty if there are reasonable steps he could have taken to avoid his poverty. Caplan, of course, does not argue that everyone who is poor deserves it. By his lights, many people who are poor don’t deserve it, such as those born disabled, children of irresponsible parents, or people who had the bad luck to be born in impoverished countries and who are prevented from attaining better prospects elsewhere. Nonetheless, he says, there are many people who are poor today who are responsible for the situation they are in, and thus they deserve to be poor. Now, I don’t find the above quoted statement from Caplan very compelling as stated. The aforementioned John Q. Example could have taken “reasonable steps” to prevent his death, but it still seems obvious to me that he didn’t deserve to die. And while Mr. Example is a hypothetical case, it’s not a far-fetched or fanciful one. Scenarios basically matching what I described are not at all rare. While “you are responsible for X therefore you deserve X” is often true, perhaps even true in most cases, it is not a logically or metaphysically necessary truth. More is needed to establish that one deserves X than merely pointing out that they are responsible for X. I’m hoping he spells out additional arguments to bridge this gap in his book, when it is released. But there’s another side to this coin. Because some ideas, if not decoupled,  seem “like a single thing” with “a single positive or negative valence that ‘informs’ our reactions to single instances,” many people will respond to Caplan’s argument in a particularly counterproductive way. Suppose you don’t believe anyone ever truly “deserves” to live a life of poverty. This is surely a valence many people will have. When hearing the argument “they are responsible for their poverty, therefore they deserve it,” some people, failing to decouple responsibility from desert, will play the reverse card and instead think “they don’t deserve poverty, therefore, they are not responsible for it.” To such people, I would encourage taking a third route – “they don’t deserve to be in poverty, but they are still responsible for it.” Why would I encourage this route? For one, I think as a factual matter Caplan is correct that very often people are responsible for their poverty through the choices they have made over their life. (In the past, I have been such a person myself.) And here’s another one of those hot takes I promised – I think we should say things that are true and refrain from saying things that are false. Even if you believe someone who has made those decisions doesn’t deserve to be poor, it would still be untrue to say they are not responsible for having ended up poor. And for two, if you truly have compassion for people in that circumstance, the absolute worst thing you can do for them is convince them that they aren’t responsible for how they ended up. If someone becomes genuinely convinced their choices aren’t what created their current situation, that entails convincing them there is nothing they could do to improve their situation by making different choices. Convincing someone they bear no responsibility for their situation isn’t compassion. It’s denying their basic agency and denying them even a modicum of dignity. (0 COMMENTS)

[Editor’s Note: Dear readers, you delighted us with all your responses to Professor Cutsinger’s inaugural EconLog Price Theory Problem. Thanks! We reprint that question below, followed by his suggested solution. Next week, we’ll post problem #2. Long live price theory!] Question: In his book, Basic Economics, Thomas Sowell (2015) writes, “the price which one producer is willing to pay for any given ingredient becomes the price that other producers are forced to pay for that same ingredient” (p. 20). With that quote in mind, consider the following scenario:  The demand to drink milk rises while the demand for milk in the form of cheese, ice cream, and yogurt remains the same. Assume that the supply of milk is perfectly inelastic. Explain why the elasticities of demand for milk in these other uses determine how much milk will be reallocated from these uses for direct consumption.   Answer: One of the reasons I like this quote from Sowell’s book is that it gets us to consider the role that market prices play in allocating a resource across its various uses. In this case, the milk price allocates a fixed amount between those who want to drink it and those who demand milk to produce cheese, ice cream, and yogurt.  Figure 1 illustrates this idea. The market demand for milk consists of the various demands for milk. The interaction of the market demand for milk and the fixed supply determines the market price, which, in turn, determines how much milk demanders will purchase for each use. Thus, the buyer with the highest willingness to pay for milk determines the price all buyers must pay. As the question indicates, the demand for drinking milk rises. Figure 1 illustrates the increase in demand as the rightward shift of the demand for drinking milk. Since the market demand consists, in part, of the demand for drinking milk, it also shifts rightward, and so the price of milk rises to clear the market.   Figure 1: Individual and Market Demand for Milk The question assumes that the market supply of milk is perfectly inelastic (reflected by the vertical market supply of milk in Figure 1). Hence, suppliers do not produce any more milk despite the higher price. So, the amount of milk allocated to the production of cheese, ice cream, and yogurt must fall to meet the increased demand for drinking milk. What role do the price elasticities of demand for milk in these other uses play in determining the amount of milk reallocated from these uses to drinking? The price elasticity of demand tells us how responsive quantity demanded is to price changes. It is the ratio of the percent change in quantity brought about by a percent change in price. The higher the absolute value of this ratio, the more responsive the quantity demanded to price changes. Let’s suppose that at the initial market price of milk, the price elasticity of demand for cheese is less than ice cream, which is less than yogurt. The slopes of the demand curves for milk in these various uses in Figure 1 reflect these different elasticities. Note that at the higher market price of milk, the change in quantity demanded for milk differs across the different uses of milk. For instance, the quantity of milk demanded for yogurt falls the most while the quantity of milk demanded for cheese falls the least. This result is not surprising given our assumption that the price elasticity of demand for yogurt was higher than that of cheese or ice cream. Another reason this result is not surprising is that, intuitively, demanders most sensitive to price changes will have the largest response to price changes. For example, suppose there were many substitutes for milk in the production of yogurt but few substitutes for milk in the production of cheese. In this case, the percent change in the milk demanded for yogurt would be larger than that demanded for cheese since yogurt producers have more options than cheese producers. We could take this analysis further to uncover the effects on cheese, ice cream, and yogurt prices. We could also trace how an increase in demand for milk to drink affects the prices of milk substitutes. Our answers to these questions would also depend on these price elasticities.  This question highlights the interconnected nature of markets. Incorporating the concept of elasticity allows us to go deeper in understanding the nature of these connections. ____ For those interested in a formal discussion of the relationships between changes in supply, demand, prices, quantities, and elasticity, see this lecture on the supply and demand perspective by Kevin Murphy.   Bryan Cutsinger is an assistant professor of economics in the College of Business at Florida Atlantic University and a Phil Smith Fellow at the Phil Smith Center for Free Enterprise. He is also a fellow with the Sound Money Project at the American Institute for Economic Research, and a member of the editorial board for the journal Public Choice. (0 COMMENTS)

Adam Smith famously commented on how specialization increased productivity in a pin factory, where different individuals specialized in each subtask involved in manufacturing even a simple object.I thought of that anecdote when reading Razib Khan’s account of the difference between Neanderthals and early modern humans in Europe: Though Neanderthals made effective tools, they were never standardized, skillfully and cunningly fashioned, yes, but always seeming to reflect creative choices by their individual makers. Tools created by our anatomically modern ancestors have a monotonous but efficient uniformity that distinguishes them from Neanderthal blades. In Slimak’s reading, the indigenous Neanderthals were individualistic artisans, while the intrusive modern humans were collective creatures, prone to producing lines of standardized tools as if they were Paleolithic factory workers. You might assume that modern humans were more productive because they were more intelligent. In fact, there are increasing hints that the decisive factor was their greater sociability, which allowed them to work together in larger cooperative groups: Neanderthals famously had brains about 10% larger, on average than our own species, so it is unlikely that they were unintelligent. However, it is quite plausible that they had different cognitive strengths and were comparatively antisocial. And this antisociality is likely the cause of their greater socio-cultural stasis vis-à-vis the human populations coming out of Africa, who proved much more protean and changeable. . . .  Anatomically modern humans spreading across Eurasia and into Australia clearly organized their societies differently from Neanderthals. Genetic results from sites in Upper Paleolithic Europe ~35,000 years ago show the bare minimum of within-band inbreeding, with mates consistently being wholly unrelated to each other, which requires access to widespread social networks. . . . And yet evidence is now accumulating that Neanderthal social groups were both smaller and more isolated 50,000 years ago than our ancestors’ were. They simply seem to have been less social than their African cousins. In a previous post, I argued that America’s economic success was partly due to its ability to assimilate highly talented people from all over the world. Perhaps the same was true of early modern humans.  Indeed, modern descendants of early Eurasians are roughly 2% Neanderthal, and the genetic share was probably at least 10% around the time Neanderthals went extinct.  (Of course these events happened in a very different world, and we cannot assume that this example has important implications for modern political issues like immigration.)   The comment about the intelligence of Neanderthal artisans vs. modern human cooperators reminds me a bit of similar comparisons in the modern world.  Compare an English worker in a Smithian pin factory circa 1770 to a Native American living in what is now Montana.  Which was more intelligent, in the sense of capable of doing a wide range of complex tasks? Khan ends with some interesting comments on how the intelligence of the modern world is embedded in the institutions of society: Because of information technology, the modern world is to a great extent a collective brain, with synergies of innovation across many societies driving aggregate gains in productivity. Maybe this sort of transition, or cultural phase change, was also what marked the rise of our species as lone survivors, a collective borg-brain in contrast to our quirkier Neanderthal cousins with their isolated geniuses and bespoke creations. Rather than individual intelligence, a cultural shift to a collective brain may have occurred. Perhaps IUP humans pioneered mass-production, forgoing individual social status for the more lasting victories of the tribe. Read the whole thing. (0 COMMENTS)

Britain’s incoming Labour government got a nasty welcoming present in July when independent pay review bodies told ministers that millions of public sector workers should receive a 5.5% pay increase. The cost of this accounts for about half of the £20 billion “black hole” in the budget which Chancellor Rachel Reeves claims to have inherited.  Some noted that these increases were not conditional on increases in productivity. This is true, but that illustrates a phenomenon which will put increasing pressure on budgets across the developed world. It is known as “Baumol’s cost disease.”  This states, as economist William J. Baumol explained, that: …the costs of health care, education, the live performing arts, and a number of other economic activities known as the “personal services” are condemned to rise at a rate significantly greater than the economy’s rate of inflation…This is so because the quantity of labor required to produce these services is difficult to reduce. To see why, consider two workers; one works in a car factory, the other is a teacher. The car manufacturer’s output of cars per year can be increased with more or better machines or with a more efficient combination of the capital (the machines) and labor (their work) inputs into production (this “entrepreneurship” falls under “Total Factor Productivity”). This increase in productivity will, ceteris paribus, drive an increase in the car manufacturer’s wage. Baumol called this “the progressive sector.”  For the teacher, it is much harder to increase productivity. Their labor is a much greater share of the factors of production – indeed, the labor largely is the product, or service – and it isn’t as easy to substitute it for capital. A teacher with 20 kids in his or her classroom could send recordings of their lessons to 100 kids to watch at home, but this would be an inferior service. Likewise, we could cram 100 kids into the teacher’s class and increase “kids taught per year,” but, again, this would be an inferior service. Baumol called this “the stagnant sector.”     This is where the “cost disease” comes in. If we want people to teach, we must pay them at least what they could get in other sectors, and those other sectors include those, like car manufacture, where productivity increases are driving wage increases. Productivity driven wage increases in these other sectors will, then, drag up wages in sectors where there have not been the productivity increases to justify the wage increases by themselves.  This disease is especially acute in sectors which are labor intensive and cannot be made much less so, like education or personal care. Britain’s pay hikes cover more than 500,000 teachers and about 1.3 million National Health Service staff. We can, and should, embrace measures like telehealth which could increase productivity in the healthcare sector, but these are unlikely to be more than marginal when the service is so inherently “hands on,” or labor intensive.      ‘Stagnant sector’ industries are often government monopolies or include a significant element of government provision. But not always. The cost of the average cremation in Britain increased by 43% between 2011 and 2020, for example, while the overall Consumer Price Index increased by just 16%. When you see that famous chart showing price changes in different sectors of the economy grouped as private or public sector, you might be seeing the effects of the Cost Disease at least as much as the effects of relative government inefficiency.  Baumol sounded an optimistic note, writing: The flip side of the cost disease-the near universality of rising productivity in the economy as a whole-means that we can afford healthcare, education, and the other personal services despite their disturbingly persistent rates of cost increase. “The only thing that will change, in terms of the cost to us,” Baumol writes: …is how we will have to divide our money among these items. Table 1 illustrates this. With growth of 1.5% annually, GDP per capita rises from $66,814 to $296,121 by 2023. If health spending rises from 15% of income to 40% over that period, health spending rises from $10,022 to $118,449. But, because of the overall growth in per capita GDP, non-health spending can also increase – from $56,792 to $177,673 – while decreasing as share of all spending – from 85% to 60%. If that growth doesn’t materialize, neither will the wage increases in the progressive sector required to drag up wages in the stagnant sector. “The only thing that will change, in terms of the cost to us,” Baumol writes, “is how we will have to divide our money among these items.”  One implication of Baumol’s analysis is that the public sector share of GDP will increase dramatically. “The experiences of planned economies indicate that this is not a promising arrangement,” he notes. A gifted economist, Baumol was also a master of understatement.    John Phelan is an Economist at Center of the American Experiment. (0 COMMENTS)

  Because this is the 50th anniversary of the announcement that Friedrich Hayek was co-winner of the Nobel Prize in economics (the person who shared it was Gunnar Myrdal), it’s a good time to look closely at his 1945 article in the American Economic Review, “The Use of Knowledge in Society.” When I used to cover the article in my classes about 30 years ago, the students had trouble following his argument. Part of it, I think, was Hayek’s Germanic writing style: lots of long sentences. So for a few years, I quit covering the article. But that wasn’t satisfactory. So instead, I sent the students detailed comments and questions on various paragraphs to guide them through the article. That worked well. Each time I look at my notes, I update. So this morning I updated yet again. Here are my notes.   Teaching Notes on Hayek, “The Use of Knowledge in Society” http://www.econlib.org/library/Essays/hykKnw1.html David R. Henderson October 9, 2024 I think this article is one of the ten most important articles published in economics in the last 80 years. So, it’s worth the effort. The most important paragraph in this article is the third paragraph and the most important sentence in the article is the first sentence of this paragraph: The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality. Economists today who draw on Hayek’s insight often refer to this point about dispersed information as “local knowledge.”  Think about kinds of local knowledge you have about your job or other parts of your economic life, knowledge that would be unavailable to a central planner.  Now ask yourself how things would work if you had to get a central planner’s permission each time you wanted to act on this knowledge.  Think about your job and about other parts of your economic life. In Section II, second paragraph, Hayek writes: The answer to this question is closely connected with that other question which arises here, that of who is to do the planning. It is about this question that all the dispute about “economic planning” centers. This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals. When economists stared criticizing the idea of central planning early in the 20th century, the comeback from some of those who wanted central planning was, “Don’t you think we need to plan?” That’s why Hayek has this paragraph. Read and reread Section III, second paragraph. There’s so much in there. One example: Think of someone who graduates at the top of his/her class at Stanford, Yale, or Harvard Law School. On a scale of 1 to 10, what does he/she know on the first day at the job that will help him/her do the job? My guess is that’s no more than 4 and could well be 2 or 3.   In Section III, third paragraph, Hayek writes: Even economists who regard themselves as definitely immune to the crude materialist fallacies [i.e., thinking in terms of material wealth] constantly commit the same mistake where activities directed toward the acquisition of such practical knowledge are concerned—apparently because in their scheme of things all such knowledge is supposed to be “given.” About 15 years ago, our dishwasher was leaving our dishes streaky and so we called the appliance repairman. He came out—minimum charge $69.95—and in 5 minutes assessed the situation and told us we should use powder instead of liquid dishwash detergent. For a few minutes I was angry. Then I remembered Hayek.  Explain.  What did I figure out that is contained in this quote?   Read Section IV, fifth paragraph. Some economists who studied the Soviet Union and other centrally planned economies have claimed that the biggest failure of such economies was not in manufacturing but in agriculture.  Given Hayek’s reasoning in this paragraph, explain why.   In Section IV, sixth paragraph, Hayek writes: It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place and that the central planner will have to find some way or other in which the decisions depending on them can be left to the “man on the spot.” No question on this: Just think about it.   In Section V, first paragraph, Hayek states the dilemma: We need decentralization because only thus can we insure that the knowledge of the particular circumstances of time and place will be promptly used. But the “man on the spot” cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit his decisions into the whole pattern of changes of the larger economic system. This is the dilemma. So far, Hayek has explained why central planning can’t work. Things seem hopeless. Information constantly changes and each person has only his or her little bit of information. It seems as if things would end in chaos. Is there hope? Yes, which is why I call this next part, “Free markets to the rescue.” Let’s see what solves it.   Carefully read Section V, fifth paragraph, another key paragraph. Hayek writes: It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. Why is it very significant that it does not matter?   In Section VI, first paragraph, Hayek gives an analogy between the price system and machinery.What is that analogy?   In Section VI, second paragraph, Hayek uses the word “marvel” to describe the price system and then explains in the third paragraph why he uses that word.Why?   See the reading I’m attaching from that noted economic analyst, Howard Stern, for a humorous example of local knowledge. http://www.theloonies.co.uk/1998.02/0012.html (0 COMMENTS)

Last month, I visited Taiwan for the first time in my life. Before I traveled, I knew I would find an advanced country as well as a truly free and democratic nation. But it is not until I actually got there that I understood the significance of the very existence of Taiwan for the world. At a time when China advertises its supposedly capitalist model with ‘Chinese characteristics’ for the world to imitate, the Taiwanese show us that there need be no such characteristics. Taiwan is a living example of what can be achieved when economic freedom and democracy are coupled, even in culturally Chinese settings. The Taiwanese are free to express themselves, to argue, to campaign. They do it, and they pride themselves on doing it. Their lives remind Westerners that there is no reason why China (which shares the same religions, language, culture and heritage) must live under one-party rule. To be sure, Taiwan’s economic success is first and foremost linked to economic freedom. Taiwan has received help from the international community, and particularly the United States, after Mao’s victory in 1949 across the Taiwan strait. But it is free trade, fiscal responsibility, strong property rights, and limited regulation which have elevated the people’s standard of living. Today, Taiwan is ranked as the 11th most economically free country in the world according to the 2023 Fraser Economic Freedom of the World Index, up from 36th place in 1980.  But the fact that the strength of institutions has secured Taiwan’s success in the past decades distinguishes the country from China, where all property rights depend on ties with the Chinese Communist Party. Furthermore, whoever visits Taiwan does not see the kind of ghost towns and other abandoned infrastructure that are found in China due to the CCP’s irresponsible economic policies, which have led to significant malinvestment and an economic crisis. Throughout Taiwan, the traveler finds efficient uses of land, outstanding technology, and limited government. In this regard, Taiwan’s political success seems to be key to the sustainability of its economic model. After being ruled by Chiang Kai-shek for decades as the country left the civil war behind, Taiwan has finally transitioned into a functioning democracy with free elections and no restrictions to free speech. Accountability exists: The people can praise or condemn government policy and change course. Nobody goes to prison for expressing an opinion, and nobody has any doubts that the institutions that keep the Taiwanese free within their borders are strong. In fact, any visitor can attest that the main threat to Taiwan is precisely an external one: China. Open a random newspaper and you will see that the Chinese Communist Party is to be found virtually in every piece of news, whether it is because of conflicts and potential military escalations that involve Taiwan or other Asian countries. Ironically, the CCP is also a major threat to China’s economic future itself, since nobody knows what could happen to its institutions in the event of a regime change —and markets are no fans of uncertainty.  But as the CCP attempts to portray China as a model for the rest of the world, the case of Taiwan shows us that there is a much better alternative right across the strait. Taiwan as a country only exists because the Republic of China was forced to go into exile and managed to escape to the island, but the people in both countries are the same. This means that it is not inevitable that the Chinese must live under a dictatorship. If Taiwan could transition into freedom, why not China? The future is unknown to all of us, but Taiwan is right here for us to see today. The freedom of the Taiwanese people, their eagerness to do business with the world, and their strong adherence to democracy are all testaments to the outstanding value that this country provides to the rest of the world. Taiwan is a story of freedom and success. We would do well to take its example into account.   Marcos Falcone is the Project Manager of Fundación Libertad and a regular contributor to Forbes Argentina. His writing has also appeared in The Washington Post, National Review, and Reason, among others. He is based in Buenos Aires, Argentina. (0 COMMENTS)

The concept of “state capacity” has become popular in the economic literature, notably to explain why today’s democratic governments seem incapable of doing anything correctly, from supplying public services to controlling their budgets. The headline of a recent article in The Economist illustrates the phenomenon: “Governments Are Bigger than Ever. They Are Also More Useless: Why Voters Across the Rich World are Miserable” (September 23, 2024). According to the magazine, a major cause lies in the growth of entitlements (guaranteed transfers) as opposed to public services such as schools or infrastructure. The phenomenon is visible in America and elsewhere in the rich world. Another factor is crippling regulation. One example (“The Harris Broadband Rollout Has Been a Fiasco,” Wall Street Journal, October 4, 2024): The 2021 infrastructure law included $42.5 billion for states to expand broadband to “unserved,” mostly rural, communities. Three years later, ground hasn’t been broken on a single project. The Administration recently said construction won’t start until next year at the earliest, meaning many projects won’t be up and running until the end of the decade. … States must submit plans to the Commerce Department about how they’ll use the funds and their bidding process for providers. Commerce has piled on mandates that are nowhere in the law and has rejected state plans that don’t advance progressive goals. … The Administration has also stipulated hiring preferences for “underrepresented” groups, including “aging individuals,” prisoners, racial, religious and ethnic minorities, “Indigenous and Native American persons,” “LGBTQI+ persons,” and “persons otherwise adversely affected by persistent poverty or inequality.” It is not a matter of which political party is in power. What the government cannot do correctly often refers to what the specific defender of state capacity thinks the state should do more of. “State capacity” is an euphemism for state power. It looks rather surprising that the democratic state would lack state capacity as its scope and means of action have grown for more than a hundred years. One indicator is that, across the OECD, government spending has grown from around 10% of GDP at the turn of the 20th century to more (and sometimes much more) than 40% today. The Code of Federal Regulations contains 1,089,462 restrictions (at the end of 2022), measured by the frequency of the keywords “shall,” “must,” “may not,” “required,” and “prohibited,” more than double the number at the end of 1970. It is a Wonderland illusion to believe, like Daron Acemoglu and James Robinson in The Narrow Corridor, that state power can grow indefinitely as long as “social power” grows concurrently (see my review of The Narrow Corridor in Regulation). We get a glimpse of the result in the subsequent book of Acemoglu (with Simon Johnson), Power and Progress, where an ideal and benevolent Leviathan follows their advice and fights for all progressive causes, against greedy corporations and with the support of powerful and altruistic trade unions (I barely exaggerate: see my Regulation review of Power and Progress). Anthony de Jasay’s model of the democratic state (see notably his book The State) is more useful in explaining where state capacity leads. For decades, an adulated state has been responding to the grievances of politically powerful groups by discriminating in their favor (with subsidies, tax breaks, and favorable regulations) at the cost of other citizens. The leaders and activists of the newly disfavored groups vent their own grievances and stake their demands. Political competition leads politicians to try to satisfy the new grievances. Policies pile up and become more and more inconsistent and conflictual. The higher state capacity acquired in the process further motivates special interests and their activists to demand more privileges, and the process continues. Analysts who observe the growing discontent typically can’t put their fingers on its real underlying cause. Janan Ganesh merely comes close in a September 23 Financial Times column titled “The End of the Popular Politician.” The cause is state capacity—read “state power”—in a democratic regime, which degenerates into a political war of all claimants against all, with growing and churning redistribution. Because of the churning, it is often not clear whether one is, on the net, a beneficiary or an exploiter of the system. The state is less and less able to satisfy all the contradictory demands addressed to it. The monstrous state seems impotent. Everybody grows more dissatisfied. The populists rise with their own promises to appease their supporters’ grievances at the cost of somebody else. ****************************** You will see many strange things in this image created by DALL-E to illustrate this post, but many strange things are also happening in the political world. We can understand that this poor robot is lost. Angry crowd shouting grievances and contradictory demands to the government (0 COMMENTS)

Matt Yglesias recently directed me to this tweet: Conor Sen may well be correct about the need for further rate cuts.  But I worry about a Fed policy that focuses more on the unemployment rate than the GDP growth rate.  (Sen may have been referring to real GDP growth, but I’ll focus on NGDP growth, which is clearly the right variable for monetary policy.) Fed policy between the late 1960s and 1981 was extremely unstable, leading to an inflation burst that was far greater than the recent episode.  The cause of this policy disaster is clear; the Fed focused on the unemployment rate and largely ignored the growth rate of nominal GDP.   To be effective, monetary policy needs a nominal anchor.  That’s because policymakers do not know the natural rate of unemployment, or the natural rate of output.  Even a slight error in estimating the natural rate of unemployment can cause inflation to spiral out of control.  In contrast, while NGDP targeting may not be precisely optimal, any policy errors resulting from NGDP targeting are likely to be relatively small. Between the late 1960s and the 1980s, estimates of the natural rate of unemployment crept steadily higher.  In 1960s textbooks, the natural rate of unemployment was estimated to be roughly 4%.  By the 1980s, estimates were closer to 6%.  It seems likely that the natural unemployment rate was rising, and that Fed policymakers were chasing an impossible goal.  I don’t know if there has been a recent increase in the natural rate of unemployment, but it is certainly possible.  Targeting NGDP entirely avoids the need to estimate the natural rate of unemployment.  There is no natural rate of NGDP growth—it is entirely a policy choice. You might wonder if inflation provides a nominal anchor for monetary policy.  Why not have the Fed put equal weight on inflation and unemployment?  That sort of policy would certainly be better than a single-minded focus of unemployment, and indeed may have been what Sen had in mind.  But inflation is a flawed indicator because it is impacted by both supply and demand shocks.  NGDP is a cleaner measure of demand shocks, and thus a better target for monetary policy.   (0 COMMENTS)