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Analyzing Emergent Properties of Systems of Decentralized Exchange: Part IIIA of My "The Economist as ?: The Public Square and Economists: Equitable Growth Notes for October 11, 2013

So what do economists have to say when they speak as public intellectuals in the public square? As I see it, economists have five things to teach at the "micro" level--of how individuals act, and of their well-being as they try to make their way in the world. These are: the deep roots of markets in human psychology and society, the extroardinary power of markets as decentralized mechanisms for getting large groups of humans to work broadly together rather than at cross-purposes, the ways in which markets can powerfully reinforce and amplify the harm done by domination and oppression, the manifold other ways in which the market can go wrong because it is somewhat paradoxically so effective, and how the market needs the state to underpin and manage it on the “micro” level.

These five are:

The Deep Roots of Markets: First, and probably most important, at some deep level human sociability is built on gift-exchange—I give you this, you give me that, and rough balance is achieved, but in some sense we both still owe each other and still are under some kind of mutual obligation to do things to further repay each other. Wherever we look in human societies across space or across time we find such overlapping networks of gift-exchange and resulting reciprocal obligation to be an important share of the social glue that holds us humans together. On top of this deep gift-exchange sociability, economists say, we humans have built an economic system of decentralized market exchange. Today a great many of our gift-exchange relationships are not long-term relationships over time with people we come to know well, but rather one-shot exchanges with people we do not necessarily expect to ever see again. These exchanges are mediated by tokens called “money” that are acceptable to each of us as payment or repayment because they are acceptable to all of us. And this great enhancement of our potential network of those with whom we can exchange is what allows us to have a wide and productive rather than a cramped and penurious social distribution of labor.

This part of what economists have to say has been very clear since Adam Smith in 1776 published the first edition of his Inquiry into the Nature and Causes of the Wealth of Nations. Because humans have a “natural propensity to truck, barter, and exchange”, we can build markets of wide extent. Because “the division of labor depends on the extent of the market”, our extensive markets allow a detailed and sophisticated division of labor. And Adam Smith saw the detailed and sophisticated division of labor of eighteenth-century Britain as the principal cause of its relative productivity and prosperity. It is, perhaps, the most important thing that economists have to say as public intellectuals in the public square.

The Extraordinary Power of Markets: Second, and probably second-most important, organizing a great deal of our societal distribution of labor around market exchange mediated by tokens called “money” is not just something that works with the grain of the crooked timber of humanity, but also something that turns out to be extraordinarily powerful and effective as a decentralized societal calculating mechanism for determining what is to be collectively produced, how it is to be produced, and for whom it is to be produced. Take market exchange, add private property in things, and the proviso that people can get together and form smaller hierarchical or cooperative forms of economic organization within the matrix of the market economy when they think best, add the proviso that there is a government to enforce its conventions about property rights and contract obligations, and you find that you have a system that as a whole has marvelous advantages.

First of all, it happens that the great bulk of commodities in this world are what economists call rival in use—if I am making use of it, you cannot be. Thus one person’s enjoyment and use of a particular item reduces the available options of others. It thus makes sense for a rational and efficient social system to make a person who decides to feel the effect of their actions on the opportunities and choices of others. It turns out that if you (a) assign exclusive property rights to use to someone, and (b) require a person to pay a market price for the privilege of transfering those rights, then you have (c) a marvelously effective way of making each feel the effect of their decisions on the well-being of all. This is quite a coincidence. Nineteenth-century economist Richard Whately—the only person ever to have been in rapid succession Professor of Political Economy at Oxford and Archbishop of Dublin—detected the hand of Providence in this truly divine coincidentce..

Second of all, it just turns out to be the great bulk of decisions about what is the best economic use of resources in the world are best made at the local level, by individuals who actually know what is going on. It is not good to make them in some centralized Kremlin or GOSPLAN office. And, again by coincidence, it turns out that exclusive and transferable private property is a good way of making decisions take place where the information is at the periphery, rather than at the center where the information is not. And, as Ronald Coase pointed out, one of the geniuses of our market system is that it allows for islands of centralized hierarchy wherever and whenever people decide that there is stuff to be gained by centralized hierarchical planning and coordination, or by some other mode of coordination and collective decision-making other than decentralized market exchange.

That extraordinary power of markets that just happens to fit our world of largely rival commodities in which decision-making is largely better decentralized is, perhaps, the second most important thing that economists have to say as public intellectuals in the public square—along with noting that what has been true in the agrarian age in which Adam Smith lived that ended with the eighteenth century and in the industrial age of the nineteenth and twentieth centuries may not be true in whatever kind of age the twenty-first century tuns out to be.

Market Systems Reinforce and Amplify the Harm of Domination: Third, and probably third most important, is that market systems can and do amplify the harm done by power imbalances: slavery in the context of the American South’s cotton plantations was a much worse thing than slavery in the context of West African households precisely because the first were embedded in a market economy and so there was a great deal of money to be made by whipping slaves to work until they dropped. Market systems are at the bottom very good ways of getting people to respond to incentives. Power imbalances create situations in which we would rather that people not have more reason to use their power.

Such power imbalances can cause enormous misery in the context of a market economy even in the absence of incentives to behave with affirmative cruelty, for power imbalances turn into wealth imbalances, and a market economy’s underlying calculus is a calculus of doing what wealth wants rather than what people need. Wealth imbalances alone produce a situation in which we do not like the pattern of incentives that the market system provides to individuals, and in which market systems go horribly, dreadfully, diabolically wrong.

Consider the Bengal famine of 1942. In Bengal, in 1942, because of the interruption of world trade, those whose sole wealth was their labor in the jute plantations found their wealth valued at zero—nobody wanted to hire them because nobody thought it worthwhile to grow jute that would then have to be shipped out through the Indian Ocean as long as there was a chance that the six aircraft carrier’s of Japanese Admiral Nagumo’s Kido Butai might be prowling the ocean. Without wages to earn, the ex-jute workers of Bengal had no wealth and no money to pay. With no money to pay, the market provided those in other parts of India who had food with no incentive to move the food to Bengal and sell it to the ex-jute workers. Two million people died, even though there was ample food in India for the population as a whole.

And the British state that ruled India, and was responsible for checking to see whether the incentives the market system was providing really were the incentives that people were responding to? Prime Minister Winston Churchill sent a telegram, asking: if it were really true that there was famine in India, why was Mohandas Gandhi still alive?

As people here at Notre Dame know well, such behavior by the British Empire was not exceptional. My Gallagher ancestors and the founders of this university knew well the earlier failure of the British state to take appropriate action to rebalance the distribution of wealth and prevent mass starvation in 1846-8, similary in the midst of ample food nearby and plenty of resources to transport it.

Other Ways in Which the Market Can Go Wrong: Fourth, even when the distribution of wealth is right, the market system can still go wrong and provide the wrong incentives. The brilliant Ronald Coase of the University of Chicago—still productively at work as an economist early in this decade even though his age had reached three figures—was interpreted to have argued that pretty much any arrangement of property rights will do about as well as any other and the government should simply step back. The canonical case adduced was the locomotive that occasionally throws off sparks that burn the nearby farmer’s crops. If the railroad has a duty of care not to burn the crops, Coase said, the railroad will attach spark-catchers if it is cheap and makes sense to do so—and the railroad will pay damages and settle in order to avoid being hauled into court on a tort claim if it is expensive and doesn’t make sense to do so. If the railroad has no duty of care, Coase said, then the farmer will offer to pay the railroad to install spark-catchers—and spark-catchers will be installed if the potential damage to the crops is greater than the cost of the spark-catcher and it makes sense to do so, and spark-catchers will not be installed if the damage to the crops is less than the cost.

Thus the same decisions will be made whatever the property rights—as long as there are settled property rights. If there are not settled property rights, then the crops burn and lawyers grow fat. But as long as there are property rights, the market will work fine. Maybe the widows and orphans who own railroad shares will be wealthier under one setup and maybe the farmers will be wealthier under the other, but that is rarely a matter of great public concern.

Now this argument has always seemed to me to be wrong. If there is no duty of care on the part of the railroad, it has an incentive not just to threaten not to install a spark-catcher, but to design and build the most spark-throwing engine imaginable—to make sure that the firebox is also a veritable flamethrower—and then to demand that the farmer bribe it not to set the fields on fire. What economists call “externalities” are rife, and call for the government to levy taxes and pay bounties over wide shares of the economy in order to make the incentives offered by the tax-and-bounty-augmented market the incentives that it is good for society that decision-making individuals have. Cutting property rights “at the joints” to reduce externalities is important. But it will never be efficient: what economists call Pigovian taxes and bounties make up a major and essential part of the business of government.

The Market Needs the State: Fifth, the market needs the state. For the market system to work well and produce a good outcome, outcomes need to be dictated not by inequalities of wealth or power but by genuine win-win exchanges. This means that the government has to set out and maintain its laws of property and contract, so that what is yours stay yours and what is promised is delivered at good weight. In the absence of a properly-regulating government, what is yours is not yours, what is promised will not be delivered, and weight will not be good: instead, either roving bandits, local notables with bully boys functioning as barely-better stationary bandits, or the government’s own functionaries abusing its powers will decide that what was yours is now theirs. And having a government powerful enough to set out and enforce laws of property and contract that does not then turn around and become the largest and most destructive stationary bandit of all is perhaps the most diicult of all problems of political economy, for a government is, as the philosopher Ibn Khaldun wrote, at its foundation an organization that prevents all injustices save for those it commits itself.

Those five points and their application to the issues of today are what economists have to say about “micro” topics when they don the mantles of public intellectuals and speak in the publish square. Moreoever, it is economists’ task to speak about how much the technical details matter, and the technical details do matter—would you have thought ex ante that it would be important whether the property rights of the farmer were boosted by a requirement that anybody running machinery nearby have a duty of care? Economists are worth listening to—and hopefully paying—to the extent that they can combine their knowledge of the basic principles with sufficient institutional knowledge to understand just what small differences in regulatory institutions and organizations will mean for the distribution of wealth, and for the on-the-ground incentives provided to humans.

Economics in the public sphere is thus a difficult, important, and subtle discipline. It is concerned with what are the emergent properties of basing a great deal of the construction of our collective social division of labor on a decentalized system of money-mediated market exchange. Many of these emergent properties are not obvious and not well understood. And the devil is often in the details. That is why I looked forward in my twenties to making a comfortable living as an economist—as a speaker in the public square, as someone pushing forward we economists’ collective understanding of these emergent properties, and as someone teaching non-economists how to listen when we do speak in the public square. So far I have not been disappointed.

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