Does Market Failure Justify Government Intervention? (with Michael Munger)
Jun 17 2024

another-way.jpg Economics students are often taught that government should intervene when there is market failure. But what about government failure? Should we expect government intervention to outperform market outcomes? Listen as Duke University economist Michael Munger explores the history of how economists have thought about this dilemma and possible ways to find a third or even fourth option beyond government or markets.

RELATED EPISODE
Matt Ridley on How Innovation Works
What's the difference between invention and innovation? Could it be that innovation--the process of making a breakthrough invention available, affordable, and reliable--is actually the hard part? In this week's EconTalk episode, author Matt Ridley talks about his book How Innovation...
EXPLORE MORE
Related EPISODE
Robert Frank and Russ Roberts on Infrastructure
Robert Frank of Cornell University and EconTalk host Russ Roberts debate the merits of a large increase of infrastructure spending. In the summer of 2012, Frank and Roberts were interviewed by Alex Blumberg of NPR's Planet Money. That interview was...
EXPLORE MORE
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.

READER COMMENTS

Abe
Jun 17 2024 at 8:36am

Munger quotes Rodrik: “Mistakes are an inevitable and necessary part of a well-designed industrial policy program; in fact, too few mistakes are a sign of underperformance.” and summarizes this as “So, the more mistakes you make, the better, because that means you’re trying more hard stuff.”

That is such a bad faith summarization. Rodrik might be wrong, but his point is pretty clearly that there is an optimal amount of policy error, and that amount is greater than zero. This is the same as the following (obvious, and obviously true) point: the optimal traffic control policy will result in some people dying in traffic accidents, because the only policy that would result in no traffic deaths would be to ban driving. I think Rodrik is too sanguine about industrial policy, but he is clearly not saying “the more mistakes you make, the better”.

I also think that this podcast seems to assume that there is always an obvious policy which constitutes government non-intervention, whether or not that policy is the correct one. I want to make the point that in the presence of externalities, or more generally when the hypotheses of the welfare theorems are not satisfied, it is far from obvious what non-intervention even means.

Michael Munger
Jun 17 2024 at 12:13pm

Abe: I think that’s a fair point.  “We should make more mistakes” is not the same as “We should maximize the number of mistakes, as a GOAL.” And an uncharitable person could certainly characterize what I said as being the latter.

But, two things:

In his 1932 speech, Roosevelt said, “The country needs and, unless I mistake its temper, the country demands bold, persistent experimentation. It is common sense to take a method and try it: If it fails, admit it frankly and try another. But above all, try something.” So what I meant was that maximizing the number of EXPERIMENTS will cause many more mistakes. “Persistent experimentation” simply assumes that state action can improve the market outcome. Why? Net of years of failed experiments, why is there any reason to expect the “solution” to be better? For large externalities, such as climate change, the solution would have been to impose a substantial carbon tax and LEAVE IT, so people could use it in their expectations, in 2010. Instead, we have had constant experimentation, where no one knows what the policy is, and the externality is not internalized.
The idea of the welfare theorems is simply nonsense. With increasing returns to scale from division of labor, there is no general equilibrium against which actual market, or government, outcomes, can be compared. That is the point of the Keech-Munger article: It may well better to accept market failure rather than guarantee government failure. Government is no more capable of general equilibrium optimality than markets are; that’s a silly comparison.

Mike Krautstrunk
Jun 17 2024 at 3:50pm

This episode is unadulterated Viagra for the economist-adjacent among us. Or even for actual economists, I suspect.

Bill Allen
Jun 17 2024 at 6:45pm

I found this one of the most informative economics discussions of all the EconTalk episodes.

A small bug in the notes: the link given for A.C. Pigou takes you to Ronald Coase.

[Thanks! The typo is fixed now. –Econlib Ed.]

Mark
Jun 17 2024 at 8:14pm

I like the idea of government experimentation. The problem is that there’s no forcing mechanism, as there is with voluntary exchange in a free market. That seems like the great unsolved problem with this proposal.

It seems Pigou recognized destructive forcing mechanisms, such as political pressure or moneyed interests, and sought to remove these. That’s great on the negative side of the ledger (though it seems more concern is given to political pressure, when distortions from moneyed interests seem at least as troubling), but it doesn’t seem to go far enough to create positive incentives to build the kind of system we want.

 

Is it the position of Pigou et. al, that experts don’t need incentives (other than a desire to do good work) to build a system that would be viewed by the majority of people as superior to the alternative approach?

Brandon
Jun 18 2024 at 12:01am

In my industry (tech) we have many non governmental, non corporate bodies that set standards. ISO and IEEE are examples. There is a range of how “captured” by corporate and/or government interests, but it does seem they are quite similar to the third option of economic organization identified by Pigou and discussed in this episode.

Jonathan Andrews
Jun 18 2024 at 3:07am

This was great and well timed.

My A level (UK pre-university) Economics class have just done their end of year exams. One question mentioned that prices of pasta in Italy had been rising and asked whether the state should intervene.

Joel
Jun 18 2024 at 1:08pm

Mike mentions that there is a relatively low level of respect for bureaucrats in the US and lists some potential root causes (Vietnam, etc.) but fails to note that ‘government bureaucracy’ has become a political punching bag. Therefore approximately 50% of the country is trained to loathe, or alternatively love, whatever broadly falls under the umbrella of government bureaucracy.

Michael Munger
Jun 18 2024 at 1:38pm

I guess two things can be true.

It could be true that Vietnam, Watergate, Tuskegee Syphilis Experiments, and (I could go on for a LONG time) had zero effect, and the entire difference is that there has been criticism by crazy people in the U.S., for no reason.

But I doubt that.

Still, you are not wrong that there is a strain of reflexive, and sometimes unthinking, opposition to government in the U.S., and that is part of the problem. Fair enough.

 

Ben
Jun 18 2024 at 2:20pm

Identification of the incentive and information problems a century ago does not equate to the suggestion that they understood the problem or potential solutions. For example, we identified K-12 education problems decades ago with little or no progress since.

 

Experimentation as a method of developing solutions sounds like a distant cousin to the feedback processes and tools used routinely in the private sector. Experimentation that takes years to evaluate is not competitive with the rapid incorporation of feedback that drives continuous improvement in the private sector.

 

Greed incentives in the private sector have millions of people who provide a check on private companies by challenging the subjective or objective value of the products and services provided.

 

Greed in the public sector is dismissed via propaganda that uses straw-men to make their case. The phrase, “it would have been worse without government intervention” comes to mind. Checks on bureaucracies are provided by congressional oversight committees and well-informed voters. I am doubtful if 1 in 10 oversight committees are competently done. Not sure who can claim we have well-informed voters. However, those same voters can tell you if the price of milk is lower at one store vs. another. They vote best with their feet.

 

So assuming we do not throw the constitution away, I do not see the idea of government groping as worth trying. Unfortunately, thoughtful efforts to find a rational approach for government intervention is likely to enable many politicians to grab one sentence and use it to justify any kind policy they want…while telling us top economists agree with this approach. It is the old phrase that you can draw a line in any direction from a single datapoint.

 

In The Forgotten Man, Amity Shlaes does not see evidence that FDRs approach to trial and error was a net positive for the country. By the way, imagine the simplification of taxes and regulations as well as the reduction of the cost of government if it stuck to protecting our rights.

TS
Jun 18 2024 at 10:00pm

I enjoyed this episode and appreciated how Munger gave credit to the Cambridge Welfare School where it was due.

I think there are certainly some areas where government can perform better than markets, and the airline safety example was a good one. Much discourse on government failure focuses on the most salient and controversial areas (e.g. megaprojects, industrial policy), but there is a lot of stuff in government that functions reasonably well, too — it just doesn’t make the news. In my personal experience as a former government official in tax policy (not in the US), I found sensible, principled reforms were more likely to go ahead in dry, technical areas in which the public and politicians were generally uninterested.

I would have liked to see the idea about different cultures and attitudes towards the public sector explored further. People sometimes assume that a strong, well-funded public sector means a “big” state, but that isn’t necessarily true. After working out which areas the government can do better than markets, we should empower it to perform in those areas—but only those areas. The podcast mentioned Europe but I think Singapore is a good example of a strong state that has remained small. I understand the public service is paid reasonably well and held in higher regard there (likely influenced by their mandatory public service requirements).

Luke J
Jun 19 2024 at 1:56am

Mike Munger’s podcast The Answer is Transaction Cost is already referenced in the show notes, but I want to give a special shout-out to the Jun 17 episode “Dam Shame: It’s not eash being government” which perfectly supplements this week’s Econtalk.

Krim Delko
Jun 22 2024 at 1:18pm

Michael recently spoke about the Trolley problem in this podcast. I see economics as the attempt to find approximate solutions to trolley problems. Examples are Covid (save lives vs lockdowns, unions vs harming kids who can’t go to school, climate change, even the Fed is in principle a trolley problem, in so far as we’re sacrificing future generations for the immediate wellbeing of rent seekers.

Suggest a discussion of economics as seen through the lens of the Trolley problem.

Dallas Weaver Ph.D.
Jun 22 2024 at 8:50pm

One factor in markets that makes a difference is the response times. Markets can be viewed as a feedback control system where a change in demand and price is a signal to create more/less supply. This is a standard feedback control system that we use everywhere from thermostats to rockets landing on barges.

However, if the supply response time is slow relative to normal demand variations (like with a business cycle) the system is unstable and will wildly oscillate and crash. Imagine putting a pillow over your thermostat and wondering why the temperature is unstable.

Markets like many commodities with long supply response times and demand shocks have unstable prices. The regulators can make some markets unstable by adding time delays.

For example, when Germany had their push for solar energy that pulsed the demand for solar silicon and the market went to 10 times the production cost but all the Western companies faced many-year delays for permissions for new production facilities. All countries have sand required for making solar silicon.

In China, they built a privately owned 1.5 billion dollar plant in less than 16 months which added 30% to the world production capacity. No competitor could get permission fast enough and I heard that the capital cost of the facility was paid in profits in the first 6 mo of operation. Now they own the solar silicon market.

Delays can make markets unstable justifying a claim of market failure often used to create more regulatory delay.

This is just math from Control Theory, but that gets you into partial differential equations and economists aren’t as good as control system engineers at this level of math.

Craig Lambie
Jun 26 2024 at 1:04am

Great episode – Thanks!

I am curious if you, @Russ, have interviewed anyone that has covered Citizens Juries in the past, I couldn’t find a link between you and that idea.
I am also curious if you @Mike read anything on this during your research for the paper – given you don’t mention it

At around 20min in you discuss this “What we need is a government committee of experts that will manage the inevitable problem of choosing, making mistakes, and then updating.”

This in essence is a citizen’s jury that is informed by a committee of experts. BUT it also brings in a unelected political angle. That is what I like about it.
The problem with “experts” is they each have a different opinion, so it is important to have someone listen to a group of them argue their positions and then make a choice that is right for the stakeholders – in this case, the public. Technocracy misses the important “politics” I think.

The NewDemocracy foundation in Australia have run multiple juries or deliberative discussions and the results have been super sensible and non term based political outcomes – more long term and thoughtful.
I could imagine this would be more sensible than the FDA or Federal Reserve in decision making.

Would be super interesting to hear you cover it.

Student of Liberty
Jul 1 2024 at 1:34am

Mike Munger says:

“I’ve actually found in a number of places where A.C. Pigou, in the 1920s, should be recognized as the first Public Choice theorist.”

I would argue that the first Public Choice theorist might have been Frédéric Bastiat as early as 1850 when he writes in The Law:

The law has become corrupt under the influence of two very different causes: unintelligent selfishness and bogus philanthropy.” and the explanation that follows.

https://studentofliberty.com/2021/03/08/the-law-2/

In any case, we are all building upon the shoulders of our elders…

Thanks for the talk. Loved it.

Gary Lynne
Jul 1 2024 at 2:30pm

Fascinating conversation about the Cambridge Welfare Economists, and how Coase misrepresented Pigou.  And, yes, makes sense:  Humans are about trial and error, so, whether operating within the domains of Market and/or Government (to include Law) it is what works.   Now, what the conversation missed is: Humans work best when striking good balance in Market & Government, like the Roosevelts fully understood in working at building the 1930-1980 New Deal Order.  Humans have dual interest, as in seeking an own-interest whether working in the Market and/or the Government, composed of joint self & other-interest.  And, that is why The New Deal Order (unfortunately taken down by the Market Fundamentalists) worked quite well, and why the economies of places like Norway and Sweden do so to this day. It is not about seeking only self-interest as mainstream economic theory and public choice theory claim.  The shared other-interest (reflecting the ethic that works for everyone) also plays a key role.  It is about incentives & ethics, not just incentives, and it takes trial and error to find the best balance. So, use Dual Interest Theory (DIT) to go beyond, transcend Single (self-interest only) Interest Theory (SIT), which makes easy sense of all of it, including the trial and error in finding what will work for the other, the shared other-interest (which is what also explains transaction costs, another story).  Try DIT, don’t just SIT.  You Might Like It.

Student of Liberty
Jul 1 2024 at 11:06pm

Russ Roberts says:

“Your claim, which I’ve never heard before, of tâtonnement–which is groping or heading toward or trying to get to–the idea that that process would be trial-and-error is fascinating.”

I do not find it fascinating but enlightening! There are quite a few concepts in economics that I always struggle to translate into French and trial-and-error was one of them. I believe that the concept of “tâtonnement” is exactly that indeed and Michael Munger’s find will help me improve my French writings in the future.

If “groping” was the translation of choice for Walras (whom I have not read yet – shame on me), it’s funny it did not stick and was replaced by “trial-and-error” subsequently.

Thanks for that.

Susan Rico
Jul 12 2024 at 2:33pm

Late to this, but wish citizens’ assembies had been part of the convo!

LEAVE A COMMENT

required
required
required, not displayed
required, not displayed
optional
optional

This site uses Akismet to reduce spam. Learn how your comment data is processed.


DELVE DEEPER

Watch this podcast episode on YouTube:

This week's guest:

This week's focus:

  • "The anatomy of government failure," by William R. Keech and Michael C. Munger. Public Choice, May 2015. See this article for full documentation of most of the quotes from Pigou read aloud during the podcast episode.

Additional ideas and people mentioned in this podcast episode:

A few more readings and background resources:

A few more EconTalk podcast episodes:

More related EconTalk podcast episodes, by Category:


* As an Amazon Associate, Econlib earns from qualifying purchases.


AUDIO TRANSCRIPT
TimePodcast Episode Highlights
0:37

Intro. [Recording date: May 29, 2024.]

Russ Roberts: Today is May 29th, 2024. And, my guest is economist Michael Munger of Duke University. This is Mike's 47th--yes, 47th--appearance on EconTalk, which is roughly once every 20 episodes or a little over twice a year. Mike was last here in September of 2023 talking about Adam Smith and the trolley problem. Mike, welcome back to EconTalk.

Michael Munger: It's a pleasure, Russ. Thank you.

1:05

Russ Roberts: Our topic for today is government failure, based on a paper of yours co-authored with William Keech. Bill Keech was a friend of both of ours who has sadly since passed away. Your title is a riff on an older paper about market failure. Market failure is a term that's used frequently by economists. I thought we might start there and talk about what market failure is, and how you're trying to respond to that.

Michael Munger: Yeah, let me say something about how we came to this. As you said, Bill Keech was a mutual friend of ours. We actually, the three of us, got together once, I think, at the Southern meetings and had some very nice scotch during the conference. I'm very sad that I did not get a picture of you and Bill together. It wouldn't quite be Friedman and Stigler, but it would be close. Bill was six foot eight--just shockingly tall. In fact, Bill and I used to carpool to Duke. And, surprisingly, the car that Bill had was a Mini Cooper. Now, the reason he had a Mini Cooper was that the front seat would go all the way back on top of the backseat, and that meant that--uniquely, that car meant his enormous six-foot-eight legs would fit in.

So, one day Bill and I pulled into a parking space, and a woman was walking just in front of us, heading towards the office. And, just by accident, Bill and I both abruptly got out at the same time. I'm not a small man, and Bill is six foot eight. She actually stopped and looked and said, 'Are there more?' She thought it was a clown car because a Mini Cooper is very small.

Well, so Bill, I wanted to give the idea of--Bill had a manner of speaking that was something like Eeyore, where, '[low Eeyore-like voice] Everything is bad'; but if you talk to him, he actually had a great sense of humor. He did die recently.

And, part of the reason that I had brought this up that we might talk about it, Russ, was that 10 years ago, this very day, Bill and I were in a coffee shop at the beach in North Carolina working on this paper. And, what we were struggling with was the idea of how to express the problem of government failure in a way that was on par with what you talked about when you said market failure.

So, market failure has a long history in economics. In some ways, the idea of market failure was prompted by the events of the late 1920s and the 1930s we now call the Depression. But, the question is: why are there such large fluctuations in aggregate economic activity?

And so, the classical explanation doesn't explain those cycles very well--the classical economic model. But, the claim was you have to let prices work themselves out.

And then, the question in the early 1930s became: is there ways that government could intervene that would either shorten the time period in which prices will work things out or reduce the amplitude of the decline in the first place? So, can we make recessions shorter and shallower? And, the classical response was, 'No, no. If you do that, you'll distort prices; you'll make things even worse.'

So, this laissez-faire, this kind of hands-off approach, was difficult for politicians and for citizens to accept.

And so, people were casting about for ways: How can we explain these enormous fluctuations in aggregate economic activity? And: Do we have a way of thinking about them that will let us find points of intervention for the government?

So, the Austrian response to that--as you know--and Ludwig von Mises, as early as 1920, had written this book on Socialism, saying that the government didn't have enough information. Without prices, there's a variety of reasons why the government would not be able effectively to intervene. The Public Choice response in the late 1950s and early 1960s took the Austrian objection as being correct, but added an incentive problem.

So, I have written recently that in order to understand an economic system, you have to look with two eyes: Incentives and information. And, the question is: Can you generate by looking with two eyes--incentives and information--a better outcome than you would get from markets?

Because, markets create a set of information, and markets generate information from prices. Can you do better than that?

So, the Public-Choice response usually would claim that government doesn't know enough and government bureaucrats will have the wrong incentives. And so, we probably can't do better.

Now, there was a response that I think Public-Choice people don't take seriously enough, and that was from the Cambridge Welfare School. And, let me take just a second and explain the Cambridge Welfare School.

So, Oskar Lange famously said, 'Socialists certainly have good reasons to be grateful to Professor Mises, the great devil's advocate for their cause. It was his powerful challenge that forced socialists to recognize the importance of an adequate system of economic information. So, as a memento of the prime importance of sound economic accounting, a statue of Professor Mises ought to occupy an honorable place in the Great Hall of the Ministry of Socialization of the socialist state.'

And so, his claim--what Lange claimed--was Mises is right. We may not have enough information. We need to work harder on information than we thought.

Well, what information do we need? Well, when you look back, there's another school of market failure, and that is the equilibrium people. So, the Cambridge School was welfare economics: Can we have better outcomes? And, the equilibrium school had to do with: Will markets produce coherent outcomes or will they just be chaotic?

And so, Leon Walras in the late 1890s said, 'What must we do in order to prove that the theoretical solution of the problem of the determination of equilibrium prices is identically the solution worked out by the market?' That is, we can come up with an ideal. Will the market approximate that? 'Our task is very simple. We need only show the upward and downward movement of prices solve the system of equations of offer and demand by a process of groping.'

Now, in French, groping is par tâtonnement. So, tatonnement is the process by which markets are going to discover the correct prices.

What's interesting is that Oskar Lange took exactly that par tatonnement--that groping--and said, 'That's what government should do: experimentation. So, what we need to do is experiment with different policies.'

That is literally exactly where President Roosevelt, when he made his speech about experimentation, and where people who favor government control, government intervention in the market, they are advocating for experimentation.

So, the Austrian critique that government doesn't have enough information is possibly true. But, the--Public Choice in the 1950s, looking back, said, 'Well, government can't have enough information. And, they also don't have the right incentives.' Because, when you look at Ronald Coase or Gordon Tullock, they say, 'Well, government officials--people who advocate for government--don't recognize the political problem.

What I have found is that the Cambridge economists, and A.C. Pigou in particular, very much recognized the political problem, both the incentive and the information problem.

And, I've actually found in a number of places where A.C. Pigou in the 1920s, in the 1920s, should be recognized as the first Public Choice theorist. And, I can read the quotes if you want, but I've written several things about this.

What's interesting is that the Cambridge economists--the Welfare School people--recognize the information problem to an extent that I think many later people didn't give them credit for. But their answer is groping. They want government to have enough power to do constant experimentation.

And, here's the important thing: It has to be insulated from political incentives. So, it has to be completely outside of any democratic pressures.

This is why, during the 1930s, the Roosevelt Administration--many theorists in the Roosevelt Administration--and people in the United Kingdom were such fans of Mussolini: not because they wanted to be Fascists but because they recognized that the incentive problems of politics were so severe.

So, just one more thing and I'll be done with my introduction--because I think this intellectual history is interesting for people who have grown up in the Public Choice tradition.

In the Public Choice tradition, we are catechized to learn people who favor government intervention don't understand the information problem, and they don't understand the incentive problem. And, once you put politics in, then the scales will fall from their eyes.

That's not true. They actually recognized those problems before; they just have a different solution.

But so, there's a paper in 1938 by Abram Bergson that isn't often read anymore but should be. So, in 1938, Bergson said, 'If the production functions and individual indifference functions are known, they provide sufficient information concerning the economic welfare function for the determination of the maximum position, if it exists.' All the details--all of them--are just matters of implementation. So, all we need--

Russ Roberts: That's the silliest thing I've ever heard. But, go ahead.

Michael Munger: It was in the American Economic Review. It was the standard.

So, you say it's silly. We don't read that. When I say that's what people used to believe, people, 'Nah, people never believed that.' They did. That was literally what they believed.

11:40

Russ Roberts: Let me just clarify for non-economists in the audience why I think it's silly and what Bergson was saying.

What we're talking about here--and what I understand you to be talking about, Mike--is this question of: Can the government outperform the private sector, either by taking on some of its tasks or by improving, by intervening, by regulating, subsidizing, taxing, the choices that would emerge from a market private choice, a set of private activities?

And to be clear, neither of us is an anarchist. When we talk about private outcomes or market outcomes, we're not talking about literally unregulated. Of course, government is playing a role in property rights, deterring fraud--perhaps through the courts--and so on. We're talking about the next level of government intervention, which would be subsidies, taxes, regulation, or taking nationalization, taking over a task that the private sector might not be doing well.

So, those are the kind of things that we're talking about.

And the goal, in the abstract--and that's very important--in the abstract, when economists are writing about this, they're asking the question: If government intervenes--taxes, subsidies, regulation, taking over a task--can they outperform? Can government outperform the private sector?

And, one of the huge problems I have--and we'll probably get to it, but we might not--is that just defining what outperform means is very complicated. Does it mean every single person is better off? Does it mean that the benefits to those who are better off are at least as large as the harm to those who are worse off? Those would be two obvious things you could look at.

But, the reason I said that about the Bergson thing--read the first sentence again.

Michael Munger: "If the production functions and individual indifference functions are known, they provide"--

Russ Roberts: Stop! So, the production function is an absurd idea that Arnold Kling has talked about--

Michael Munger: I can write it down. I can put it on a blackboard-

Russ Roberts: Yes, you can--

Michael Munger: You used to do it: Russ Roberts, 1992.

Russ Roberts: What he's claiming there is that we can treat everything the economy produces, goods and services, as a mathematical equation where we combine workers, resources, and capital to make Stuff. And Stuff is capital S. So, we want to have a lot of Stuff to allocate to the citizens.

And, in this story--which is, in my mind, an absurd story--this story says two things. We're going to, if we know how much we can make--how much is literally a scalar, S, 53 units--and, if we know how much people like the different parts of S--guns and butter, say--then we can figure out how to make everybody maximally happy. A phrase which sounds reasonable and actually makes no sense in my view, but it's a Benthamite utilitarian idea.

But, there's a phrase in there that I had to stop you short on, which is, if we knew people's indifference--did he say curves or functions?

Michael Munger: Functions--

Russ Roberts: Function--what he means by that--which is a totally confusing phrase for a non-economist--but what he means by that is: If we know how much people like different things, that is to say, if I give you, Mike, three hamburgers a week and you're eating three hamburgers a week; I'm going to take them away and I'm going to give you a certain number of soy patties. How many do I have to give you to make you indifferent to your loss of three hamburgers?

That's a formal concept in economics captured by something called an indifference curve. Of course, they can't be known. They can't be known by the government. The government cannot know how much Mike Munger likes guns versus butter, meat versus soy, vegetables versus cheese.

And, even Mike might not know--which is a different, even bigger problem.

That's the so-called information problem that you've been talking about. We don't have complete information at any one time about how much people like different stuff.

So the idea that we could allocate the Stuff to the people in a way that makes them as happy as possible is, to start with, a meaningless idea because of that lack of information.

And, James Buchanan went on to say--which is a wonderful two-page, three-page piece--that we only find out what people like in the process of and how they respond to change in the process of them going through it.

Okay, so that's my first footnote.

But I want to add one more thing and let you carry on. Your claim, which I've never heard before, of tâtonnement--which is groping or heading toward or trying to get to--the idea that that process would be trial-and-error is fascinating. Because, one of the most powerful aspects of private decision-making is it's often driven by trial-and-error. And then, competition among different types of trial-and-error determines how stuff gets chosen: which product wins or which product has a bigger market share, or how much of a resource gets devoted to an activity, or whether a new product can survive.

Maybe in this version it won't, but eventually there will be an innovation that will make it possible.

And you can't write that on a blackboard. Typically, it's through trial and error.

We had an episode with Matt Ridley where we talked about this in great detail, how the Wright Brothers--they didn't sit down and figure out the best way to fly. They tried a bunch of different stuff, and most of it didn't work. And then something did. And, that's often the less romantic, but actual way that product innovation occurs.

The idea that the government could do that--especially that it could do it insulated from the political pressure that politicians would face--the idea that there would be a technocratic alternative to the messy, chaotic, dog-eat-dog competition of the private sector--is fascinating.

And listeners may remember--one of my favorite moments in EconTalk, when I debated Robert Frank about infrastructure, and we will put a link to that episode. And basically, I think, Robert Frank said: 'Well, we just need a committee of experts to decide what infrastructure is needed. Don't pick politicians.' I said, 'We already have that. It's called the Senate,' or, you know, 'the Congress.' He said, 'No, not that. We'll have a committee of experts who would be insulated from political considerations and would simply pick the amount we should spend on bridges, roads, sewage, etc. And, that will be better than the messy government solution and much better than a private solution in this case; because there's a market failure: There's no way that private sector activity will generate the right amount of infrastructure.'

So, end of speech.

Michael Munger: What you just said is literally my discovery. And, it's a stupid discovery because everyone who had done the reading already knew.

And, the discovery is--I actually, I found this out from my Duke colleague, Steve Medema, who is--by the way, I have my own podcast called The Answer Is Transaction Costs. And, the most recent [?ti-d-c?], Medema and I talk about Pigou and transaction costs, and R.H. Coase.

Backhouse and Medema wrote a paper about the Cambridge economist's view of groping and tatonnement in the 1920s and 1930s.

And, it is explicitly there. They read Walras. And they said, 'That'll work. What we need is not a government committee that will make the final choice. What we need is a government committee of experts that will manage the inevitable problem of choosing, making mistakes, and then updating. Because these experts can do it better than the sort of blind groping of the market,' which doesn't have any telos. Markets are evolution--

Russ Roberts: No goal--

Michael Munger: Yeah. Well, there's nothing that normatively it is trying to accomplish. Survival is the only thing markets do.

20:39

Russ Roberts: And that--the 'they' in the sentence that you just finished--is the Cambridge economist, not the two authors of the paper.

Michael Munger: What they wanted was really smart, able people, and the Cambridge economists saw those in the mirror every morning. Yes.

And so, it was pretty clear who they intended. They didn't say me. And, yes, you're right. What Backhouse and Medema are doing is just documenting the fact is that the Cambridge welfare economists fully--in fact, surprisingly fully--recognized both the information and incentive problems as early as 1920. But their solution was one that, for some reason, most of us have ignored.

So, can I read something from--this is from a paper by Dani Rodrik in 2014?

The case against industrial policy, and industrial policy is a form of government activity to improve the working of markets, specifically by picking winners and losers and subsidizing those industries, which ought, from a positive perspective, to be, we want green energy, we want better things, we want to get rid of coal. Market system won't do that fast enough. And so, industrial policy will do it.

So,

The case against industrial policy comes in two forms. The first is that governments do not have the information needed to make the right choices as to which firms or industries to support. The second is that once governments are in the business of supporting this or that industry, they invite rent-seeking and political manipulation by well-connected firms and lobbyists. Industrial policy becomes driven by political rather than economic motives.

Exactly right. That is the Public Choice objection. He has stated it fairly.

I contend the first claim is largely irrelevant.

And, the reason is he wants experimentation by--

Russ Roberts: He, being Rodrik.

Michael Munger: He being Rodrik, he being Frank, he being Pigou, he being everyone in the Cambridge Welfare School. This is a 100-year-old tradition. It's not something new. I just have not recognized it enough until now. So, it was new to me maybe 10 years ago, when I was working on this paper.

Russ Roberts: Mike, you have many personal failings, of course, but I would suggest that you're not alone in failing to appreciate the prescience and achievement of the Cambridge Welfare School in anticipating these objections. And, again, just to reemphasize the point. It remains the question to whether their answer works, but--

Michael Munger: It's a different question--

Russ Roberts: it's fascinating.

Michael Munger: It is a different question. You are right. Empirically, they may be mistaken, and it won't work, but it's a different objection than the sort of stupid one that I have made until fairly recently: 'Oh, they just don't understand politics.' They understood it perfectly, and they understood it 100 years ago.

So, Rodrik says,

I contend the first of that information is largely irrelevant, while the second about political influence can be overcome with appropriate institutional design. Good industrial policy does not rely on government's omniscience or ability to pick winners. Mistakes are an inevitable and necessary part of a well-designed industrial policy program; in fact, too few mistakes are a sign of underperformance.

So, the more mistakes you make, the better, because that means you're trying more hard stuff. So, that--

Russ Roberts: Sorry, I just want to emphasize--I don't know if we were going to get to this--but one of the standard critiques of the market is people will look at some outcome and say, 'Oh, look how horrible that is. And, therefore government should intervene.' This has now been flipped on its head. The market people look at this government activity--industrial policy, urban renewal, public schools--and their answer is, 'Oh, well, sure, it doesn't work every time. How could it?' Which, of course, is what the market people say. 'It's reality, isn't it?' And then, the response to the government intervention then says, 'We just now need to do it better. We've got more information. Of course, it doesn't work every time. Now is our chance to improve it.'

Michael Munger: But, let's be fair. What they're saying is: Mistakes are going to happen under either system, markets or government.

Russ Roberts: Correct.

Michael Munger: The question is, which system can learn better and faster? And, markets, you have to wait for someone else to try something.

Now you said it's been flipped on its head. Franklin Roosevelt, in 1932, before he took office, made a speech that was based explicitly on this viewpoint, where he said, 'We are going to make lots of mistakes. We're going to have systematic experimentation, and we're going to make lots of mistakes.' It is based explicitly on this view that that's how we're going to learn.

And so, we are finally now starting to turn towards the Keech/Munger article about government failure, because what Keech and I wanted to do was to put these two systems on more or less an equal footing and recognize that the people who advocate for government failure are--forgive me, the people that are arguing for government intervention are doing it in a way where their claims about information, their claims about incentives are much more sophisticated, and[?than?} until now, I think we have realized.

26:01

Russ Roberts: And, to give the government-intervention position its due--and, I didn't mean to suggest that my raised voice or ranting a minute ago was to mock it. I find it quite interesting, that these parallels.

But, to take another step in their direction, they--the interventionists--correctly point out that the private decision-making and the private outcomes have a different kind of incentive problem, which is that the producers of the goods--the owners of the companies--are self-interested, greedy, and have an incentive to exploit their customers and their workers. And, you and I look at that and say, 'Well, of course they do.' Adam Smith recognized that, and I'm sure it's probably in the Bible. But, the point is, is that for you and me--I'll speak only for me. For me, of course, that's true. It's competition that constrains the greed and self-interest, and that turns it into a force to serve the customer.

And then, there's a separate question. Well, what's enough competition? And, should the government intervene to achieve that through antitrust laws, regulation, and other things?

But, the idea that the private sector has lousy incentives is certainly true. And our insight--not our insight--our position that government bureaucrats have bad incentives because they do not have skin in the game is also true.

So, both sides are correct. The incentives of the people making the decisions are deeply flawed; and then becomes a question of: In what situations are those incentives improved either by the constraints of competition--in the case of private decision-making--or by noble desires, elections as a constraint on political nefariousness, corruption, rent-seeking, and so on?

And, I guess--I'm going to--SPOILER--tell you where I come down most of the time. Not all the time, of course. But, much of the time, my difference with people who want to intervene more than I do is my belief that the private market competition outperforms the political market competition of elections and better, more noble sentiments that some politicians might have.

Michael Munger: Yes. Okay. So, you said a bunch of things. Let me break it out a little bit.

First, when it comes to market failures, not all listeners may recognize what that term of art means.

So, one of the problems is that if a firm has market power, it may be able to exploit that market power in terms of higher prices, lower wages. So, that has to be disciplined by competition.

And so, one government action might be antitrust or competition policy. That is, to make sure that that system works effectively, exactly to make sure that markets work well.

Another is asymmetric information, where sellers have better information about the product than consumers do. That is a market failure in the sense that consumers then are not really willing to pay much for these products, and a bunch of mutually beneficial transactions will fail to take place. So, government licensing--like airline pilots or meat inspection--things like that will actually allow the market to perform better.

The third is the problem that self-interest will lead me to disregard costs that are paid by other members of society but not by buyers or sellers. And then, using taxes to cause me to internalize those things, like pollution, to get prices right. In fact, the whole point of that market failure perspective is for government to get prices right. They're relying on the market; they want to make the market work better.

And then, the final one is activities that would benefit us from cooperating but that we will underproduce because it's too difficult to charge a price for. And, those things are called public goods.

And so, having the government provide those things and then collect fees called taxes in order to finance them is something that we all might unanimously support because we would like to see those things provided, and they'll be under provided by markets.

So, competition policy and monopoly, asymmetric information, externalities like pollution, and public goods are the four kinds of market failures. Those would indicate some possible place for government action.

And, the thing is that I need to now go back a hundred years to Arthur Cecil Pigou because he recognized all of this. You just gave the orthodox public choice response. You know: politics is going to screw this up, and in fact, democracy is going to screw it up more than markets. He agreed completely. That's why expertise has to be placed beyond the reach of democracy.

Russ Roberts: Yeah. I just want to footnote: I didn't say 'all the time.' I just said 'sometimes.'

Michael Munger: Well, the point is that for the Cambridge Welfare economists, that's not the relevant comparison. They want to end democracy in this realm, because voters, if they have any sense, will recognize they will be better off creating a clerisy--basically, a priesthood of Ph.D. economists and experts that will be beyond the power of democracy to change that will make these decisions.

31:50

Russ Roberts: And similarly, we've heard this in many situations in healthcare. The question of healthcare is--one of the questions when you have a public system of healthcare--what should be covered by the public insurance? What techniques should be covered? What pharmaceuticals should be covered? What procedures should be covered?

And of course, the hospitals have an incentive to do lots of things if the government is going to pay for it. As do consumers. So, you have to find a constraint if it's not going to be price, right?

In a true private system--which, of course, is not true in the United States, but in a true, if you had an actual market system, something like the United States in 1940 or 1950, say--then there would be some restraint on activity by rationing through prices.

Many people find that offensive. So, they'd say, 'Okay, the government should cover it. It shouldn't be up to what you can afford.' But then, you have a problem that everybody wants everything. So, we have to decide now some things are not effective enough and therefore they should be not covered. And, who should decide that?

Michael Munger: Experts.

Russ Roberts: A committee of experts. And, who are those experts, of course? Doctors.

Michael Munger: We recognize who the experts are because we see them in the mirror.

Russ Roberts: Right. Yeah. But the ideal--and again, we all understand how appealing this is--the ideal of who should or how that decision should be made of what should be covered requires medical expertise.

I would add it also requires some understanding of trade-offs, uncertainty, incentives, and so on. And, that's generally not available to doctors. So, therefore, I think that system has many problems.

And of course, very few people are unaffected by incentives--ever. The idea that somehow these experts will be locked away and untampered with--the clerisy, priesthood--is such a beautiful idea. Whether it's realistic or not, may depend on a vision of human nature that is not viable. That's the question.

Michael Munger: It doesn't have to be perfect. It only has to be better than markets.

Russ Roberts: Good point.

Michael Munger: So the--I have to make my usual point in reverse. Markets don't have to be perfect to be better than democracy.

Well, experts don't have to be better to be better than democracy, either.

So, let me go back to Pigou, and I want to read a couple of quotes. And, this is from the 1920s and 1930s. I apologize to the listeners for so many quotes, but most of you have never heard this before. And, I think it's a real problem with the way that Public Choice and economic education has been conducted.

So, Pigou said [in his book The Economics of Welfare--Econlib Ed.],

In any industry, where there is reason to believe that the free play of self-interest will cause an amount of resources to be invested different from the amount that is required in the best interest of the national dividend, there is a prima facie case for public intervention. [The Economics of Welfare, Arthur Pigou, Part II, Chap. 20, paragraph 4.]

So, we can--

Russ Roberts: Read that again. Read that again. It was a little convoluted, but the idea of it is a nice capsule of what we're trying to talk about here. Say it, read it again.

Michael Munger:

In any industry, where there is reason to believe that the free play of self-interest will cause an amount of resources to be invested different from the amount that is required in the best interest of the national dividend....

Russ Roberts: So, there's an ideal, what we would call an optimum amount. And, if it's not what--if private decision-makers don't choose that amount, there's a case for government intervention.

Michael Munger: There is a prima facie case for public intervention. That is--prima facie means, in this case, it passes the sort of first level--the presumption is going to be in favor of government intervention.

And so, he had also said, again from Pigou--we don't read Pigou enough. We ought to read Pigou. So--

Russ Roberts: Speak for yourself. I got a lot of things to read. Pigou is not up on my list, Mike. Make the case.

Michael Munger: Well, in graduate school.

So, again, from Pigou,

One person A, in the course of rendering some service, for which payment is made, to a second person B, incidentally also renders services or disservices to other persons..., of such a sort that payment cannot be exacted from the benefited parties or compensation enforced on behalf of the injured parties.... [The Economics of Welfare, Arthur Pigou, Part II, Chap. 9, paragraph 10]
To ascertain how far the free play of self-interest, acting under the existing legal system tends to distribute the country's resources in the ways most favourable to the production of a large national dividend, and how far it is feasible for State action to improve upon "natural" tendencies.... [The Economics of Welfare, Arthur C. Pigou. Analytical Table of Contents, Introduction to Part II, Chapter 1, p. xii. PDF file. Online Library of Liberty. Also quoted in The Problem of Social Cost, by Ronald H. Coase, p. 134.]

should be our objective.

And so, what his point is, that's under--

Russ Roberts: That's about externalities.

Michael Munger: It is about externalities, but it's under the existing legal system.

What he wants to do is change the property rights system so that we get better outcomes.

He wants to get prices right. He has an economist's intuition about this. He thinks democracy can't do it.

So, here's the hammer: 1912--this is from Pigou. So,

the case cannot become more than a prima facie one. [Note: Unclear if that is a quote from Pigou's 1912 Wealth and Welfare or if it's Michael Munger's summary of what Pigou said--Econlib Ed.]

So, we read before he'd established something as prima facie.

Now, that's not per se. That doesn't mean it wins. Prima facie means 'on its face.' You say, 'Okay, that makes sense so far. Now prove it.'

The case cannot become more than a prima facie one until we have considered the qualifications which governmental agencies may be expected to possess for intervening advantageously in this class of matter.[Wealth and Welfare, 1912, p. 247.]

Now this next paragraph that I'm going to read, and again, I apologize for reading so much, but it's important.

37:38

Russ Roberts: But that--I just--before you read the next one, let me give readers a chance to rewind and hear that again if they want. That--it's 1912. It's not just that it's 112 years ago, it's: There aren't very many agencies. I mean, there were some set up in the late 1880s and 1890s, but he's imagining a regulatory body, a set of regulatory bodies; and he's trying to say: Well, who should be on those regulatory commissions and what should their skills be? What do they need to know?

Michael Munger: This is his solution. Even in 1912, when he's first writing, this is the solution: Markets fail--we don't have that really worked out yet, but he's prescient about these problems with markets. What we need is a set of experts to solve these problems. What sort of qualifications would those agencies have? What rules should they have? How could this work?

And, I sometimes will put this up and ask people to identify it as a quote and say, 'Which of Hayek's works does this come from?' This is Pigou in 1912, and it gives me goosebumps to read:

It is not sufficient to contrast the imperfect adjustments of unfettered private enterprise with the best adjustments that economists in their studies can imagine. [Pigou 1912, pp. 247–248.]

So, economists sit in their studies. That is, literally, their study. Where I am, this is my study. You can see it behind me, all these books. I've got my desk, I sit here. I can imagine improvements on the market system. That's not good enough, says Pigou. You being able to imagine it doesn't help.

It is not sufficient to contrast the imperfect adjustment of unfettered private enterprise with the best adjustment that economists in their studies can imagine. For we cannot expect that any State authority will attain, or even whole-heartedly seek, that ideal.

The government won't do what you imagine that they should do. "Such authorities are liable alike to ignorance,"--information problem--"to sectional pressure,"--democracy--"and to personal corruption by private interest,"--incentives. [Pigou 1912, pp. 247–248.]

Russ Roberts: Public choice.

Michael Munger: Yes. In 1912, he invented Public Choice. "A loud-voiced part of their constituents, if organized for votes, may easily outweigh the whole." [Pigou 1912, pp. 247–248.]

The ischaracterization of Pigou honestly by Coase--the nearly tendentious portrayal of Pigou's view in Coase's 1960 paper--this is something that my friend Steve Medema often writes about, and I've actually come over to his side. Coase did many great things: good for him. But, I think a lot of our misunderstanding of Pigou comes from Coase describing what Pigou said.

It's not unlike Keynes' mischaracterization of Say. Most people don't read Say. They read what Keynes says Say said--which is a sentence I've never said before. What Keynes says that Say said--and Keynes gets it wrong in a way that benefits Keynes' argument--Say doesn't say that.

Well, Pigou doesn't say what Coase said he said.

And, I think once we start to take that seriously, we have to recognize that we need to rethink the problem of government action. And therefore, we have to rethink the problem of government failure.

41:19

Russ Roberts: I just want to first point out, I think Pigou is a student of Marshall.

Michael Munger: Yes.

Russ Roberts: And, there's a story, which I may have told on the program or not, I can't remember, where Marshall would come to class and Pigou was the only student. I don't know if that was every week or every session, but at least some, or much, or all the time Marshall would come to the front of the lecture hall, to the stage, and spread his notes. And, in the front row, probably, I assume--although maybe it's in the middle--sat Arthur Cecil Pigou--A.C. Pigou--and Marshall lectured at him. I don't know if there was any Socratic questioning or class discussion; but it was a unusual tutorial, wherever I read that or heard that.

So, I think the idea and what you're--

Michael Munger: May I say: For those who might work on the drinking game, they might add that, because I believe that's the fourth time that you have told that story on EconTalk. And so, once it's been told four times, it can appear on the drinking game. I think that's the Mendoza line.

Russ Roberts: But, I wanted to add one clarification--which is not a clarification; just, again, a footnote. The 1960-year paper that you're referring to is "The Problem of Social Cost," where Coase takes Pigou to account and says Pigou's solution for dealing with externalities, which were taxes and subsidies, is wrong. There's a richer way to look at that. And, Coase then expands on that.

It's probably the most influential--might be the single most influential paper in economics. It's way up there. It's definitely in the top 10, top five in terms of citations and actual influence, whether you can measure or not. I'd say it's five-ish.

And you're saying that that's kind of a strawman caricature of Pigou's view of market failure.

So, Coase said: Yeah, Pigou thought markets fail, and the way you fix it is government intervenes, and these taxes or subsidies. And, you're saying that that really was a cheap shot at Pigou's nuanced understanding of this problem.

And, I would just add that Coase has been a guest--Coase is gone--but he was a guest on EconTalk. I'm sad to say Pigou never will be. He's long gone.

So, what Pigou is saying there is: Markets fail, governments fail, and therefore we need a third thing. That's what I hear you're saying, Mike. Is that fair?

Michael Munger: Not only a third thing: We don't know what that third thing is yet. And, that should not distress us because we can only discover it par tatonnement. We need to devise a new set of government institutions based on expertise that will guide markets correctly by getting prices right.

Russ Roberts: And, going back to the Robert Frank conversation: Robert Frank was saying--[?] to give him his due--he was saying that, of course, politicians will not be good judges of how much we need to spend on infrastructure. We should use--I say this with a straight face--engineers. Now, that has its own problem, which I would suggest--I'm guessing--Pigou recognized. Perhaps. No? Maybe?

Michael Munger: Of course he recognized it. Absolutely he recognized it. So did Dani Rodrik. The fact that there are problems doesn't mean we can't solve them. We have to start making more mistakes.

45:03

Russ Roberts: And, by the way, the extreme caricature of this--which I find, to be honest, deeply offensive--is Thomas Friedman's argument, which I think is not a straw-man argument. I mean, I'm not straw-manning Thomas Friedman. Thomas Friedman has written: Sure, China is a horrible government in many ways, but you got to give them one thing, they can get stuff done. And, if we could just have, like, a day in the United States where we could just, like, cut through all this red tape and political log-rolling, and other problems that democracies have to cope with, man, it'd be great because we could get so much done, like the Chinese. And--no comment. Or you can comment if you want.

Michael Munger: Well, I was so taken by that view, which is actually quite common. Thomas Friedman did say it, but many people have said something like that.

So, I wrote a paper, and maybe you can put it up in the show notes, which is, the title of it is "A Good Industrial Policy Is Impossible in a Democracy." And the argument is: suppose, for the sake of argument, that there is an industrial policy which would improve on markets. Let's suppose, for the sake of argument, that's true. It will not be implemented in a democracy.

So, your solutions are to accept an inferior industrial policy, in which case why do it? Or to end democracy, which means we have China. And you can't do it for a day. It doesn't switch back. If you end democracy, that's the end of democracy.

46:40

Russ Roberts: But now I'm going to critique my own critique, which is--I'm making fun--I really haven't had a chance to do the kind of mockery and cruel, sardonic cynicism of these kinds of solutions that I would really enjoy if you and I were having that scotch again. But let me make fun of myself, which is--what I'm saying here is that I really am not a big fan of a Committee of Engineers to decide how much infrastructure we need, or economists to decide how much of X we need, whether it's industrial policy or anything else.

But the truth is that every once in a while, democracy do exactly what Pigou was talking about. And, the case that comes to mind is you: have to close some military bases. The Cold War is over. We've got too many bases. And of course, in a democracy, every Member of Congress who is got a base in his or her backyard is going to go and fight to the death for it, and the Senators will fight to the death for it.

And so, everybody recognizes that. So, they solved that problem. They create a commission, which is a, quote, "committee of experts"; and they say--it's imperfect, but it's probably an improvement--and, they say, 'Look,'--make some recommendations about--you could argue it's not plausible--but the idea is make some recommendations about what's best for our military capability at a lower level, which bases should be closed. And, I'm guessing it's an up-or-down vote either by the President or by some committee because you don't want to then open it up to like, 'Oh, no, no, what about this one? or that one?' 'Here's our recommendation; take it or leave it.' And, I think that's what we've done in the United States a number of times--

Michael Munger: That example is too narrow--

Russ Roberts: and it's a good idea. What?

Michael Munger: Your example is too narrow. The Federal Reserve is a priesthood of experts which are appointed, not elected, for a fixed term. They can't be removed from office. And, the reason was that politicians' democracy recognized that the incentives to renege on the promise not to inflate their way out of debt was not credible. And so, we'll have a priesthood of experts that will do this, that will make the promise not to inflate more or less credible.

We have the Supreme Court, which is a priesthood of experts which are appointed for life and cannot be removed. So, this happens a lot, actually. So, we can make fun of the idea, but the fact is, they're right. The people who make this argument empirically, at least there is some case to be made for: this is an alternative to either markets or politics.

Russ Roberts: Again, you might want to rewind, listeners, or review the transcript. There's a three-word phrase that Mike used there about credible claims not to overinflate--you said 'more or less.' Because, of course, even the Fed, although for whatever reason, has struggled to avoid inflationary finance. And has other issues with, say, coddling Wall Street and other challenges. But, again, I think I've spent a lot of effort and pages and writing in my book on the Financial Crisis, making fun of that kind of thing and other things like it.

But, the fact is, that's not the right standard, is what I'm learning from this. And, I know it in some sense, but I'm being forced to recognize it here. Which is: it's not so much that the Fed is flawed. It is flawed. The question is whether it's better than a monetary policy that would be run by Congress or the President. And the answer is: Yes, it is.

Michael Munger: Yes, it is.

Russ Roberts: Is it better than private money? We have friends, you and I have friends who would argue no; but I don't think it's so much worse than private money. It's a pretty good system.

Michael Munger: Well, the Food and Drug Administration for the way that drugs are allowed to be sold in the United States.

Russ Roberts: Perfect example.

Michael Munger: The licensing system for pilots--that is, can you fly an airplane? We could just have competition; and we could judge between airlines based on how many fatal crashes they've had in the last year. They'd have a reputation for having better pilots. That's pretty expensive. So, instead, we have commissions of experts.

Russ Roberts: A.C. Pigou might've pointed out that if you have no crashes--which is often a year of flight in the United States--it's too onerous, the standards.

Michael Munger: I thought you were going to say there's not enough experimentation. I was hoping you would not. No crashes mean not enough experimentation. You should be trying to--

Russ Roberts: That's what he might say. But, I'll leave that as an exercise for the reader.

Michael Munger: Well, so, the interesting thing about where we have come is that the usual separation between markets and politics, where markets are probably going to perform better than democracy in deciding how to allocate resources, was not only conceded by the Cambridge Welfare Economists: they anticipated Public Choice arguments by 60 or 70 years. They just had a different solution. Their solution was to have commissions of experts whose job will be in each sector to get prices right.

Now, I happen to think that may not work very well. But, you said before, that's actually an empirical question. That's a very different criticism than the usual criticism that's made, which is to say, 'Yes, government will get prices wrong because they'll be using democracy.' Well, if they're using experts, maybe they can do better. Then we have to take seriously this question of whether government intervention is going to improve on market outcomes.

So, this leads us, if we can spend 10 minutes on it, to the actual paper that Keech and I wrote about government failure.

52:54

Russ Roberts: We can, but I have a case study I want to close with.

Michael Munger: Please.

Russ Roberts: But, we will take that 10 minutes; and then I'll give my case study and I think you will enjoy it and you'll react to it.

Michael Munger: All right. Thank you.

So, what Keech and I pointed out was, and what actually sort of pissed us off at the beginning, was the caricature--

Russ Roberts: You mean annoyed you?

Michael Munger: Yeah. It annoyed me. It may have done something else to Bill. But, it just annoyed me, yes.

The usual story of government failure in the public policy literature is to limit government failure to the failure to correct market failure. That was a bunch of words; let me say it again. So, markets fail. We've talked about the four ways that they do that. Government's job, then, is to correct those four things so as to perfect the system and approximate the best equilibrium which might exist. And, what we've shown is that this equilibrium exists. The First and Second Welfare Theorem have certain properties. We know what to do if markets fall short of that; government policy will get us there.

Now, governments will fail because they will fall short of perfecting those things. And, the question is, how can we work on that?

That notion of government failure is nonsense, if you talk to a political scientist or a political theorist. Governments are fully capable of failing entirely on their own. If you look at--there's a book called Democide--if you look at the great genocides and disasters of the 19th and 20th centuries, they're all perpetrated by states, by government. The mass starvations, the mass executions, the failure to govern, the returning us to a Hobbesian state of nature, something like Somalia. Those, Keech and I wanted to say, are substantive government failures.

And, there are a number of substantive government failures that we want to raise as being the main functions of government. Governments that do not do these things fail. So: Regulation of a financial system. The availability of a reliable, independent system for adjudicating disputes--so, a judiciary. Stability of the currency. The ability to control the expansion of debt, to secure modest interest rates. The incapacity to provide the basic State function of controlling the border. And, the incapacity to keep order and enforce the laws. So, that doesn't necessarily mean the laws are good or bad, but just that the usual kind of law and order--be able to go to court and fairly quickly be able to adjudicate disputes.

Now, the State might choose private agencies to do that. You might have something like the law merchant; you might have a public judicial system. But, the point is, our claim is: Politics comes first. That is, politics sets the basic rules of the game, and then markets, exchange, at scale, take place within those basic institutions.

And governments--and this is a Doug North perspective, I'll admit, so I'm biased by that. And, listeners who have heard a lot of mine will now be able to drink because I always mention Doug North, and this is relatively late in the podcast by that standard. So, having made fun of you, I'll make fun of myself.

So, the context, the institutions that determine how markets function: government is responsible for at least maintaining those. They may not establish them. They may come down to us from the traditions of the past, like the common law. But maintaining them and making sure that they function, that's a government role.

And so, governments fail when they fail to do any of those substantive things.

Now, there's a second category of government failure, and that's procedural. The procedures that government either chooses, or again maintains, have to do with the ability to choose between Pareto optima--and that's a technical term. Often, the efficiency standard in markets will say: What we need to do is make sure we end up at a Pareto optimum. Pareto optimum just means that there's no waste. It's efficient in the sense that all mutually beneficial transactions actually take place.

Now, they can't all take place because there's frictions within the system, but for the most part, any cooperation or exchange that would make people mutually better off is allowed to or is encouraged to take place.

If that doesn't happen, then we often call that some kind of failure, be it market or government.

Well, the question is: we usually have to choose between Pareto optima.

Let's suppose that we're considering building a dam. The dam will be financed out of general tax revenue. There's a number of people, all of whom will pay the same amount to finance the dam. The dam will create electric power that all of us will be able to use. But, some people who now live in the watershed that will be flooded by the dam, will lose their homes. They've lived there a long time. They don't want the dam. They're relatively small in number. There's a lot of people who benefit from the dam. How should we decide which of these two Pareto optima we should pick?

And, Keech and I suggest there's five different procedures we might use.

And we show that each of those procedures is not likely to choose the Pareto-optimal outcome.

Now, that is an analogy to the market failure analysis because markets generally do not pick--in the case of market failure, they don't pick the Pareto-optimal outcome. The discovery process for government: it could be voting; it could be bureaucracy, where we do cost-benefit analysis. But, people misrepresent their preferences though they have the information problem, the demand-revelation problem.

So, in terms of a short summary, what we do is we say the job of government is to choose between Pareto optima. Can it do that? And, given the procedures available to it, our answer is No.

Well, then the empirical question is the one that you and I have already talked about. In a particular case, given that both systems are going to fail in the sense they fall short of approximating the utopian ideal of frictionless, full-information, benevolent dictator, which one is going to do empirically better?

So, we're thrown back on our resources of trying to decide case by case.

So, the case that Keech and I were trying to make is: If you put these things on an equal footing and you're comparing their ability to achieve Pareto optimality, neither markets nor politics can possibly do that. And so, the market failure approach--which usually says, 'Markets fail, therefore the state should act'--is mistaken. But it's also mistaken to say governments fail; therefore, markets should act.

We're put in the position of having to make a case-by-case comparison based on the empirical observation: Which performs better?

1:00:24

Russ Roberts: There's a general feeling that certain bureaucracies work better than others, and it may be romance. It may be that we romanticize, say, European bureaucracy, where, say, compared to American. European bureaucracy, there's more respect, it's claimed, for the European bureaucrats, the people in civil service. Whereas in the United States, they're looked down on.

Underlying this procedural question of how to intervene and inevitably and perfectly, but how to intervene, it might be worth looking at how to make the bureaucracy more effective or more honorable to draw more talented people into it, or pay a higher salary to draw more talented people into it.

And, I think the--which is another aspect of this--I think the outcomes that such bureaucracies or the administrative state--to take another term--that they produce, there's a lot of devil in those details of how those bureaucracies actually work. It's easy to wave your hands as an economist or political scientist and say, 'Well, they don't have great incentives or information. They don't work very well.' Okay, fine. Is there a way to make them work better? Is there a way to improve them?

My only view on this is that government should do the things it does best and focus on those things rather than trying to be all things to all people and be mediocre at it. And I think how effective or creative government bureaucracy is, is an untouched topic.

Michael Munger: It's certainly a very difficult topic. Having been myself, the Dean of the Master of Public Administration Program at UNC [University of North Carolina], Chapel Hill, a place you and I share in a way, that was something we were very concerned about was the norm, what we call the norms of the guild.

And, one of the things you need to recognize is that the reason that you have power is that you don't use it outside of your area of expertise. So, there's a famous saying about the Supreme Court that the river cannot rise above its source. And so, the source of the delegation of authority is: we're going to entrust you to do the following things. If you try to use that authority in a way that exceeds the reason for the delegation, the river has risen above its source and it will flood backwards, and you're going to lose your legitimacy.

So, the perception, right or wrong, particularly after COVID, is that the medical establishment in the United States exceeded its authority. They tried to rise above the source of the delegation and to control society in a way that exceeded their mandate.

And so, that is something that at least people used to worry about for the norms of the guild. I think that the cult of expertise in the United States had become so self-regarding that the level of self-regard had become excessive. And, the result is they've actually lost a lot of their esteem and authority.

But, you can see it in economists also. So, what Dani Rodrik says is that the second concern about political influence can be overcome with appropriate institutional design. He's just saying, 'Well, let's rewrite the Constitution.' No. No, you don't just get to rewrite the Constitution. That's not how it works. So, if experts want to have authority that is delegated to them within a particular area, maybe we can do that.

If you think, well, we'll just rewrite the Constitution, who is this 'we'? Why do you think anybody will go along with that? Is there anything in your actual practical experience that makes you think that rewriting the Constitution will make it better instead of worse? That just seems like nonsense to me.

So, the big problem that I have is when experts say that it's really just a problem of institutional design to give me enough authority that I can do good; and my conception of doing good is so encompassing that I will actually start to--it will expand. It will metastasize beyond the original mandate, at which point it will collapse.

So, the question is, why has that not happened so much in Europe and Japan? So, France, Germany, Japan are the three places where, if you look at surveys, the level of respect for government bureaucrats is highest.

In the United States, it used to approximate that up until the 1970s. Then the aftermath of the Vietnam War, and then more recently in the aftermath of COVID, we're not doing very well. Our experts are not esteemed, they're not respected, and as a result, we're thrown back on democracy, which in my mind is probably even worse.

We've talked about markets, experts, and politics. There is a fourth category that Richard Cornuelle called the Independent Sector of Voluntary Private Associations, and it dates back to Alexis de Tocqueville, who said that the particular genius of the United States was that, whereas in France, maybe you see a school that's falling down, not working very well, we would say, 'The state should do something.' Well, in the United States, 'We'll form a committee, we'll raise donations, and we'll pay money for this school.' So, Tocqueville was worried that this was a problem with democracy; and he said that democracy could enfeeble this voluntary impulse because I pay taxes. So, I don't know the French word, but the word he used, this translated as enfeebled.

So, everyone has this impulse, but government can crowd out that impulse because I think, 'Well, I already gave at the office. I paid my tax money. Dang, the government is doing a bad job. What can I do?' Well, the answer is often you can do many things. While you can't solve all the problems, you can do something.

But, notice what I'm talking about now: I'm talking about public sector experimentation.

So, having myself said, we need markets. Now, you and I are talking about different kinds of public sector experimentation, which actually lends credence to the view that I have long criticized. And I guess that's where I think we might work towards an ending here is: having thought about this, having myself worked on the problem of government failure quite a bit, I think the straw-manning of the sort of Cambridge economist view that still plays out in the form of Robert Frank, Dani Rodrik, and many people that I respect and like, this idea of experimentation in the public sector is one that should not be dismissed and probably should be embraced.

Russ Roberts: My guest today has been Michael Munger. Mike, as always, thanks for being part of EconTalk.

Michael Munger: Such a pleasure, Russ. Be safe.