Russ Roberts

Klein on Knowledge and Coordination

EconTalk Episode with Daniel Klein
Hosted by Russ Roberts
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Dan Klein of George Mason University talks with EconTalk host Russ Roberts about the ideas in Klein's new book, Knowledge and Coordination. Klein argues that allegory is a powerful way to think about outcomes of emergent order. He goes deeply into the concept of the invisible hand and creates a novel way to evaluate processes that not under any one's control. Klein then suggests novel ways of evaluating economic outcomes outside of the traditional metrics and techniques. Along the way, Klein emphasizes the role of uncertainty and imperfection in the entrepreneurial process.

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0:36Intro. [Recording date: November 28, 2011.] Book will be coming out in December. At the center of the book is the idea of economic coordination and trying to capture what economists talk about, loosely, sometimes formally; but you and I always talk about it much more loosely, which is sometimes describes as market, sometimes described as complex interactions, sometimes described as spontaneous order. Talk about the underlying issue that you are trying to illuminate in this book, this issue of spontaneous order and coordination. It's about seeing the economy as a vast concatenation of things and talking about the better or worseness of that. But recognizing that we don't actually see it, we want to talk about the beauty of it and the improvement of it, and in that sense the better coordination of it. The virtues of it. Yes, but at the same time acknowledging fully that we don't actually have a window on it. And as you say, I talk about coordination; and I distinguish two types of coordination. One is this concatenate coordination that we've begun to talk about; the other one is what game theorists call coordination and what Thomas Schelling calls coordination, which is mutual coordination. I don't really mean so much to get into all that. What I want to get into is this viewing of it and the role of allegory in that, because we don't actually see this concatenation but we, as it were, imagine a being who does. Let's back up a minute and talk about what you mean by concatenation. You and I have talked about this before on the program; and I think that the unseenness of this is crucial. The invisible hand has some unseenness to it; Frederic Bastiat talks about the seen and the unseen: a bad economist only sees the seen; a good economist sees the unseen. What you are trying to do is lift the veil; of course what we all try to do as good economists is lift the veil on the unseen. But it's still unseen. You've got to find a way to organize your thinking about the complexity and chaotic nature of the world. So, what aspect of it are you trying to illuminate? The concatenation--a word you use a lot when you talk about coordination. What do you mean by that? Some of it is the Smithian woolen coat. Exactly. So, Leonard Read's "I, Pencil" description and Adam Smith's woolen coat description both go into all of the inputs and activities that flow into the making of the pencil or the woolen coat. And just beginning to list some of those; and it quickly expands throughout the entire world and in some ways encompasses all of humanity as well as contributions made generations ago in terms of producing machines and ideas and everything else. And so the idea of this as a vast set of linkages and chains is one way to think of it, to describe what I mean by the concatenation. But a concatenation--it's not the concatenation; it can be what you see in the pin factory. Smith spoke of the spectator in the pin factory--in fact, that's one of the only times he uses the word "spectator" in the Wealth of Nations when he says that a spectator see the division of labor on the floor of the factory. And he talks about one man drawing out the wire, the next man cutting it, and so on. And that's a concatenation that we can delimit and refer to. And then speak of the coordination of. But then we can take that whole idea beyond the factory, beyond the firm, to the vaster concatenation throughout the economy, throughout the world, even, as Smith did with the woolen coat.
5:26So, the way I often think about it is: There's order built into the fabric of the world--it's a fun phrase because fabric and coat have something in common, but that's a coincidence--that we don't understand naturally. We don't just see that order the way we see the order in our desk or neatening our house up. But there's an order built into the world that when more people want pencils or coats, things are set into motion that no person is in charge of. And yet, if you stepped outside of it in some dimension, if you looked down on it, whatever that means exactly--because it's not a question of a physical instance, as if, if you get on a high enough ladder you could look down and see it; you can't, of course. Those are metaphors for abstractness. Correct. So this concatenation, which means linked together, chained together, connected--there are all kinds of dimensions of it. There are the connections of the people who produce the good; and connections even within the process on the factory floor. You want to give us a way to think about that and evaluate it, which is another important part of it, that we might not be able to do otherwise. And you want to use allegory. Is that correct? Yes. I think we've been using allegory. And what maybe is different in my book is that I want to declare it. I want to unfold it and declare it. Bring it out in the open. Show how it relates to a number of major topics in the market like communication. Or price signals. Like coordination, like cooperation. Like market error and correction. And I think it's time to recognize and declare the allegory. I think there's virtues from it; so I'd also like to talk about why we should do this. And one way to think about this: we could contrast your view, which is very outside the mainstream--my view, also--and that economics in the last 60 years has moved increasingly toward a mathematical treatment of these ideas; and things that can't get treated mathematically don't get treated. And these ideas, to me, outside of a simple supply and demand diagram, which is pretty powerful, but outside of that, the complexity and the richness of what you call concatenation can't be captured through equations. And the allegory, perhaps ironically, perhaps surprisingly to some, you are going to argue, I think, is a better way to illuminate than a formal mathematical treatment. I'm not so wedded to holding this up against mathematical treatments. In fact, the mathematical treatments in a way are their own metaphors, their own allegories. For sure. And in some sense make it clear. But they fancy a semblance of precision which I think we should be ready to confess not to have and to accept not having. So there is that element. It's a little embarrassing. We'd rather be precise than imprecise. We want to be scientific.
9:10I wanted to talk about two of Smith's metaphors. He sketches an aspect of this coordination we've been talking about, and he says: "It is the interest of the people that their daily, weekly, and monthly consumption should be proportioned as exactly as possible to the supply of the season." The food supply. And he talks about the marvels of the market forces and he says that in the pursuit of profit, the grain dealer adjust price in ways that conduce such coordination. This is from The Wealth of Nations.
Without intending the interest of the people, he is necessarily led, by a regard to his own interest, to treat them, even in years of scarcity, pretty much in the same manner as the prudent master of a vessel is sometimes obliged to treat his crew. When he foresees that provisions are likely to run short, he puts them upon short allowance. Though from excess of caution he should sometimes do this without any real necessity, yet all the inconveniences which his crew can thereby suffer are inconsiderable in comparison of the danger, misery, and ruin to which they might sometimes be exposed by a less provident conduct.
Great quote, which I don't remember. So, he introduces a metaphor about how the market in a way works like a benevolent crew-master who has a kind of view, who beholds the concatenation of the crew eating, the hunger on the ship, and adjust things in a more beautiful way, from his point of view. That master of the vessel, the captain of the ship, is foresighted and prudent. He looks ahead, he sees that there might not be enough, and he, through dictate, top down, says maybe not today, we won't eat so much; we'll eat it tomorrow. Right. And then he says the grain dealers in the market basically do something parallel, although from different motives and perspectives. And this crew-master is a miniature of the following--another quote, another metaphor:
[The individual generally] neither intends to promote the public interest, nor knows how much he is promoting it... he intends only his own security..., he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.
So, the crew-master is a metaphor, the invisible hand is a metaphor, and by extending the metaphor we develop allegory. The dictionary says allegory is an expressive style that uses fictional characters and events to describe a subject by suggested resemblances. An extended metaphor. And we have seen some people do this. For example, Edwin Cannan once said that "the reason it pays in the market place to do the right thing, to do nearly what an omniscient, benevolent Inca would order to be done, are to be looked for in the laws of value." And I propose developing this allegory and being mindful of it. I, in the book, do so, and I call this benevolent figure "Joy." It's like a monotheistic God, you might think of it as. She's universally benevolent. She has superior or super-knowledge--I don't like to use the word omniscient--but certainly super-knowledge, and also a sort of God-like ability to communicate personally with each individual. And individuals believe in Joy's benevolence and trust her knowledge and value her love and approval. So, this is all in an allegory. I'm not saying this is the way it is. You don't think there is actually a creature or a being called Joy. I don't. I'm not religiously inclined. I mean, I don't deny it; but I don't think it, like at home I pray and I really feel I'm in touch with God or something. So, it's an allegory. The question is: Is it a useful allegory? And in the allegory she communicates with us in some manner. There's still more to it. So, suppose she speaks to Bridget, a baker. She tells Bridget that perhaps she should buy new ovens or look out for better deals in flour or advertise her confections; and she communicates these instructions to Bridget, and there's a sort of meeting of the minds between Joy and Bridget. Now, Bridget is again sensible to her benevolence and ethical wisdom, and Bridget feels entrusted to advance what Joy finds beautiful. She generally follows Joy's communications--in the allegory, which I get to write. It's a creative fairy tale. The signals from Joy are embraced voluntarily by Bridget. It's not a dictatorship, at least not in my allegory here. It's a voluntary choice on Bridget's part. She can go against Joy's suggestions, but she might pay a price just in terms of Joy disapproving of her or something like that. Maybe she does so from what Smith would call her sense of duty. And those communications from Joy tell her to take actions rather like the market signals would lead her to take. So, when we talk about the profit-seeking baker doing this, this, and this and it working out good for everybody and it's being a form of cooperation with society, that she's following price signals and so on, I think that is referring back not necessarily to this exact allegory--and we can change it. We do so as needed. We can also dispute aspects of it, about what's most valuable as a way to draw the allegory. But I do think that all that talk is actually referring back to some such implicit kind of construction or narrative. And in that narrative there's bona fide communication; there's beholding by Joy of the coordination of the vast concatenation--so, she's actually seeing it. We don't see it, and Bridget doesn't see it; but we're cueing off her, almost like a quarterback, so we're cooperating that way in the allegory. In that sense, there is cooperation writ large among the participants--among the baker, the brewer, the butcher--in the sense that they all have common knowledge that they are all in communication with Joy and trust Joy. Just like guys on a football field follow the quarterback--they are cooperating. That would be like a literal form of cooperation in the allegory. But then we talk about cooperation through the economic system metaphorically or allegorically, which I think is a valuable thing to do, but I think we should be ready to explain in what sense it is this extensive cooperation. Because otherwise people challenge us on and point out there is a lot going on there besides actual literal cooperation between two individuals. And accuse you of just making up feel-good paeons to the marketplace and to liberty and so on.
17:38Right; well, there's no doubt that one of the accusation against free-market folk--liberals in the classical sense--are that they are dogmatic, about the power of their beliefs or the market, the market is going to solve every problem. And poetic sometimes. But I'm wondering what we've gained from this allegory. So, I'm going to give you an example. I'm going to challenge you with an example and you tell me how it's different--what the allegory helps me understand. I'm doing this on the fly; you are doing this on the fly. So you may not be able to come up with it on the spot. So, I use the example often in class about the time I lived in St. Louis; I was going to build a porch on the back of my house. I went and got drawings for the porch, and the architect told me what he thought it was going to cost. We went out and bid the deal and the bids were 50% higher than the architect suggested they would be. Instead of being in the $15-20,000 range they were around $30,000. And I thought perhaps the architect had deceived me at the beginning of the project when he said this was going to be a $15-20,000 project. I didn't want to spend $30,000; I wouldn't have hired him to draw up the drawings; and I thought: did he encourage me with a false price because he wanted to sell his drawings? And one of the things I was buying from him was his market knowledge. It was nice to not have to go out and sample what builders would charge me because I didn't have any plans, I didn't know what it would be; so it was a coordination problem there already. So, I thought that's weird. I thought about it for a little longer, fortunately, and I realized: Well, a few months before we'd had an enormous flood of the Mississippi River and every carpenter within 250 miles was busy not building porches and decks--what I wanted was actually a porch/deck combination--but was actually rebuilding people's houses who were desperately needy and eager to see their house rebuilt. So, what that price signal told me to do was to step aside. That I was literally--a different metaphor--standing next to the person whose house was ruined by the flood knocking on the door of the carpenter, and the carpenter said: Well, I'm really busy right now. I don't know if I have time for both of you; and I would have said: I'll go second. It's nice to have a porch and deck, but this guy doesn't have a roof over his head; you ought to do his first. And so the price signal told me to step aside. So, I waited a year and built a porch for $17,000, whatever it was a year later, because I had been induced by the price signal to cooperate with my neighbor. Now, I didn't literally cooperate with him. That was the beauty of the price signal. I couldn't. I didn't know who needed the carpenter more than I did. But the price signal induced me to do the right thing. In what you just told, there's the communication element and the cooperation element, which I would say are really based on allegory. You are saying the price told you to step aside. The price didn't tell you to step aside and the guy charging the price didn't tell you to step aside. All the guy charging the price told you is: You've got my construction services for $30,000. That was the literal communication. And that's all there is in a price. I could have decided I want one anyway at $30,000. There was no literal: Step aside. And whenever entrepreneurs go off and calculate and decide on investments and entrepreneurship, that's just like doing bookkeeping and calculations in their private study. There's no literal communication at all. So the only basis for talking about it in the way you want to talk about it--the price telling you to step aside--is in this allegorical sense, as if Joy were telling you to step aside. It's not that Joy did tell you to step aside, but it's parallel to the benevolent allegory story of Joy telling you to step aside. And that would be a sort of stepping aside that would be a cooperation with the whole, the larger set of people, to make a more beautiful concatenation. And in that sense you are cooperating in stepping aside. So, let me tell another story. Because I want to get back to Joy. I think I tell the story in The Price of Everything, my book. So, there's a hurricane. This is mostly a true story--didn't happen to me, but to a student of mine. Hurricane; people lose power. So, Home Depot and other retailers have generators available for people who don't have a backup power supply already. And they are very expensive. We can imagine two different scenarios. One is Home Depot raises the price. Which they often don't want to do, for public relations reasons perhaps mistakenly but that's the way the world is right now. The other thing, which happened here in Washington, D.C. was that some people bought them at the low price but then resold them in the parking lot, for a higher price. So, one of my students told me that her husband went to buy one of those generators, and found that the price was really expensive. In the parking lot? I can't remember; it doesn't matter, which is what's beautiful about it. And her husband is a very successful business person. So he bought it anyway? And she said no, he didn't buy it. He already had two backups he'd already bought before, and at the high price he said: I'll just get by with those. And that decision again like the porch and the carpenter freed up that generator for somebody who didn't have any backup--whose freezer was about to thaw his meat or whose kid was hungry or whatever it was. I want to pick two Joy stories out of that. Story 1 is the story I just told you, where the business person steps aside and lets someone else have it, implicitly led--perhaps through Joy's benevolence--to step aside. But we can also imagine a world where the business person says: Well, I've got two backups, but I've got a lot of money; I'll buy another one. That person who shows up a half an hour later, either doesn't get one or says the price is so high that I can't afford it. It's not worth it to me. But it's not because of anything benevolent; it's because the person doesn't have any money relative to the first buyer. So, what's benevolent about Joy in that story. It's not perfect. And that's an important insight about diminishing marginal utility and a dollar being more important to a poor person than to a rich person. The free market isn't ideal in every conceivable way. I think it's possible that Joy is looking on and sometimes she's sorry about--maybe her instructions would be that the rich guy should not buy the additional unit and in fact the market doesn't follow what Joy would do. And I think we should admit that. I don't think we should construct our notions of welfare, efficiency, and what have you, or coordination for that matter, as Israel Kirzner might, for example, to somehow eradicate or deny that problem. Now, that gets into issues of: Is there a better way to do things? Some kind of contravention of the liberty principle, about rationing the units or redistributing money. Price controls. Or the welfare state, redistribution of some kind. You get into comparative institutions, and they have other problems. I just think we should deal with them honestly. You have to kind of admit or confess sometimes that maybe what you are favoring, let's say you oppose redistribution and favor sticking to free market principles here, that it's got these limitations, or drawbacks as it were. A footnote I'd add to that is: you are going to oppose coerced redistribution. You certainly could still have voluntary redistribution. You could have a fund for poor people to buy generators out of that a charity could administer. Right. And people in some sense are doing Joy when they make those decisions. So, it's silly to then deny Joy when it comes to doing it coercively. I mean, to act like that's some wild, unacceptable, illegitimate move.
27:03So, should a profit-maximizing business person, steeped in what you and I might think of as "good economics," who raises prices after a hurricane because of a scarcity problem, a knowledgeable inability, an acceptance of an inability to look into people's souls and figure out who needs what and simply says: The best I can do is to raise my price and let the price ration these--should that person feel Joyous? Is it a healthy thing for that profit motive--is it a better world when that person says: I'm not just doing what serves my self-interest; I'm doing what's good for Joy, for society at large? Absolutely. I think that economic theory helps to authorize the pursuit of honest profit and ought to give the guy who makes a lot of honest profit a strong sense that I've done my best to serve universal benevolence. I really couldn't have done it a better way; I made all these profits and I understand how it conduces to the coordination of the larger concatenation or however you want to put it, social good. Absolutely. That's one of the funny things about Adam Smith's books. It's like when he talks about these guys in the Wealth of Nations, the merchants and so on, he kind of talks about them as though they are never going to read his book. Because they are always just thinking about their profit and never thinking about the social good it does. By his own description. But, Adam, if they just now read your book, now they can think about both. And I would argue, and I assume you would too, is that the beauty of the system is they don't need to read the book. That's right. But I think it helps to read the book, because there are those interstices where you don't just maximize profit, because things don't fit the simple story for some reason. Let me ask you about the key word in that phrase, the pursuit of honest profit; for me, it's the word "honest." I think the challenge to being a moral person who has to inevitably interact with others is that word, and so--I've been thinking a lot about this Richard Feynman quote lately: The most important thing is not to fool yourself, and you are very easy to fool. I think the danger of this worldview that you and I share, that you are elaborating here, is that you will distort what you consider honest because of the comfort you get by thinking that profit in and of itself leads to good outcomes, that it makes Joy happy. And it could then justify in your heart things that are probably not honest, if you are not careful. To me, that's the danger of the business person reading the book; the merchant thinks: Profit's good. It often is; but not always. You are working for a Wall Street firm and you convince yourself you are doing God's work, and therefore anything that leads to your profits must be good for the country. In fact, that's not true. Just opportunities to take advantage of people's lack of knowledge and be misleading, somewhat. I shouldn't say misleading. Deceptive. Well, that might violate honest. But, sort of not informing them when it would be beneficial to them but less profitable to you. We can come up with other examples. I think there's a number of--I think we should talk about market communication and price signals; we should talk about cooperation and so on, but talking this way affords us questions like: What are the relevant signals? It's by being able to talk about signals that we can ask what are the relevant signals? How do they conduce to the general interest? How do they adjust when practices go wrong? If the signals start telling people to do in the wrong direction will the system correct itself? Will it come up with changes? Will it dig up new opportunities? New matters for communication? All of those are good questions and answering them is very useful and yields good insight, but it's all based on talking about allegorical terms. Price signals, communication, and so on. We need these allegories.
32:28Let's talk them about entrepreneurship generally. When people hear the word entrepreneur in everyday life we think about someone who creates a new product. A Steve Jobs or a Thomas Edison. When you use the word entrepreneur, when Austrian thinkers use the word entrepreneur, they are really talking about a much richer set of discovery than the eureka moment of a filament light bulb or something like that. They are thinking about an enormously rich tapestry of knowledge. Talk about what you mean by an entrepreneur and a discoverer and knowledge in that context. I do go into this quite a bit in the book. It wasn't so much what I had planned to do today, with the allegory, but it certainly relates. I follow Kirzner in formulating entrepreneurship, principally as the discovery of opportunity. That's sort of his idiom and I follow that. He's not entirely distinctive that way, I think he's the paramount figure talking that way. Joseph Schumpeter is very similar; he talks about creation; other people talk about bearing uncertainty--Knight. I have a chapter talking how all these relate to each other, these different formulations. I don't really believe in a definitive formulation of entrepreneurship, and in that way I might be a little different from Kirzner. So, this discovery--it can be discovering new bits of information, but maybe more importantly it can be hitting upon a new interpretation of existing information. Suddenly, Robinson Crusoe one day realizes he can catch more fish by making a net, and maybe there's been no new information that brings that about; it's a sort of epiphany, an insight, the light bulb; and it's a new interpretation of the information he had, you could say. The Paul Romerish idea of recipes--there's nothing new; maybe we're just thinking up a new way to combine stuff we see around us. Yes. And so the idea of new interpretations, and getting into the idea of asymmetric interpretation and how all of the knowledge out there in the vast concatenation is disjointed. That speaks to some of that richness that I think you are referring to. So, what we want is not only the creative searching and digging up of new information but the creative interpretations and testing and competing of new interpretations, resulting ultimately in judgment, like judging which interpretation you are actually going to act on or take stock in. So, I see knowledge as entailing information, interpretation, and judgment. And I do see that as a richer Michael Polanyi-ish understanding of knowledge that does go beyond how economists talk about it. Because they kind of flatten knowledge down to information. You use that phrase a lot in the book, and I think that's very power; it's a metaphor, too. Sort of a hammering process in which what you are left with isn't necessarily--you get a cracker instead of a loaf of bread. It's drier and less vibrant, perhaps. What do you mean by the flattening of knowledge down to information? There's a tendency to confine the discourse to stories where everyone has the same underlying interpretation of things. Like, they have this sense that there are so many possible boxes or options out there; they don't know which one it is; they don't know where they are going to get the best price or the highest wage. Payoff matrix that's got certain probabilities assigned, costs to searching. But in some underlying sense the models generally assume common knowledge, explicitly or implicitly. And common knowledge is really an assumption of symmetric interpretation, that I don't know what your cards are--you hold your cards and I hold my cards--but I know that we are playing with a deck of 52 cards and that you have 5 of them and there can be this. You know what the payoffs are for certain types of outcomes. Right. And so they want to confine the discourse to that kind of talk, which basically leaves them not addressing these other matters of knowledge as richness, which matter to the issue very often. Very often I think to policy issues. And the reasonableness of government intervention. If you are talking about a government intervention and you've already assumed that there's symmetric interpretation, sort of a sense of what the options are and the costs of doing things, then there is a sense of being able to optimize within that and maybe tinker with some of the incentives--which interventionist economics hopes and tries to do. But if there is more of this humble sense of actually the world is full of disjointed knowledge, we all have different interpretations, what this so-called government expert says about how it works is just one guy's story and he's got an agenda and a self-hood that he's trying to maintain and trying to lead people in a certain direction and so he's making it sound simpler than it is. If you look carefully at what he's saying you can start to think about all the stuff he doesn't know. Or can't know. You can't think about all of it, but you can start thinking up illustrations that there's a lot he doesn't know or can't know, which then generalizes. And so the whole idea of the pretense of knowledge in interventionist economics is informed by this richer approach to knowledge--that it's richer than information, it's also interpretation. You know what's a good example of this richness is people say: Look at the Internet; there's so much information. And there is. And so much information is now readily accessible. But what about the right interpretation? Information is great. But it shouldn't be confused with knowledge. And people are trying to use the internet to create knowledge--it's much harder. Yes. There's not been a lot of convergence on interpretation. That's really interesting.
39:59I want to try to bring it back to Joy for a minute. Certainly your description of the interventionist approach, where you've limited the number of options and you've sort of specified the number of tradeoffs in advance, it's a different metaphor. It takes this enormously complex problem and says: No, no, it's just a technical problem. You just need to figure out the costs and benefits and weigh them up to see whether the intervention is good or not. And of course it's dramatically more complicated than that. I hope to talk about the problems of simply saying it's more complicated than that, although I think that is the correct answer. I want to give you an entrepreneurial example to try to illustrate what I understand of your story about this richness. So, five, ten years ago there was a revolution in the bookstore world where bookstores got bigger. I remember my local, favorite bookstore in St. Louis expanded dramatically; and I thought: That's interesting. Why are they doing that? The answer was: Because they knew, or were worried that an enormous chain was coming--at the time it was Barnes and Noble--about a mile and a half away, and they had 100,000 titles. Say, 8,000. And they realized they were not going to be viable. They were not sure they were going to be viable expanding, but they knew they weren't going to be viable if they didn't. They expanded in a lot of ways. They added a lot more books. They added a stationery section. They may have added a cafe--which, at the time was really novel. We were all really fascinated by it. So, that transition took place--you could argue there was a test, a choice--small bookstore or large bookstore. Of course, coming around the corner, unforeseen by almost everybody, was another competitor called Amazon that was suddenly going to rip open that landscape in a really radical way. Borders, which had done the same thing as Barnes and Noble was now suddenly not able to make it. And then on top of that, we got the Kindle, the iPad, the Nook--digitization of visual, written content--we don't know how that's going to play out. So, at any one point of time in the story, we look like the choice is between a big bookstore or a small bookstore. We can talk about the costs and benefits, small bookstore is homier; you can know the owner, it's independent. And, we made all these tradeoffs. And this world changed radically; all of a sudden, 15 years later, we are in a world where maybe bookstores aren't going to be viable. Maybe books aren't going to be viable. We don't know how it's going to turn out. And I like the idea--and maybe you do too--that this Joy character is looking down and saying: That was good, that was good, that's good, too; but we in the middle of it, it's a tumult, it's a chaos. And so, we don't have the information. Forget omniscience. We can't foresee anything close to what's coming next. And so, you and I tend to look at it and say: I'm not so worried about how this is going to turn out. We are both lovers of the written word--whatever you want to call it--transmitted word. I'm not so worried about it because Joy's in charge and it will turn out okay. Other people are panicking. They are saying: Google's making a stupid--people are losing their attention spans; the iPad is going to ruin this industry; no one is going to make any money. And we just say, in one version: The market will take care of it. But you are saying: maybe it's better to think of it as if there were this omniscient creature/being looking down and saying it's going to be okay; at any point along the way these entrepreneurs are making the best decision they can imperfect information; and it will work out all right. Yes; we have principles which do reassure us that way. Principles, as long as they are still working--volunterism, voluntary choice, buying and abstention from buying in the marketplace--that does give us a lot of reason to believe that what will thrive will be good and what will perish should perish. In Joy's eyes. And that's a good example. The Borders example, just to pick up on it--that's another area of allegory or relates to one, and that's market correction, market error and correction I should say. I think we would tell the story as economists about Borders moving in a certain direction there, and it turning out unprofitable, and it turning out a market error which then gets corrected. It's withdrawn; and their activities are reformed. That manner of speaking again I think is principally allegorical. It could be that the person who decided to enter there--Mr. Borders, whoever that is, the chief of Borders--he may have looked back later and said: This didn't turn out well and ex post I see I did the wrong thing. But he also might feel that from what I knew going into it, I don't think I made a bad decision. I couldn't see this; it was reasonable of me not to be thinking that Amazon would be so tough. And he may not actually regret in that sense. Just like a poker player--he makes a play and it's a good play but the other guy draws a good draw. You don't say you made an error. You just lost. Just like Borders made losses. He may feel that way; and I say that if he felt that way, we would not say that he erred. Correct. And so it's possible that we have market error without any actual agent error. Agreed. This is something that Kirzner disagrees with me on. In what sense do we have error at all if there is no actual agent error? And I say: it's a Joy error. If Joy were giving instructions and told Mr. Borders to go open those bookstores, she should regret that. Because she has knowledge; she knows a lot about Amazon. She's got super-knowledge. So she would feel regret, and hence have erred. But you had conceded earlier that Joy is not omniscient. I just don't like the word "omniscient"--it's not a coherent concept in my view. But one of the things--I think it's the right level of knowledge--I think you should rule that out is there is a lot of uncertainty about whether Amazon was going to make it. If Amazon hadn't made it--if Jeff Bezos had had a set of migraine headaches or maybe had made some bad decisions during that stretch where their future was uncertain, Borders might be a thriving competitor of Barnes and Noble, and the Kindle wouldn't have been invented. We can imagine a set of futures where the Borders CEO made all the right decisions. You don't beat yourself up over every decision that doesn't turn out well. So, I like the idea of saying that Joy doesn't know how that will turn out, either. I'm not committed to saying she knows exactly, but when we talk about market error there, I do want to talk about Joy knowing enough that if she had told them to do that, she would look back and say: Oh, my goodness, I overlooked that interpretation where that would turn out badly, and I should have seen it. That's what an error is. I'm just saying that talk of market error and correction--I think we do want to impute that much knowledge, some of that knowledge, to Joy.
48:14So, what does this have to do with the case for liberty? What's the advantage and disadvantage of this allegorical approach to ruling out certain intervention or in justifying certain intervention? Talk about that. I think classical liberal economists have often sort of denied allegory. And I do think there are problems with doing that. They might play into the role of someone who is unattuned to the social, to social embeddedness, social effects. And again in issues of maybe the welfare state, or local externalities based on the opening of a strip joint or different kinds of things, when classical liberal economists just are unwilling to talk about certain effects, certain consequences. I think they are playing into this caricature of them, which unfortunately isn't as much of a caricature as it should be. That they are sort of unattuned to the social. Because the allegorical represents the social. These social things are sort of implicitly allegorical things. Like Margaret Thatcher said: There's no such thing as society. And in a literal sense, we understand what she means. But we do talk about society, we do talk about social effects and things that matter across people and among people. So, I think they run into that trouble. They nonetheless speak of market communication, coordination, social error and correction, and so on in ways that aren't sustained by literal definitions of those terms, as we've seen with the prices. And so they contradict themselves. They fall into inconsistency; and that opens them up to charges of: What are you talking about? And if they are not ready to deliver the allegory, they are not going to be able to answer that question. Does this have anything to do with utilitarianism? For example, in a sort of neoclassical public finance framework where one of the criticisms of that from the left is: Oh, you just think everything can be put in dollar terms and you just add everything up and you just make a green eyeshade calculation. It may be my bias working: one of the things, when I hear you criticize some of the classical liberal approach--meaning market-friendly but without this richer understanding--they are ignoring those effects of society that you are talking about. You are saying there is something to that criticism of a cost-benefit approach, that everything has to be monetized. And that none of us make decisions that way. Nobody says, and I don't mean this as a methodological point--I mean it as: if we seek the good life--no one says: see what I'll do, I'll do what's most profitable. No one monetizes literally or I think figuratively their daily activities for when asked is this a good policy. I don't think anyone other than an economist says: Well, I'll add up the costs and benefits and see where the net gain is. Is that part and parcel of your criticism? It relates, but I don't think it relates so simply. I think there's allegory going on in cost-benefit analysis. Big time. And I think again it's not precise and accurate. It's actually loose, vague, and indeterminate, a lot more than people admit or are even aware, because of all the different ways you can talk about willingness to pay, different assumptions, different conditions. I think all this definitely does entail something like social aggregation and social sense and social costs and benefits and balancing. And strong sort of Mises-Rothbard approaches sort of deny social aggregation at all, any role for it. I don't want to make it sound all precise because it's not, but there's definitely a sense of social aggregation in all this. And in Smith. And this is different from the Mises-Rothbard tradition. I think that's an important development, because I think we've been led sort of into a cul-de-sac by that tradition. Why? They try to make things precise and accurate; they pretend to be categorical, sort of 100%-ish in their claims, when they really can't be. And like I say: Then they go off and often contradict themselves. And they fall into these traps that I'm talking about about denying allegory, of playing into the role that they are accused of. Also, they are relinquishing allegory to their opponents. I think we need to fight illiberal allegory not by denying allegory but with liberal allegory. These tenets of Mises-Rothbard go against doing that. They just discourage that. At the same time I think some of them contradict it. The ones who try to blend it with Hayek. But couldn't you argue that, if you are going to take the extreme, modern version of economist as technocrat, which is: I'm going to build a social welfare function; I'm going to aggregate across all individuals' utilities to get a social utility; I'm going to call that--isn't that we you are doing essentially? Aren't you saying that Joy has a utility function? That she's the benevolent planner, and the people who are illiberal, who want to intervene in the market economy, they are agreeing with you. They are just saying: Yes, we've got to take account of all these interactions and all these externalities; and I'm going to do that in this rigorous way; and I'm going to get social policy, optimal tax rates, intervention? I think we need to meet and engage them, and on sort of two sides of the discussion. One is: What are the actual consequences of these different policy moves, and how do they play out? Do they actually serve what you say Joy loves or cares about? But there is also the side of developing our understanding of Joy's sensibilities. What the standard is. And very much unlike the guy with the social welfare function, the Smith approach admits up front that that's loose, vague, and indeterminate. It's essentially an aesthetic matter. And he's very clear about this. Talking about justice, for example. Yes; particularly beyond commutative justice: namely distributive justice and esteem justice. Which I believe Smith is talking. So, we need to engage them again about how things play out. And at the same time we're actually developing what our notions of Joy's sensibilities are; what it is we think Joy thinks is beautiful. Just like if we were to talk about a movie. Let's say I just saw Hugo, the new Scorsese film. And we could talk about it. What do you give it on a scale of 1 to 10? I'd give I think an 8. I'm glad to hear that; I haven't seen it yet; I'm looking forward to it. We could talk about is the movie successful, is it effective, what did it do right or wrong, but at the same time we are developing our sense of what is a good movie. How do we develop our sense of what is a good movie? It's by watching and talking about movies. It's not like we have an algorithm, a social welfare function analogy to a good movie function. No one has written down the formula for producing a good movie, and they never will. In that sense, it's loose, vague, and indeterminate. And it would be a mistake to think that we should work on that formula. Because with enough effort and time we'll figure it out. It's better to recognize in advance. Right. You can develop criticisms that are loose, vague, and indeterminate, or like the rules that critics lay down for what is sublime and elegant in composition, as Smith puts it. So, you can develop points and principles and insights and some guiding maxims and so on. But the idea of working out the definitive algorithm is preposterous. And it's something that Smith sneered at. Or scoffed at.
57:40That's a very deep idea. Let me restate it and let's talk about it for a minute. You are saying that the good life, writ large, good society, the good way to organize our interactions, is not a question of cost-benefit analysis. And it's not a question of measuring the distribution of income, the GINI coefficient, of measuring the distribution of income, or some other precise measure. Rather it is more akin to how we feel about works of art. That there is something artful about the texture of daily life. I agree with that. I think that's a very profound idea. And I think that is fundamentally at odds with modern welfare economics, the measures of well-being. And it's fundamentally difficult. So, if one wanted to pursue that enterprise, is it a matter of discussing it, talking about it, exploring it? I'll ask it a different way. Has film criticism advanced anything? Has it gotten better? Film has. Film's different. I wouldn't say it's better. Fortunately it's a fairly free market. It is. Fairly. I'm sure that a lot of the stuff on offer there I and each of us would find useful and if we have any interest in the matter at all, be glad that stuff's there to tap rather than not there. And discussion, conversation, is sort of the only way to do it. Including like the more systematic and responsible forms of conversation we call scholarship or science. But even human welfare, even the individual and the notion that he knows what's good for him and what he wants to become and what's going to make him more beautiful or happier or wiser or more virtuous, that in itself, it's like that's often something the individual himself does not have a good handle on, and is constantly grappling with. Our own choices we make are aesthetic in nature, decisions we make about who to marry, where to go to college, what to study, what field to go into. Those are not scientific at all. And we tell stories about them to ourselves. We craft our own narratives, an allegory of our life. We get committed to things. And then: Are we overly committed? Should we give up this commitment and then try to shift and become something else?
1:00:36There's a couple more benefits from declaring allegory. I'll just kind of mention these. Making the allegory explicit I think helps to make it innocuous. When we talk about Joy about super-knowledgeable, benevolent, having this God-like ability to communicate personally--the more we talk about that the more we see it's not like the government. And the idea of seeing the government as Joy becomes more and more clearly wrong. Ludicrous. So, I think making explicit helps to make statist forms of Joy innocuous or avoidable. Again, I think it helps us confess the looseness of aspects of our analysis. We've talked a little bit about that, particularly Joy's sort of aesthetic sensibilities. I think that the allegory can to some extent help to answer classical liberal way: the yearning for larger meaning and connection. Your podcasts often do this; they often strike that marvel-ous note, or that marvellous feeling about being part of the vast concatenation and how we are contributing to it in our voluntary participation, some appreciation for how it works. And that can be rewarding. Just like we talked about the guy actually reading Wealth of Nations and then going out and making a lot of honest profit, appreciating, being proud of himself for his contribution to universal benevolence. At the same time, I think the allegory can help people to see that they must subdue or re-channel the yearning for larger meaning and connection. Because this is an allegory. And Joy has these assumed powers. And we are not going to realize that. We are not going to recapture the feeling of the small band or the family. If you want that, look to your family. Don't look to Washington. So, it teaches us to subdue certain of these yearnings for larger meanings and to re-channel things and satisfy our meanings--our family, our friends, our job, sports, whatever you are into--and not politics. It's kind of like--liberalism is not a philosophy of life. But I do think it helps in a philosophy of life, kind of telling the individual where not to look. And I think the allegory is helpful that way. So, Yogi Berra--this is my final remark--once said: If you don't know where you are going, you could end up somewhere else. And The Theory of Moral Sentiments [Adam Smith] was published in 1759, and it was deeply allegorical. And very shortly thereafter people like Dugald Stewart and Thomas Brown and Thomas Reid protested allegory and moved away from it. And influenced, I think, the future of liberalism, and I think the 19th and 20th century tried to deny allegory. Including the classical liberal tradition to a large extent. So I think we ended up somewhere else than where we were at first pointed with The Theory of Moral Sentiments. And you think we ought to go back to that other destination, I assume? That other path, yes.

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COMMENTS (25 to date)
Scott G writes:

Looking forward to this podcast and hope Klein's book is excellent.

Max writes:

Amazing... I believe that Klein has provided what may be the first fully articulated manifesto for an atomistic reactionary/conservative post-structuralism. Kudos!

David C writes:

I was confused about a god who is prophet maximising.

Its ok, I've figured it out now. The downsides of audio...

rhhardin writes:


Catenate means the same as concatenate, if you want a shorter word.

Hence the unix command "cat".

John Strong writes:

Ironically, a frustration I feel with my fellow liberals is their reluctance to acknowledge the social idealism behind their convictions. This is not faithful to Adam Smith's work which is charged with moral conviction based on a vision of the public good.

Dan Klein is a student and scholar of the Theory of Moral Sentiments and I often hear an echo of Smith's vocabulary when Dan talks. For instance, Dan (rightly) speaks of utility as something "beautiful."

Utility is not a "categorical imperative," for sure. There's "moral propriety," as Smith points out, and Dan well knows. But I'd love to see more liberals openly acknowledge that they have a principled commitment to the public (social) good.

I understand, of course, the difficulty of specifying what "the public good" is. Nevertheless, the indignation of, say, a Don Boudreaux against trade protectionism, is simply not credible on purely individualistic terms. Liberals advocate methodological individualism because of a judgment about the way coordination and cooperation work in practice. This is phronesis, practical wisdom, but it is not what gives moral energy to the liberal project.

DAN KLEIN, way to go!!! Thanks for this honest and open insight!!!

Charlie writes:

At first this made me uncomfortable, because creating allegories with names like "Joy" always does. But after sleeping on this, I think it would be very useful for classical liberals to adopt this framework. I see it akin to the "Planner's Problem" in welfare economics, except that the planner's problem tends to be much more explicit about what types of knowledge Joy has and what it is that Joy is maximizing.

Classical liberals tend to focus much too much on morality arguments, like "taxation is theft." I find them much more persuasive when they focus on practical arguments. The limits of alternative policy choices to achieve the desired results. Typically, in refusing to even discuss concepts like Joy, they reject that there is such a thing as desired results. Instead they fall back on desired rules and assume that wherever they lead must be the desired result.

Frank Pasquale writes:

I really enjoyed this podcast, and the general methodological efforts here. Could you host Mirowski and McCloskey sometime? I think there's room for a much larger challenge to mathematicization of the primarily narrative realities of economic life. (A point obliquely made by both Freeman Dyson (reviewing Kahneman) and Thom Nagel (reviewing books on disgust) in the NYRB.

A quick question re the Smith metaphors. Invocations of the “invisible hand” can be suspect. Adrian Vermeule has argued that there are “necessary conditions” for invisible hand “justifications to be cogent.” (Adrian Vermeule, The Invisible Hand in Legal Theory, Harvard Public Law Working Paper No. 09-43 (October 6, 2009), available at http://ssrn.com/abstract=1483846)

Such a justification must combine “(1) an explanation that identifies an invisible-hand process with (2) a value theory that identifies some social benefit arising from the invisible-hand process and (3) a mechanism that explains how the invisible-hand process produces that benefit.”*

As one commentator notes, financiers’ “$4 trillion daily trade in cross border capital, their $600 trillion of derivatives, about twice the capital stock of the world, [and] their algorithmic trading that accounts for about half of the turnover in the US stock exchange” have “never existed before,” and are as new a variant of “capitalism” as China’s system is of “communism.” It is naive to claim these enormous flows of funds are viable or even imaginable without sovereigns capable of guaranteeing order...and perhaps even envisioning the whole in ways that the "I, Pencil" narrative rejects as impossible.

(By the way, could you also host a talk with Dani Rodrik on his "I, Pencil" takedown, which points out how CHina has captured the pencil biz via top-down mercantilism?)

Charlie writes:

Frank,

There was a podcast with McCloskey.

http://www.econtalk.org/archives/_featuring/deirdre_mccloskey/

There are some more on methodology:

Leamer on econometrics for instance:

http://www.econtalk.org/archives/2010/05/leamer_on_the_s.html

John Strong writes:

Chinese Capture of Pencil Market

What does Dani Rodrik think that this proves? Are we supposed to conclude that mercantilism is a good idea?

Chinese elites favor particular Chinese producers at the expense of a billion Chinese tax payers, importers, and consumers. Why?

Chinese elites are not mercantilists because of a wise economic master plan that we dumb liberal societies are just too dogmatic and beknighted to understand (Dani Rodrik). They are mercantilists precisely because of institutional failure. They have to divy out privileges to buy the support of groups that otherwise might cause trouble. Order is the first priority of every government, and it is not free.

In other words, the Chinese promote pencil makers as part of a corporativist social contract intended to secure the power of the eiltes domestically.

Will Chinese pencil makers enjoy their dominance for ever and ever? No. Contrary to what mercantilist theory says, this was never about "market share". It's not really an economic story at all. It's a political story.

If you want a good treatment of the interdependence of markets and institutions, then you have to go to someone like Elinor Ostrom. Pete Boettke talks about her work here.

Brit writes:

After listening to podcast, I can't help to think that economics really needs a shot in the arm - an injection of radically new ideas and insights that show how shallow this current type of thinking is. With each of your examples, I was thinking of other counterexamples proving the opposite, which made much of the discussion sound like confirmation bias.

Let's take some counterexamples:
(1) Monopolies. I'm not talking about government monopolies, but rather, monopolies who have managed to capture the entire market or an oligarchy where multiple competitors combine together to set prices. I could say a lot about this, but I think most of it is pretty obvious - specifically: monopolies aren't serving the public interest and do not make the world a better place, despite the allegory that "Joy" knows best. (Case in point: the monopolies over the movie production and theaters or Stanard Oil which were ultimately broken up by US anti-trust laws.) There are a lot of natural barriers companies will use to attempt to prevent competition from competing against them. (And I say natural barriers specifically to point out that monopolies will exist even in the absence of government intervention to create monopolies.) According to "Joy", those monopolies are doing something good. I'd also point out that laws to break-up monopolies are an instance of government intervention in the market, and I do believe it's for the best. Perhaps this serves as an example of the positive effects of government intervention and the failure of "Joy" to arrive at the best solution for society.

(2) One of the issues I think about with competition is how competition in the free market can sometimes create sub-optimal solutions. For example, let's get back to the discussion about books and bookstores. Let's say there are physical bookstores that we can browse through and let's say there are online bookstores. Now, because of overhead costs, physical bookstores need a certain amount of traffic each month to stay in business. Let's also say that we, as consumers sometimes like browsing through physical bookstores and we sometimes just want to buy a book online because we're short on time and don't want the hassle of driving or whatever. So, we buy half of our books in person and half of our books online. The very existence of on online bookstore means that half of our business goes to them, which could very well drive the physical bookstores out of business. This results in a situation where the physical bookstores no longer exist and we must now buy all of our books online, which makes our life worse. Perhaps if we had to choose between (1) "shop at physical bookstores and online bookstores", (2) "always shopping at the physical bookstore" or (3) "always shopping at the online bookstore", the majority of people would chose #1, #2 and then #3 (in that order). But the fact that we give some of our business to online stores might result in a situation where we only end up with online bookstores (i.e. the worst of the three options). So, in this case, we can see that the free market actually results in the worst of the three options. I'm not so much making an appeal for some sort of intervention in the market, I'm just pointing out that the free market or "Joy" in all her infinite wisdom, is not necessarily going to lead to the best outcome. Therefore, we should *not* simply assume that "Joy" will lead everyone to the best outcome. I actually consider it dangerous that people would accept this allegory because it will aid them in ignoring the complexities of what's going on and to simply assume everything will simply work out for the best.

Daniel Klein writes:

@ Brit:

In describing certain business actions that you posit as bad, you write: "According to 'Joy', those monopolies are doing something good."

Not necessarily. The "Joy" stuff is not meant as an allegory to suggest that all voluntary action is deemed for the best, nor in which all intervention is deemed undesirable. Russ and I no doubt tend toward narratives that illustrate why he and I maintain a strong presumption of liberty, but the "Joy" stuff per se is meant as neither a basis for nor an expression of such sensibilities.

Joy certainly often frowns on the voluntary actions of market players, and she may smile on certain government interventions. We (you, me, Paul Krugman) debate different characterizations of Joy.

I think it is useful to mind the allegory in our talk. And the we in this "our" is not just the "we" of classical liberals who favor a strong presumption of laissez-faire.

Jason Briggeman brings this C.S. Lewis quotation to my attention:

"it is a serious mistake to think that metaphor is an optional thing which poets and orators may put into their work as a decoration and plain speakers can do without. The truth is that if we are going to talk at all about things which are not perceived by the senses, we are forced to use language metaphorically. Books on psychology or economics or politics are as continuously metaphorical as books of poetry or devotion."

In the podcast we discuss some of the benefits of declaring the allegory behind our economic talk. We say that Joy may disapprove of certain voluntary actions. I'm not sure that we say that she may approve of certain government interventions, but I say it now.

Russ and I focus on the allegorical talk of classical liberal economics -- market communication, price signals, cooperation throughout the global economy, and so on.

But some of the terms we discuss are not so specific to liberal purpose. For example, I don't think that concatenate coordination, with its tacit beholder of the vast concatenation, is specifically classical liberal. Maybe Joy dislikes very unequal outcomes and thinks that government redistribution policies, even with all their problems, make things more beautiful, on the whole.

Likewise, social/market/policy error and correction. I don't think that such talk is specific to classical-liberal discourse.

One of the virtues of declaring allegory is that it makes clear that the sensibilities of judgment (of beauty, coordination, etc.) are akin to aesthetics. At the same time that we debate the myriad micro consequences of, say, reforming the minimum wage, we are also developing our "aesthetic" sensibilities. Like Russ and I discuss by way of the movies analogy.

For us mere mortals it may not seem like aesthetics; we don't really get to "see" the landscape, and hence we are not struck with what Smith (in History of Astronomy) calls admiration. But this is one point where the allegory is helpful: We are debating Joy's aesthetic sensibilities -- for her, as a great beholder, it is a matter of aesthetics. She does admire the landscape.

Charles Griswold, in his excellent Adam Smith and the Virtues of Enlightenment, refers to the second side of our discussion, the side that develops our sense of beauty, our standards, as the protreptic. (At least that is how I take Griswold's discussion of the protreptic.)

Thus, it is not the case that we assume that Joy anoints laissez-faire and spectates as that policy "will lead everyone to the best outcome,"
as you put it. Really, my pitch for declaring allegory has existence separate from my commitments to liberalism (though no doubt the two are related).

Ghislain writes:

@Brit:

In your point 2, you probably underestimate the online bookstore benefits to people. You seem to neglect the fact that by having an improved productivity, they can offer better prices, and so people pay less to buy books. With this amount of money saved, people can buy other stuffs (maybe books). So your propositions should be:
#1: Buy books online and at physical bookstore (let's say this is the reference)
#2: Buy books at physical bookstore, but not all the books you would like
#3: Buy books online + some other stuffs (smartphone or whatever)

Do you really think people would classify the proposition in this order?

Brit writes:

> @Daniel Klein
> "Joy certainly often frowns on the voluntary actions of market players, and she may smile on certain government interventions."

So let me ask you this: why, during the podcast were you casting Joy as super-intelligent and talking about how Joy's super-intelligence acts as a counter-argument to governments' (less intelligent) mettling in the markets?

I'll have to go back and dig up the exact quotes, but it seemed very much along the lines of - we have to cast Joy as super-intelligent as a counterweight and counterargument to the idea that government intervention is a good thing; since governments are obviously less intelligent and less capable of seeing the economic landscape, why should they think they know better than Joy?

> @Ghislain
> "Do you really think people would classify the proposition in this order?"

That's not a relevant counter-example. My point is simply that it's not hard to imagine situations which lead lead to worse outcomes. When you add extra features ("but not all the books you would like" or "some other stuffs (smartphone or whatever) is you are altering the particular case, but I'm showing a more general case: that the free market *can* lead to worse outcomes. If you want me to explain in more detail why your counter-example is not a good counterargument, I can do that in the next comment.

To put it another way, the claim is this: Joy always knows best. How do you refute this claim? You refute it by showing cases where worse outcomes happen in certain situations. So, I provided "Example A". You countered by saying, 'well, if we imagine Example A to be different and it had features X,Y, and Z, then that wouldn't really be a counter-example'. My response: You've taken my Example A and turned it into Example B (which doesn't disprove the "Joy is always right" assertion), but that's a different situation. Not all Example A's can be transmuted into Example B. I'm saying that given Example A, Joy will fail.

Brit writes:

By the way, if you want another counterexample, here's another one:

Let's say that there's a small town and Coffeeshop A exists there. Let's say that the town is only large enough to support one coffeeshop. Coffeeshop A is bringing in a profit of $2000 per month. Now, Coffeeshop B comes into town. It's not as well liked, but the company behind Coffeeshop B decided that they've got a lot of money in the bank and they're willing to wait two years for Coffeeshop B to be profitable. During this time 1/3rd of the customers start going to Coffeeshop B and 2/3rds stay with Coffeeshop A because it's better. However, Coffeeshop A sees a 1/3rd decline in sales and eventually goes out of business. Now, Coffeeshop B is the only coffeeshop in town and they get all the customers. Because they aren't as well-liked, they're only pulling down a profit of $1000 per month. (Note that Coffeeshop B is bringing in less profit than Coffeeshop A used to bring in.) This is another example where the lesser product wins. In this case, it's because the market can only support one coffeeshop and because Coffeeshop B had a lot of capital to keep them in business during the period of time when two coffeeshops were competing.

John Strong writes:

@Brit, concerning your monopolies example:

Why do you bifurcate monopolies into two types: private and public? Aren't most monopolies just private businesses with privileged access to government power?

In Mexico, where I live, the government has a long history of blatantly purchasing social & political order by granting monopolies to economic elites (chronicled in lurid detail in Stephen Haber's book, The Politics of Property Rights: Political Instability, Credible Commitments, and Econommic Growth in Mexico 1876-1929). I think the same thing happens in the U.S. in much more subtle ways.

The empirical evidence suggests to my mind that monopolies are more prone to emerge as a result of the abuse of state power rather than market power. You probably know more about the history of Standard Oil than I do, so tell me: didn't Standard Oil use its political influence to deploy police power in defense of its monopoly?

And BTW, why are we always treated to this ancient example of Standard Oil in any discussion about monopolies when there are monopolies all around us right now that would be more fruitful subjects of study? For example, why do you think Carlos Slimm, Mexican telephone magnate is the richest man in the world? Here's a hint: it has nothing whatsoever to do with the abuse of *market* power.


John Strong writes:

@Brit, concerning "government intelligence" VS. "market intelligence"

Governments have no more claim to being a rational mind than markets do. In fact, they have *less* of a claim.

Government institutions are no less emergent than market institutions. The usual Rousseauian political narrative that assumes government is the product of a rational Collective Will is mostly just moral camouflage. Returning to the Carlos Slimm example, for instance, you may be amused to hear that he has a nice nationalist narrative to justify his monopoly control of the Mexican telecom industry. He is just ensuring that the Mexican telecom industry "doesn't fall into the hands of foreigners." What an admirable patriot!! I'm sure he's also concerned about Mexican workers and the fate of the tortilla.

Here are some reasons why markets are generally more reliable at producing an approximation of what might be called the public good than governments:

* attention span of economic actors (Principal-Agent problem / Information Problem)
* clarity of incentives (Principal-Agent problem)
* phronetic ordering of real priorities based real choices that are themselves emergent ("revealed")

I could go on.

Dave writes:

In contrast to all your others, I found this podcast childish and uninteresting.
The allegory of "Joy" broke down around willingness and ability to pay issues, so let me suggest a change. "Joy" values individuals based on their wealth. Strange all of a sudden your story doesn't give me warm fuzzy feelings....

All I heard was a rehashed version of the Puritans' beliefs; God rewards those who are pious with wealth, therefore those who are wealthy are pious.

The only interesting point made was Russ's comments about individual actors being unable to distinguish between "honest profits" and rents.

Perhaps this podcast can return to interesting debates on stimulus multipliers, rather than libertarian love rests.

Daniel Klein writes:

@Dave:
You get the drift wrong when you write:

"The allegory of 'Joy' broke down around willingness and ability to pay issues, so let me suggest a change. 'Joy' values individuals based on their wealth."

Your concerns with distribution can be cast as Joy's dissatisfaction with what she sees.

The "Joy" bit really is not specific to libertarianism -- In fact, some libertarians might say it is antithetical to libertarianism.

The embarrassment of "economic efficiency" is that willingness to pay is based on many assumptions, including assumptions about how many dollars each person has. Dwelling on all such embarrassments and showing that there is no terribly focal set of assumptions for willingness to pay, nor data given whatever assumptions one favors, is part of my agenda of showing why "economic efficiency" turns out to be, not grammatical, but loose, vague, and indeterminate.

Dave writes:

I listened to the podcast again, and still don't understand the value of moving to allegory holds. I don't disagree that one of the biggest failings of economics (or any science-ish disciplines) is false precision and unwarranted confidence. But I feel that your allegory fails in this regard as well. It implies that prices convey complete and unambiguous information (Joy is all knowing and able to communicate without misunderstanding).

When I think through ways to make the allegory more representative of reality the same problems that face neoclassical economics arise. It seems you're making the same heroic assumption that individuals are able to predict the course the economy will take and determine the best way to position themselves within it (perfect information and infinite computing power compared with Joy's perfect communication).

Where do market failures fit in? Would that be an individual misunderstanding Joy's intentions? Intentionally working against Joy? Do they not exist in this allegory?

Perhaps I'm misunderstanding your intentions, if you mean to encourage awe of the information gathering power of transactions between individuals and humility in economic analysis (or story telling), more power to you.

And thank you for responding, I'm about to enter grad school in economics and being able to talk with intelligent and established thinkers makes me feel Joyous.

-Dave

PS: I would purchase and read your book but cannot afford or have time for all the books I'd like to consume.

Brit writes:

@ John Strong:
"Why do you bifurcate monopolies into two types: private and public?"

I split them into two types because the libertarians would like to say that all monopolies are really just government power given to certain actors (in other words, government abuse of power leading to economic inefficiency, but it makes some people rich). I want to point out that market monopolies can and do exist without government intervention.

@ John Strong:
"Aren't most monopolies just private businesses with privileged access to government power?"

I'm not clear on your point. Also, by saying "most monopolies", you're admitting that market-driven monopolies can exist. And that's my point: Joy would support market-driven monopolies even though we (as a nation) would break them up. This suggests that we are doing something wrong by breaking them up.

@ John Strong:
"The empirical evidence suggests to my mind that monopolies are more prone to emerge as a result of the abuse of state power rather than market power. You probably know more about the history of Standard Oil than I do, so tell me: didn't Standard Oil use its political influence to deploy police power in defense of its monopoly?"

Again, I'm unclear on your point. I'm making the point that monopolies can exist purely through the market. You seem to be trying to prove that monopolies can exist because of government favoritism - which is a point I don't dispute. I don't understand what your point is. It's like I was arguing that smoking causes cancer so you shouldn't smoke and you come along to tell me that other things cause cancer, too. (So what? You haven't shot down my argument that you shouldn't smoke because smoking is still a high risk factor for developing cancer.)

Standard Oil, by the way, would lower prices below wholesale to drive competition out of the market. Once competition was gone, the barrier to entry was a lot harder for any new competition. This is similar to what movie companies did - they made the barrier to entry very high because they owned both the movie-production and the movie-theaters, meaning any new competition had to simultaneously create their own movies and setup their own movie theaters all over the country. This was a very high barrier to entry.

@ John Strong:
"Governments have no more claim to being a rational mind than markets do. In fact, they have *less* of a claim."

By talking about the intelligence and rationality of the market's "mind" versus the government mind, we're setting up a false analogy. You see, we imagine intelligence to be "higher" or "lower" and we whenever a higher mind and a lower mind disagree on something, we feel that we should listen to the higher mind. The problem is this analogy of "intelligence" has serious flaws. We cannot think of the "mind of the market" and the government mind as values on a 1-dimensional scale of measurement. My point is this: if a market becomes a monopoly, that's bad. But, it's not "bad" from the standpoint of the "mind of the market". The logic goes: "Well, if the market drove itself into a monopoly, and the mind of the market is superior to the mind of the government, then rationally, we should allow this monopoly to exist because it was chosen by the superior mind of the market". You have to think of the mind of the market and the mind of the government not as values on a 1-dimensional value of intelligence, but as different perspectives on a problem, otherwise you'd *always* side with the market. My inclination is to side with the market, but there are exceptions to this rule.

To use a comparison, if Adam has an IQ of 100 and Steve has an IQ of 120, which one will have better advice? You'd immediately say, "Well, it's Steve!" But, what if Adam is a cook and Steve is an auto-mechanic. You have a question about cooking, which one has better advice? Now, you might answer "Adam". But Adam is the less intelligent, less rational of the two. In my analogy, Adam is the government and Steve is the market. The market isn't *always* right and you have to be careful if you look to the market as always coming up with the right answer.

John Strong writes:

Brit:

> we imagine intelligence to be "higher" or "lower"

Indeed. Rank-ordering is the most fundamental characteristic of all rationality.

> Adam has an IQ of 100 and Steve has an IQ of 120, but Adam is the better car mechanic

This simply exchanges a rank ordering based on IQ for one based on mechanic skills. It refines but does not elude value judgments.

Epistemic Canard

Let's concede that our value judgments about what is in the "public good" are "loose, vague and indeterminate." Let's go even further and acknowledge that our notions of "state" and "market" are loose, vague and indeterminate. It's not hard to find epistemic problems with any of these concepts.

(Lest you think the notion of "state" is an exception, consider the example of "home owners' associations." Are they simply "private covenants" or are they actually a form of municipal government? Some argue, correctly IMHO, that they are looking more and more like governments).

Choosing Our Heuristics Well

But the epistemic concern is a canard. The attractiveness of a dogmatic formula, whether in religion or social science, is not measured by its conformity to absolute truth, but rather by how many people are likely to misinterpret it and arrive at harmful reductionisms.

Faith in government is much more likely to lead to harmful reductionisms than faith in markets, therefore I feel we can "trust the market" in a way that we can not "trust government." If people viewed governments as emergent phenomena, I would not skew my dogmas so strongly in favor of markets. But they don't. People view government in a Rousseauian manner, as an expression of a Collective Mind.

Between the government most people imagine exists and the market, we can not remain neutral. We must rank order the former really low and the latter much higher.


AC writes:

Sorry, I find the whole "Joy" thing bizarre and unnecessary. Just read Russ Roberts' The Price of Everything.

Steve writes:

A lot of comments so far relate to the attribution of superior knowledge to Joy. The bigger flaw with this allegory is the attribution of benevolence.

Why must she be "universally benevolent?" the goal is to model the origin of a complex economic order that *often* coincides with our own interests. Russ immediately came up with an example regarding a generator being purchased by someone wealthy enough to ignore price signals. Dan Klein says that this indicates a exception where Joy is being ignored. It is only an exception if her goals are the same as ours. If you renamed her Glory and assumed she was self interested the allegory would make more sense.

Glory seeks to coordinate human actors to maximize her own growth. Imagine she is like all other life forms. She is neither malevolent nor benevolent. This is more consistent with the exceptions being pointed out. In this case it would also encourage a more serious study of the how the interests of people differ from those of the market. There is no justification for assuming they are the same.

Brit writes:

@John Strong
I don't understand what the point of your comment was. I attempted to show that, even if you can accurately claim that Steve is smarter than Adam, it doesn't follow that Steve has better answers in all domains than Adam. Similarly, even if we concede that the market is smarter than the government in general, it doesn't follow that we should always trust the market over government intervention in specific cases. I used the specific case of monopolies - government intervention is often used to break them up, but the market loves monopolies and "Joy" loves monopolies (because if you're getting paid, it must be something that Joy loves).

I don't understand how your comment addresses any of this. It seems to me like you've decided to talk about some completely different issue and I don't understand its relevance to the topic at hand.

John Strong writes:

Brit wrote:

"I used the specific case of monopolies - government intervention is often used to break them up, but the market loves monopolies and "Joy" loves monopolies (because if you're getting paid, it must be something that Joy loves)."

I see a couple of problems with this, if I have understood you correctly.

  • I see no empirical evidence that markets are more inclined to produce monopolies than governments. Just the opposite. Nor do I see many examples of governments breaking up monopolies, especially if you mean monopolies created by markets. A.T.T. was a monopoly created by the government.
  • You seem to conflate "market" with "self-interest" when you say: "... if you're getting paid, it must be something that Joy loves"

Self-interest is at work within the sausage factory called "government" if far uglier ways than it is in markets.

Note that Wealth of Nations was not an anti-socialist polemic (I don't think socialism existed or was current in Smith's day). It was a polemic against business people trying to use government power to squash competition. Smith said something like, "leave business men alone in a room for 15 minutes and they will start to conspire against the public."

"Joy" in this case comes to the defense of the "Public", not the self-interested rent-seeking monopolists.

Concerning this criticism:

"I don't understand how your comment addresses any of this. It seems to me like you've decided to talk about some completely different issue and I don't understand its relevance to the topic at hand."

Well, maybe I have misunderstood you. Wouldn't be the first time I've misunderstood. "Human language is the devil's whore" to misquote a famous historical figure.

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