JTK on Economic Efficiency

In a recent blog post, John “The Fourth K” Kennedy wrote:

Can we compare the values of different individuals? In a recent piece I noted that there is no commodity which can serve as an objective measure of value by which we might compare the values of different individuals. The fact that A will pay $10 for an item that B will only pay $9 for does not demonstrate that A values the item more than B.

Does this mean we cannot make any valid comparisons at all between the values of individuals? If not, then the concept of economic efficiency is useless.

I want to clarify this matter. First, there are two different notions of efficiency in mainstream economics. Pareto efficiency refers to a situation in which there is no technologically possible way to rearrange our use of resources in order to make some people better off while not making anyone else worse off. These notions of “better off” and “worse off” are judged by the individuals themselves, and do not in any way rely on interpersonal utility comparisons.

Kaldor-Hicks efficiency, on the other hand, refers to a situation in which it is impossible to rearrange the use of resources such that the total monetary value of all goods and services (i.e. total wealth) is increased. Although it’s not as clear-cut, this second definition implicitly relies on interpersonal comparisons of “value,” specifically how many dollars different people are willing to spend on something.

Now it’s true that many economists are sloppy and write things that rely on interpersonal utility comparisons (henceforth IUC). But most of the general results of mainstream economics, in particular the welfare theorems (which discuss economic efficiency), do not rely on IUC.

Regarding Kennedy’s blog post, and the alleged necessity of IUC to say whether a certain batch of resources is being devoted to the highest end of “society,” I think this isn’t really correct (although again, many economists write objectionable statements on this stuff). Yes, Kennedy is right to say that just because Joe spends $10 on X and Alan spends $8 on X, it doesn’t follow that Joe “values X more than Alan does”; this statement doesn’t make sense if one denies IUC.

However, if we agree that [if Joe spends $10 on X but wouldn’t spend $10 on Y] implies that [therefore Joe values X more than JOE values Y], then I think we could easily save the statements about the optimality (“efficiency”) of market allocations (so long as there aren’t externalities).

NOTE: In reality, we might NOT want to endorse the above implication. For example, just because Joe would spend $1000 on a plasma screen TV but wouldn’t spend $1000 on favors from his girlfriend, it doesn’t necessarily follow that he values the former good more than the latter service. It could just be that the act of spending money on such things is distasteful per se (or tasteful to preverts like JTK).

Murphy responds to David Friedman

Friedman alleges that the person who wrote the quiz is
either misrepresenting the Chicago school or doesn’t
know what he’s talking about. I can’t speak for the
other contributors, but I’ll defend the three
questions (on interest, method, and economic value)
that I wrote.

1) I said that the “Chicago” (but actually,
neoclassical) position on interest is that it’s due to
the marginal productivity of capital, and that in
equilibrium a consumer is just indifferent between
consuming now or waiting another time period and
consuming the greater amount due to capital
productivity. This is certainly the standard position
that everyone at NYU had, including neo-Keynesians and
Chicago-educated general equilibrium theorists. It’s
also consistent with the canonical treatment of Irving
Fisher, who M. Friedman said was the greatest American
economist (or something like that). My dissertation at
NYU was in capital theory, and my mainstream committee
members (including Boyan Jovanovic) couldn’t
understand the Austrian position which said that
interest was NOT about marginal product of capital. So
I really have no idea where D. Friedman is coming
from, unless he got so pissed at the other questions
that even this one set him off.

2) On methodology, I refer D. Friedman to the Mises
Institute’s own blog, where someone has gone through
M. Friedman’s essays in positive economics and shown the affinity to the natural sciences. Now, if D.
Friedman just meant that even physicists don’t exactly
follow the Popperian story when doing their science,
OK, fair enough. But if he’s objecting to the Austrian
claim that mainstream economists try to ape
physicists, all I can say is that I’ve talked with
plenty of mainstream economists who rip Austrians for
not being “scientific” in just this way.

3) On Alfred Marshall: Since I’m going to teach
Marshall to my kids in History of Economic Thought in
a few weeks, I would appreciate D. Friedman telling me
just how I’ve misunderstood Marshall’s famous
“scissors” analogy. I’m not being sarcastic; I really
want to know.

Murphy Answers Kennedy

In a recent blog post, JTK said:

Inexplicably and unpardonably AWOL from No Treason, Bob Murphy has nevertheless written a nice piece on Mises’s Non-Trivial Insight. My question to Bob would be this: What insights are neoclassical economists like the Friedmans missing and what deficiencies does this produce in their economic thought?

To give a quick response, I would say that Milton Friedman’s famous defense of positivism in economics is quite naive. If we really followed M. Friedman’s position (which is to make any unrealistic assumptions we want, so long as the predictions gleaned from our model are sufficiently accurate) then I don’t think we’d get very far in economics. As I say in the Mises.org piece that Kennedy mentioned, economics would be as “good” as meteorology currently is.

In any event, I wish the positivist economists would actually abide by their own criteria. I.e. I think their actual predictions would suck compared to, say, *my* predictions concerning the effects of certain gov’t policy changes.

As far as David Friedman goes, I think he makes perhaps the opposite mistake of his father. Whereas Milton says, “Yeah, sure, the models aren’t realistic, but all we care about are predictions,” David says (at least in places), “The models are real, and more trustworthy than common sense.”

I won’t back up my assertions here. The interested reader should go to my Mises.org archives, and read the articles, “The Case of David Friedman” and “Econometrics: A Strange Process” to see two particular examples of neoclassical error (that I believe are caused by their faulty methodology).

Another example (perhaps) of bad neoclassical analysis which is generated by bad methodology might be this piece.

“Which kind of schoolboys carry AK-47s?”

After U.S. troops opened fire on protesters near an
Iraqi school, Col. Arnold
Bray of the 82nd Airborne Division explained that his
troops had exercised restraint amidst the shots being
fired at them. Bray said there were infiltrators in
the crowd, including some who were armed and on nearby
rooftops. “Which kind of schoolboys carry AK-47s?”
Bray asked.

That’s a great question! What kind of a sick culture
equips its school-aged boys with automatic weapons so
they can kill foreigners to achieve political
objectives?

Blunders

If you’re as smart as me, you know that the one thing we need to watch out for above all else is our arrogance. So just as a friendly warning, here are two quotes from famous thinkers:

“The deeds of the Fascists and of other parties corresponding to them were emotional reflex actions evoked by indignation at the deeds of the Bolsheviks and Communists. As soon as the first flush of anger had passed, their policy took a more moderate course and will probably become even more so with the passage of time.”–Ludwig von Mises, 1927.

“The housing problem is one which must be dealt with at the earliest possible moment. Something would be done to alleviate the situation by the taxation of land values, which would hinder the holding up of vacant land while the owner waits for a good price.”–Bertrand Russell, 1922

The Anarchist’s Dilemma

John Kennedy’s got a few
things going for him. He can write, he can argue, he has a catchy website (updated
semiannually), and let’s face it: he’s
one handsome man.

But in his latest two articles, Mr. Kennedy has outdone himself. First, he coins
the excellent term market anarchism.* Like Jeremy Sapienza, I defy intellectual
property rights when convenient, and so will henceforth use this term instead of the
awkward and geeky anarcho-capitalism. (The term never even made sense: a capitalist
isn’t one who studies or endorses capitalism.)

More important, however, is the milestone
Kennedy has reached: His are the first articles ever, devoted entirely to the ideas of me,
Bob Murphy. Whatever the flaws in his reasoning (and there are many—see below),
history will look kindly upon John Kennedy.

(In contrast, Jonah Goldberg—who
referred to me in e-print as a "no-talent ass clown," in a move comparable to
his estimation of Al Qaeda strength on September 10—will be dealt a much harsher
verdict.)

* * *

Kennedy’s articles are a response to In Search of the Antimarx, in
which I argued that "the only hope for a stateless society is a population committed
to true voluntarism." I think people may have misunderstood me, so let me elaborate.

Let’s say we’re in a stateless
society. If the vast majority of people saw nothing wrong in (re)establishing a democratic
government, then it would happen. This is almost a tautology, under present circumstances.
(If the vast majority of people see nothing wrong with abortion, then it will occur,
regardless of whatever incentive mechanisms may be in place.) In fact, if a terrorist
attack were to plunge society into an anarchic Mad Max world, I have little doubt that a
government would be one of the first things the survivors would build. (Look how
naturally Stephen King drifted into it in The Stand. It didn’t even occur to
him that a laissez-faire system might work.)

Few people realize how crucial widespread, voluntary
respect of others’ property is for social order. No amount of police would save
society if most people didn’t believe theft and murder were unacceptable. Now, what
we as evangelical market anarchists need to do is convince
people that their intuitive opinion of theft and murder is still valid when it is
government officials doing the stealing and killing. If we are successful, we will then
have our "only hope" for a stable stateless society: a population committed to
true voluntarism.

John Kennedy (melodramatically) objects to
this analysis: "Frankly I would despair if I thought this were true. And anyway, if
such a population were so committed to freedom there wouldn’t be much reason to worry
about limited government because it would work."

Ironically, it is exactly this mindset that
the rational evangelist will have to overcome if he is to succeed in proselytizing
potential market anarchists. If a limited government were in place, then the population
couldn’t be very committed to freedom, now could they? This is precisely our mission:
We have to shake people free of the notion that a minimal state wouldn’t be so bad.
It’s suicidal to rely on government monopolies to provide food, and it’s almost
as foolhardy to allow government police and military to monopolize our security.

(To the extent that Kennedy just means that
a noble population would at least keep their government to a tolerable size, he’s
simply wrong. Look at what happened to the United States. The Founding Fathers were some
amazing and honorable individuals. But since they allowed for an institution of official
violence, their scheme was bound to degenerate as it historically did.)

My original remarks apparently misled
Kennedy to believe that I rested my hopes on a new Anarchist Man, far more virtuous than
man in his present nature. This isn’t correct. As I have written elsewhere
(in response to a Charley Reese caricature), "Libertarianism simply says: Given any
level of morality, a society will function less smoothly if shackled by government.
The more moral the populace, the better, but this is a different matter altogether."

In order to drive home the point that
anarchy doesn’t require perfect people, Kennedy quotes extensively from David
Friedman, who writes:

An ideal objectivist society with a limited
government is superior to an anarcho-capitalist [What a geek! –BM] society in
precisely the same sense that an ideal socialist society is superior to a capitalist
society. Socialism does better with perfect people than capitalism does with imperfect
people; limited government does better with perfect people than anarcho-capitalism with
imperfect. And it is better to wear a bikini with the sun shining than a raincoat when it
is raining. That is no argument against carrying an umbrella.

Even putting aside his apparent endorsement
of cross-dressing, we see that Friedman commits a serious error in this analysis. Like
many mainstream economists, he assumes that the only problem with socialism (or government
in general) is that it provides the wrong incentives for people.

Friedman overlooks the much more
fundamental problem, articulated by Ludwig von Mises and later Friedrich Hayek, that
without private ownership of capital goods, socialist planners would lack the market
prices needed to calculate the profitability of possible production plans. Even if they
were angels, the socialist rulers would not know the "optimal"
goods and services to produce. This general problem is true in the specific case of police
and military defense, and so a limited government wouldn’t be "perfect"
even with perfectly virtuous citizens.

* * *

Unfortunately, Kennedy shares David
Friedman’s fascination with incentives, and devotes much of his time explaining the
mechanics of the Prisoner’s Dilemma, in which rational individuals acting in their
self-interest reach an undesirable (and avoidable) outcome. Kennedy applies the
Prisoner’s Dilemma framework to our current situation:’

Go back to the original Prisoner’s
Dilemma to understand why rational evangelism [for market anarchism] won’t work. If
you’re prisoner A and you understand the situation you can easily explain to B why
it’s in your common interest to cooperate….But you haven’t changed the
situation a bit, you’re both still individually better off defecting….In the
game where we’re all prisoners of government the overwhelming majority will
consistently choose to defect, out of rational self-interest, regardless of valid
arguments for voluntary cooperation against government….’

At this point, let us pause to point out a
certain irony in Kennedy’s position. In his articles, he chides my admiration of Karl
Marx’s rhetorical brilliance, since Kennedy would never stoop to cheap parlor tricks
in the great debate over government. Yet here he apparently uses one of Marx’s most
celebrated ploys. According to Marx, the bourgeoisie would resist the communist paradise,
even though it was in everyone’s interest, because their class membership prevented
them from seeing the truth as only the proletariat could. Yet Marx, himself bourgeois, was
mysteriously exempt from this "law" of history.

In a similar manner, Kennedy argues that it
is rational for everyone to endorse government. Yet Kennedy exempts himself from the
implications of the Prisoner’s Dilemma. But unlike Marx, who implicitly condemned the
bourgeois logic as faulty, Kennedy is not claiming that widespread stupidity enables
government; he is claiming that people correctly choose government (in the present
system). What implications this has for Kennedy’s opinion of his own rationality we
leave to the reader.

* * *

Is all hope lost? No. Kennedy writes,
"So how can we win this game? We can’t. We need to change the rules, we need
another game."

This seems to contradict his analysis from
the previous section. If we can’t convince people to stop using government, how can
we convince them to abolish it? It’s true, if everyone agreed to "change
the rules," we’d all be better off, but any individual agreement won’t bind
anyone else. Kennedy’s own logic would therefore dictate that the overwhelming
majority will rationally choose to keep the rules just as they are.

Of course, we all know what Kennedy is
driving at. Rather than argue with people on a principled, abstract level about the sins
of government action, he wants us to encourage people to opt out of the system. Show them
the techniques of successful tax evasion and encryption, not the natural law view of
contract.

But this is entirely compatible with my
philosophy, and contradicts nothing in my articles praising evangelism. I certainly
encourage people to commit acts of (nonviolent) civil disobedience; I don’t think the
transition to anarchy needs to be "lawful."

However, Kennedy fails to realize that
people won’t let the State wither away out of sheer selfishness. Even the
typical tax cheat thinks taxes "need" to be paid. Until we can be sure our
neighbors won’t report us to "the authorities," market anarchists have to
be completely above-board.

In conclusion, we must change people’s
minds, just as Kennedy’s has been changed. The dry, intellectual case for market
anarchism has been made; it has convinced people like Kennedy and me. Now it remains for
other, more creative individuals—and above all a genius whom I have dubbed the
Antimarx—to spread the truth to the masses.

Now, to communicate this truth, we
mustn’t shy away from "packaging." Kennedy acknowledges this strategy when
he uses funny appellations for me, or quotes David Friedman on bikinis. There is nothing
wrong with entertainment, and evangelists of market anarchism could take pointers from
their enemies.

* However, Kennedy admits that he may have
been influenced by this punchy piece.
(Rothbard fans, you are forewarned.)