Monday, March 9, 2009

The market and the state: Postscript, and a further irony.

One point I didn't bring out sufficiently in my last entry was in my discussion of the "free market", and how this is a misleading metaphor for how the market economy operates, which is always in tandem with the state. Now, Orwellian newspeak and ideological fervour may be two reasons. But yet another is the way that economics is taught nowadays, and for the last while. At least the last seventy years or so, since Paul Samuelson's Foundations and the Arrow/Debreu theorem. We teach our students based on stylized mathematical models devoid of any institutional detail or richness. So that in the model, whether partial or general equilibrium, the price system operates to get us to the equilibrium, without having to worry about niceties like property rights and contracts being enforced. So it's very easy to slip into a mode of thinking that the market functions on its own, if one thinks of the economy purely based on these stylized models.

Now, here's the irony. The point above is well known, and was made many times by libertarians such as Hayek, who was suspicious of mathematical modelling of the economy (whether of the classical or Keynesian varieties). To him, it was a slippery slope from a model to scientific socialism, to the notion that the economy is a machine that can be fine tuned and managed. In other words, the context in which the market operated was important, and, for Hayek and those of his ilk, that had to be a liberal society. But yet it's now often the folks on the libertarian end of the spectrum who forget this point, and imagine somehow that the economy can be disengaged from the rest of society, and the state, in which it's embedded, when they engage in discussions of the "free" market. Let's henceforth banish this term, and talk if we wish of a "minimally regulated market". It's less sexy, but more realistic, and will keep us honest about what's involved.


Rupa said...

The first time I heard of property rights, rule of law,institutions, etc.. as being important prereqs for economic growth and development to take place was in a 4th year development economics course which by the way was an elective. A shame that my first year profs or the textbooks for that matter didn't think it important enough to go over the notion of a so called "free market"! Perhaps it reflects the quality or rather lack of it of my education, but I'm quite positive a free market is literally taken to mean a self-governing system by many people.

Bombay Beauty said...

Good points, but also worth remembering that much of contemporary economics (by this I mean roughly post 1970s and onward) has precisely been preoccupied with embedding the market machinery within the framework of law, property rights, and institutions. Of course (double the trouble, double the fun) the irony is that being economists we abstract the context into a model. But here's the question -- if you had to choose guidance for future decisions would you rather turn to a historian who would draw very lessons from the past (in the 1930s x decided y and it worked well or badly) or an economist who relies on very abstract models but at least has some more general framework?


Vivek H. Dehejia said...

Thanks, Rupa and Bombay Beauty. I think your comments are complementary. While it is true, BB, that there are sophisticated models that try to incorporate information structure and institutions into a theoretical model, such models, being intrinsically difficult, haven't really filtered into the teaching of economics, at any rate at the undergrad or even MA levels, except in specialized topics courses perhaps. In any event, the existence of such models reinforces my case for banishing the term "free market" from public discourse, and using an appropriately nuanced term.

As for whether I'd rather reply on a historian or economic theorist, that's a tough call, and depends on the context. I don't think either has an intrinsic access to the "truth" of the situation, and there isn't necessary a correct Platonic model out there to predict and provide guidance. As ever, in a policy setting, it usually seems to come down to informed judgement, which is a fancier way of saying going with your gut and taking your best shot. So much for high brow theory and sophisticated understanding of history at that point!