Wednesday, June 01, 2011

A Phoney Debate

Tyler Cowen writes on Marginal Revolution (HERE): quoting Noah Smith on Interfluidity, headed:

‘Radical claims about recalculation’

‘In a typical microeconomic model, the market clears, because price adjusts to balance supply and demand. In a PSST [Patterns of Sustainable Specialization and Trade] world, this does not happen. The pattern of specialization and trade will not always be disturbed by small changes in prices, because the global pattern itself represents a stable equilibrium (i.e., is “sustainable”). How many computers I buy and sell will depend not only on the price of computers, my desire for computers, and my cost of producing computers; it will depend on the prices, desirabilities, and costs of a bunch of other goods throughout the whole economy. The economy will be riddled with network externalities, and the resultant weakening of the price mechanism means that any market may or may not tend toward efficiency on any given time scale. In other words, in a PSST world, there is no invisible hand.

This opens the door for a hugely expanded role for government (or other large, centralized actors) in the macroeconomy. If global patterns matter as much as local prices, then an actor large enough to perceive and affect the overall pattern might be capable of nudging the economy out of a bad equilibrium and into a better one. Dani Rodrik has been saying this for a long time in connection with newly developing economies, but the same may be true in rich countries when faced with disruptive technological change or globalization.

To which Tyler Cowen comments:
“Believe it or not, that’s not exactly my view. The most serious network externalities problem is most likely underinvestment in new innovation and its supporting infrastructure. Subsidies to basic research can yield very high returns, as they have done for the computer, the internet, and through NIH. Otherwise, when it comes to recalculating the resource allocation on top of the basic scheme of knowledge, I am skeptical that the public sector will do a very good job, for both information and public choice reasons. Private sector rigidities and rules of thumb generally will mean that readjustment is too slow, not that it will fly off the rails into hyperspace, finance being one notable exception. Education and confidence building can speed readjustment, as can nominal gdp stabilization, but if anything the public sector is especially sluggish itself. Traders rang the alarm bell on the subprime crisis, and its later and broader offshoots, well before the regulators did. Has the EU been ahead of the curve on Greece? I don’t think so.”


Comment
‘In other words, in a PSST [[Patterns of Sustainable Specialization and Trade] world, there is no invisible hand.’

The problem is not so much as this qualification is that there is no ‘invisible hand’ in any feasible world known to human societies. There is not really any ‘weakening of the price mechanism’ because the unreal assumption that ‘price mechanisms’ anywhere ‘clear’ in some notion of general equilibrium, which is a fantasy for a real world economy.

Setting out in search of a world where general equilibrium obtains is a chimera not worth the effort of looking for it. Proving it mathematically is nowhere sufficient for it to exist in the real world.

Noah Smith bserves: ‘How many computers I buy and sell will depend not only on the price of computers, my desire for computers, and my cost of producing computers; it will depend on the prices, desirabilities, and costs of a bunch of other goods throughout the whole economy.’ To which I would add a host of other possible factors, none of them under the control of any known human system.

At root it’s a problem arising from belief into the alleged mystical properties of ‘an invisible hand’ for which Adam Smith is not to blame. He used a popular 17th-18th Century metaphor on two occasions only and appropriately by identifying their objects which were neither mystical nor miraculous in the slightest degree, though this has not stopped talented modern economists failing to see what he was actually talking about. Instead they invented a myth I place of his clear usage, and widening out his meaning to refer to market prices, supply and demand and even natural liberty.

In that sense the debate between Noah Smith and highly talented Tyler Cowen is a phoney debate.

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