The myth of the myth of the market
Mar 30, 2013
6 minute read

Matt Yglesias argues that there is no such thing as a “market distribution” of wealth, because most wealth would not exist without the state. He lists “a few minor exceptions” to the maxim that market solutions are efficient:

— The air pollution impacts of modern electrical power generation, industrial activity, and transportation can’t be efficiently bargained away because the transaction costs are way too high.

— So-called “public goods” like basic scientific research or musical recordings will be underproduced absent some combination of state subsidy and state-created intellectual property monopolies.

— Basic infrastructure (roads, electrical lines, sewers) won’t be provided properly without some eminent domain and they won’t be priced correctly due to the monopolistic nature of the market.

— Absent deposit insurance and regulation, banks will be subject to runs and economically destructive panics.

— Without a central bank minding the store properly, the entire macroeconomy will fall into periodic recessions lasting months or years.

Since these five factors color all market activity, Matt says, there is no such thing as pure market activity, and therefore no distribution of wealth that would result if there were no government provision of pollution abatement, public goods, and so on.

In my view, Matt’s argument is not compelling. Take first his list of “minor exceptions” to the general rule that markets work best. Do we need state intervention to keep air pollution down to acceptable levels? There has never been a completely laissez-faire society that has had dirty air, so it is difficult to say. What we do know from the work of Elinor Ostrom is that we don’t need state intervention in all cases to solve problems associated with water usage or overfishing, which are structurally similar to that of air pollution (i.e., they have high transaction costs). It turns out that the threat of state-sanctioned violence is not the only solution to repeated prisoner’s dilemmas, even when transaction costs are high, either in theory or in practice.

What about other public goods? It is strange to me that Matt chose copyright protections for musical recordings as an example, because I might favor eliminating such protections even as a matter of marginal policy reform. If musicians could no longer make money from selling recordings, they would still produce recordings as advertisements for their live performances. Musicians would tour more, and the live music scene might become more vibrant. It’s not at all clear to me that it would be worse than the status quo. I don’t favor eliminating government funding for basic research, and indeed, at the margin, I would favor more such funding. But similarly, without government subsidies, research would still occur, philanthropists would still donate to universities, and so on. While the result may be some modest “underproduction” of basic research, it still seems unlikely that but for government funding of basic research, we would be living in caves.

I’ve never understood the argument about roads, since as best I can tell, roads have always existed, even in cases in which governments did not have transportation policy. The common law, which itself originated without the state, seems to have made adequate allowance for solving the anticommons problem via various kinds of easements and property rules. Matt also argues that private infrastructure would be monopolistically priced, but I think he fails to consider the possibility of customer-owned mutuals as an alternative to both government and for-profit firms.

Without deposit insurance, would banks face constant runs and panics? This is at best controversial among monetary historians. Modern economists tend to blame bank failures during the Great Depression more on restrictions on interstate banking and the concomitant lack of geographic diversification than on the lack of deposit insurance. New Zealand does not today have deposit insurance; it is not a financial hellscape. If deposit insurance were eliminated, banks would become more sober, prudent institutions than they are today, which may not be such a bad outcome. I favor the elimination of federal deposit insurance, and I don’t think I am very alone. Certainly, it is not one of my most out-of-the-mainstream policy views.

I confess to chortling a little at Matt’s line about central banks. Months or years of recession?! Unimaginable. With central banks in charge, the US is experiencing a years-long slump, Japan is experiencing a decades-long stagnation, and Europe is…fucked. Central banks were also at the helm during the Great Depression. My monetary policy views are conventional, but the central banking track record is not something I would try to draw attention to were I taking Matt’s side of this argument.

None of this is to say that we would all be immensely wealthy in a world without government intervention. The way Matt structures his argument, I don’t have to make that claim. All I need to show is that but for government intervention, we would not be dramatically worse off than we are now, which I think I have done. It seems worth mentioning, in addition, that government sometimes makes us worse off as well as better off. For example, government regulation of pollutants can and often does exceed anything resembling the welfare-maximizing amount. Governments produce public bads as well as goods, such as war, genocide, the new Jim Crow (to say nothing of the original), and immigration restrictions. Transport policy is often counterproductive, and infrastructure resources such as spectrum and airspace are often misallocated or otherwise mismanaged, relative to a common law approach. Financial regulation seems to do more to enrich Wall Street than protect the public. And as I said above, government policy caused the Great Depression and the Euro crisis, as well as innumerable other financial disasters. These costs are significant. Immigration restrictions alone cut global output in half. On top of all this is the deadweight loss of taxation, which is substantial.

What is most unfortunate about Matt’s list is how widely accepted it is. He says you can find it in “a really banal mainstream neoclassical economics textbook,” and he is right. Textbook economics presents a simple model of the world and draws conclusions from that model that are frequently at odds with reality. Most textbooks try to convince the reader of the benefits of economic analysis, not to educate the reader about the limits of the models they present. Real world institutional analysis is much more complicated, messy, and context-dependent than Matt’s textbook allows. We can and should use the tools in the textbook to illuminate our work, but applying them as Matt does to create a universal theory of the (non)existence of a market distribution of wealth seems misguided.