Arnold Kling  

PSST as Market Failure

Bubble, Bailout, and Cover-Up... PSST vs. Monetary Walrasianism...

Noah Smith seems to think of it that way.

in a PSST world, there is no invisible hand.

This opens the door for a hugely expanded role for government (or other large, centralized actors) in the macroeconomy. If global patterns matter as much as local prices, then an actor large enough to perceive and affect the overall pattern might be capable of nudging the economy out of a bad equilibrium and into a better one.

I would put the first sentence slightly differently. In a PSST world, there is no Walrasian auctioneer. Prices have to be discovered by ordinary economic actors--firms and individuals. In fact, the discovery issues go way beyond this. In contrast with neoclassical economics, I want to describe a world in which the set of inputs, outputs, and technologies is not fully specified. Those, too, have to be discovered in a process of entrepreneurial groping.

As to the second paragraph quoted above, I would say that the fact that we need entrepreneurial groping is indeed a form of market failure--at least relative to the neoclassical ideaI. However, market failure does not imply government success. I outsource further comments to Tyler Cowen.

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CATEGORIES: Macroeconomics

COMMENTS (5 to date)
Noah writes:

"However, market failure does not imply government success."

True, of course! But market success implies government failure. Large and systemic market failures open the door for government intervention to possibly be much, much more efficient than neoclassical economics would have us believe.

Nor should we try to hand-wave this possibility away, given the correlation between rich economies and strong centralized states. PSST provides a reason why this correlation might include some bi-directional causation.

david writes:

PSST doesn't actually rule out monetary phenomena. It could easily be that t√Ętonnement toward PSST is a constant background problem that is acyclical; showing that it accounts for observed variations in national income is another matter, of course.

Second, this particular market failure actively implies the possibility of getting stuck in bad equilibria, which makes state action extremely tempting.

There is no reason why states (the only macroeconomically large actor) cannot beneficially subsidize entrepreneurial experimentation, in particular - presumably entrepreneurship is underprovided at the margin? Which is the logical outcome of arguing that "recalculation" is the process of subjecting a lot of ideas to the market test. There is no reason, in PSST principle, why a state could not do this.

david writes:

(Incidentally, both net business creation and net production creation are procyclical. For PSST to explain variations in national income, it should be anticyclical - when the economy is in a (temporarily) sustainable pattern, by definition there should be less change in the pattern than when new patterns are being formed. I think those who focus on monetary phenomena generally win this one...)

Michael Strong writes:

Fascinating that Noah comes up with his pro-government intervention interpretation. I've been enjoying Arnold's PSST posts for some time, and increasingly been thinking about how our existing patterns of specialization in education, health care, insurance, and professional training (in education and health care at a minimum) are not sustainable patterns - because of government involvement.

The obsolescence of the U.S. Postal Service is obvious for most to see due to the rise of alternative technologies and competing private services. Government schools are headed the same direction for similar reasons, though it is a slower process. With the right policy changes (adequately free school choice) their obsolescence would become apparent even more quickly.

Government health care and insurance is subsidizing harmful health habits resulting increased rates of chronic diseases, addictions, obesity, etc. even as more and more costly technological health care procedures become available. This is neither a sustainable nor necessary pattern that will be replaced when and where it is allowed to be replaced by means of systems in which positive health habits are rewarded on a far more granular basis than they are at present.

Meanwhile, the university-based training systems for training teachers are nearly worthless and Indian health care is showing us that our system for training health care workers is vastly more expensive than it needs to be. I expect the same is true for legal talent as well. None of our university training systems are optimized for real-world performance, tied as they have been to government licensing standards, government funding, etc. even at private universities.

I could go on, adding more controversial premises, but from my perspective if we can create legal regimes (Free Cities?) within which we are allowed to create new and better "patterns of sustainable specialization and trade" it will become increasingly apparent that, just as the PSST of the Soviet economy was not sustainable, so too are major sectors of the economies of most developed nations not sustainable - because they are largely dictated by government.

Exactly how and when these failures become more widely recognized is wildly uncertain. The Soviet economy managed to last a long time. But to some of us it is obvious that the government-controlled sectors of the economy have already failed and it is just a matter of time before the collapse becomes more readily apparent to all.

Thus for me Kling's PSST (which, as Greg Ransom notes at Noah's blog, is a generalization of Hayek that, while helpful, is not revolutionary) is a powerful reminder of why we need economic freedom in all sectors of the economy.

Tracy W writes:

I don't see how "market success implies government failure". Take for example the introduction of individual tradeable fishing quotas. The governments have done this have healthier fishing stocks than governments that don't, but the fishing markets in those countries are also healthy. Presumably in this case, market success is because of government success (in introducing ITQs). Is there a typo? (see for the fishing story)

Nor do I see how you connect this idea to neoclassical economics. Market failures have been well-explored by neoclassical economics. Furthermore, there are ample other reasons why there might be bi-directional causation, eg strong centralised states gain more from trade, and thus have the incentive and the ability to stomp down on local authorities that are inclined to introduce local trade barriers. Eg, before the internal combustion engine, rivers were very important for shifting freight, and one centralised state that could collect a 10% tariff on all freight down a river might well be better for trade than 20 different princedoms each collecting a 5% cut. Nothing in that story that neoclassical economics couldn't explain. It's noticeable that the USA, which gives to the US congress the right to regulate trade between states, thus cutting back on this sort of harmful local protectionism, is one of the richer countries in the world.

The problem with the state subsidising entrepreneurial experimentation is that in the modern world the state mostly gets its money from entrepreneurial experimentation, aka income and capital taxes. (Natural resources generally have a lot of innovation in extracting them, the oil and coal industries are continually investing in new equipment to improve productivity and to extract resources from deeper).

If you want the state to subsidise this, then you're calling to a big shift to consumption-based taxes, both sin taxes (eg alcohol) and general taxes (VAT), and/or to a tax on the unimproved value of land. We might also want to tax pollutants more.

Which is fine with me. But tends to be politically unpopular as consumption taxes aren't progressive in income.

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