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Thursday, July 5, 2018

Market Distortions and Redistribution

Welcome friends!

I was reading some online commentary on President Trump’s various attempts to implement the latest conservative brainstorm “economic nationalism” (i.e. socialism sans taxes) though tariffs and trade wars and so on when I ran across something that struck me as a particularly apt illustration of the way a too casual familiarity with economic theory can impair one’s thinking.  The commenter I have in mind opposed Trump’s tariffs because he or she felt the resulting market “distortions” would inevitably hurt “everyone.”  It was the sort of pseudo-economic theorizing one suspects many people forced to sit through Economics 101 might espouse and that academic economists who should know better seem never in any hurry to correct mostly likely because many of them find this kind of nonsense furthers their own value judgments.  I know I’ve probably talked about it before let’s say a million times but what the heck let’s make it a million and one shall we?

I did a short summary of the overall gist of neoclassical economic theory in a recent post so maybe we don’t need to go over all that again so soon.  If it’s already faded from your memory please take another look at paragraph four (“OK, so here’s our little one paragraph refresher …”) from my post entitled The Problem with Economic Theory and Then Some from April 18, 2018.

So what’s going on with the argument that market distortions inevitably make everyone worse off?  I suppose we must be starting from the rather dubious or at best only partially correct presumption we’re operating under a perfectly competitive market structure (i.e. what casual or maybe in this case we should just say sloppy thinkers misleadingly characterize as “The Free Market” although there is no particular reason to suppose any real unregulated market would freely tend toward this particular market structure) and that the “distortions” under consideration alter the results that would have otherwise fallen out of that ostensibly happy situation.  Whats wrong with that?  Doesn’t economic theory say if we mess with perfectly competitive markets we’ll diverge from socially optimal results and make everyone worse off?  Nope.  Not really.

For those with more than a passing familiarity with economic theory the issue here will be self evident.  Our ostensible conclusion runs smack into the prohibition within neoclassical economic theory against making so-called interpersonal utility comparisons, that is, ranking or rating economic outcomes that differ from one another by at least one person being better off and at least one worse off (typically discussed in absolute terms although I’ve been thinking for a while now it might be more interesting and relevant to redo the whole thing in potentially more ethically relevant relative terms since we know humans and even some of our fellow primates tend to think of fairness in relative rather than absolute terms).

Let’s just clear this up right now to avoid any confusion down the road.  Let’s say we actually have a perfectly competitive market system but some people are tanking: they can’t find jobs, they’re out of money, they’re living in the woods scrounging food from the dumpster behind the old convenience store.  (Republicans were in the news recently complaining about some UN committee having the audacity to mention severe poverty of this sort in the USA so to play nice with conservatives for now let’s just present this as an abstract thought experiment without laying out the evidence any such controversial phenomenon actually exists.  All some of us have to do to witness this sort of thing is drive down the street and have a look around but I infer for those living in same fancy gated communities seeing a poor person living in the woods behind the old convenience store would be the equivalent of the rest of us seeing Bigfoot strolling through our backyards).  In case you were wondering there’s nothing in economic theory that says no one will tank if we have a perfectly competitive market system.  That would depend on conditions affecting the demand and supply of labor.  Anyway, let’s say we change something.  We do some tariffs, we start a trade war with China, Europe, Mexico, Canada, or heck let’s just say the rest of the world, we run some sort of jobs program, we redistribute resources directly using taxes.  Whatever.  Doesn’t really matter for this post.  Indeed, let’s follow the philosophical thought experiment approach and take everything to extremes to make things more obvious.  Let’s say we take all the institutions that support a perfectly competitive market, roll them into a big ball, and throw them in the trash.  Let’s say the economy crashes entirely and in a short while everyone other than those people we were just discussing, the former tankers, drop dead on the streets.  However, let’s say the former tankers do a little better than they were doing previously.  Imagine they’re particularly adept at scrounging what they require from the detritus of our lost civilization much like the heroes of so many juvenile video games.  Again doesn’t really matter why they’re doing better for our little thought experiment.  Let’s just say for the sake of argument they are.  Talk about your market distortions, right?  What does economic theory say about the ranking of this situation compared to the previous one?  Nothing.  That’s what happens when one deals with a theory that ostensibly looks only at a sort of utility defined in a way that renders interpersonal utility comparisons impossible.  Why?  We don’t know whether the postulated increase in “utility” on the part of the former tankers outweighs the loss of “utility” of the multitudes.  Not really the answer you were looking for?  No, I get it.  Does seem a little weird.  I guess that’s why people fudge it.

One way people fudge it is to give pride of place to the distribution of goods and services falling out of any particular expression of an ostensibly perfectly competitive market system (by which I mean the result of a perfectly competitive market given some initial distribution of resources) and characterize other potential results as “distortions” including other results that could be obtained by redistributing resources and then moving to a new perfectly competitive market outcome that differs from the former by some people being better off and some worse off, which falls into the category of comparisons that are not really supported within economic theory.  Out of nothing something.  It’s like a miracle of philosophy.  I mean honestly if one had a choice between a distorted result and an undistorted result which one would choose?  Who needs interpersonal utility comparisons if we can make a choice on that basis?  Just being funny or trying to anyway.  The language is clearly contrived to establish a ranking of outcomes that is not supported by the actual theory that language purports to express.  One can see the same phenomenon in the terms “distributions” and “redistributions” with the implication the initial distribution must have some higher ethical standing than the subsequent and derivative redistribution.  But of course under economic theory really they are entirely on the same level.  Our current distribution expresses certain value judgments external to economic theory relating to the economic power that should rightfully go to different people and a redistribution would express other value judgements.  If we ever actually made such a redistribution those who held the former set of value of judgments would be talking about redistribution.  Same values, different terms.  In other words the basis of any given distribution cannot be evaluated against any other given distribution (or redistribution if you will) under economic theory.

Another way people fudge it is to claim these so-called market “distortions” inevitably make “everyone” worse off, which is essentially a rather transparent way of trying to avoid the awkward issue of interpersonal utility comparisons entirely.  It presents a local optimum based on a given distribution of resources as a global optimum across all potential distributions of resources. It’s fine if you think so but it isn’t economic theory.  That would be your own idiosyncratic value judgement based on I know not what.

So why do these pseudo-economic pronouncements appear so plausible to the inadequately educated?  Why whenever anyone discusses distributional issues is someone sure to pipe up that we dare not redistribute resources because that would distort the labor market and hurt everyone?

Well, setting aside the obvious incentives for economists who like the current distribution and don’t mind at all if people get the wrong end of the stick about what economic theory says about it, the answer must lie in the peculiar dual role of labor in economic theorizing.  On the one hand labor is an input of production like let’s say a lump of coal or a hammer.  Under a given distribution of resources supply and demand will set a price for that input.  If you start with a different distribution of resources you will get a different pattern of supply and demand and the price will of course be different but never mind let’s just look at whatever we have right now.  If we assign a different price to some non-labor input then I suppose one might reasonably say we’re distorting the market and creating inefficiencies.  So why can’t we say the same for labor?  Well, the funny thing about labor is that it’s not really the same as any other input in one significant respect: labor is the only input we associate with the generation of utility, which is what neoclassical economic theory is ostensibly all about.  People generate utility by fulfilling their needs and desires.  Lumps of coal and hammers do not generate utility in this way.  This is not a small difference because it means changing the price of labor very quickly gets one into the sort of interpersonal utility comparisons that cannot be made within the context of economic theory.  Another way of expressing this is to say there’s nothing sacrosanct about the price of labor under any particular perfectly competitive market result.  If one doesn’t like it for any reason based on one’s ethical reasoning and wants to change things around using redistribution schemes of one sort or another a serious economist will be agnostic about whether such change makes sense.  There is no one “true” price of labor to which we must adhere to get the maximum amount of utility according to economic theory.  We can change the relative price of labor whenever we like without losing utility or more accurately without knowing whether we’ve lost or gained utility.

But after we’ve done our redistribution won’t there by another pattern of supply and demand for labor based on that distribution of resources and another price of labor from which we dare not diverge for fear of not attaining a perfectly competitive market result?  Nope.  We’re basically just back where we started.  If we notice something amiss with that distribution based on whatever ethical theory we’re using to think about distributions then there is nothing in economic theory to suggest we should not change it again.  That is to say, the ostensible optimality of any given perfectly competitive market outcome is really contingent on our accepting the ethical credentials of the resulting distribution of goods and services.  In other words, markets are meant to serve us; we’re not meant to serve markets.  We evaluate markets and determine how well they are working based on our ethical beliefs relating to distributions; we don’t look to markets to tell us what to think about distributions.

Whenever I do these little posts I’m always careful to point out I’m not really arguing for or against any particular distribution.  I may do so in another post but my concern here is simply to clarify what we’re talking about.  If you like the distribution we have now and don’t want to see any redistribution that’s perfectly fine with me.  For purposes of this post anyway.  We can discuss it some other time.  But in that case your conclusion is not and cannot be derived from economic theory.  Indeed, your conclusions most likely do not involve the concept of utility at all but are probably based on some notion of what different people deserve and why and how those considerations are captured or not in real life labor markets.  Similarly, the idea that redistribution schemes like tariffs or what have you inevitably harm everyone is a rather far-fetched claim that cries out for substantiation. It’s fine with me if you think so.  I’d love to hear your theory.  But if you think that result has been established by economic theory you may need to dig out the old textbook and take another look.  In other words all Im suggesting is that people speak up honestly for their values and stop talking rot.  And to any academic economists who may be reading this post please stop facilitating people talking rot.  It’s your field not mine.  It shouldn’t be left to people like me to clean up your mess.  Not really my job.