The various types of economic systems that we know as capitalism are characterised by decentralised decision-making by individual agents under uncertainty and shifting subjective expectations and utilities.
But decisions by a large enough number of people that appear advantageous at the micro level can have negative macro effects.
A perfect analogy is crowd behaviour during stampedes at large events that result in loss of life and injury. Rumour and panic can thrive in large crowds and the macro-effects are disastrous when people are killed or injured in stampedes. From the individual (or micro) perspective it makes sense to leave a crowded event as fast as possible to avoid what might be a treat to your life: when enough people do it the result might not, however, be beneficial to you.
Aggregate variables like investment and macro phenomena like stock markets can be subject to similar problems related to micro versus macro effects. Rumour and panic can cause crashes in financial markets or in investment decisions: negative subjective expectations (with or without rational foundation) can spread to large numbers of business people causing investment and employment to collapse.
Government is akin to the management of a theatre, where theatre managers use their power (through public announcement and their security staff) to prevent disastrous macro events like stampedes. Intervention by theatre management (the analogy to government) to prevent panic and disaster in a theatre (or government stopping secondary deflation and depression in an economy) is a better outcome than allowing large scale micro-behaviour that has terrible macro-effects.
In the case of a slump in investment owing to shocked business expectations, this can take the form of what Keynes called “socialization of investment” (public works and other public spending programs that can be analogous to investment), or increasing people’s spending power to create the demand necessary for increased production.
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I like John Cassidy's example of the Thames footbridge slightly better, because it doesn't rely on panic and is thus a more distant analogy that is easier to apply to situations not associated with a panic, such as a slow forming bubble.
ReplyDeleteIt's in his book, how markets fail and he repeats it in a transcripted NPR interview.
http://www.npr.org/templates/story/story.php?storyId=120004267&ft=1&f=1006
LK,
ReplyDeleteI was wondering if you could write something on (perhaps you already have, but I can't find it) the view of Macroeconomic study in the Austrian School - I know traditionally they have advocated Methodological Individualism, on the basis that it is individuals - not aggregates - that make decisions but it appears like they have slowly warmed to the idea (i.e Roger Garrison).
" Second and more important, individuals who are in possession of increased
money balances and who have correct, or rational, expectations still may not
spend in a pattern consistent with the New Classicist view. A spending pattern
that is internally inconsistent on an economywide basis does not necessarily
imply inconsistency for the individual. That is, macroeconomic irrationality
does not imply individual irrationality"
- Garrison, The Austrian Theory of the Business Cycle in the Light of Modern Macroeconomics.
The fact that some Austrians have turned to macroeconomic study while others are hostile to it shows yet another contraction/fissure running through their school.
ReplyDeletecontradiction/fissure
ReplyDeleteDo you have examples of crashes that did not have a rational foundation?
ReplyDelete'Government is akin to the management of a theatre, where theatre managers use their power (through public announcement and their security staff) to prevent disastrous macro events like stampedes. '
ReplyDeleteI can't emphasis this enough. Glibertarians inevitably ask 'well if people are so imperfect and can't predict the future why do governments know better hmmm?!?!?!?!?!?'
But it's a false premise. Thomas Schelling demonstrated 'rational' micro behaviour can lead to horrendous macro outcomes, and how a few simple rules/signalling processes (witness: traffic) can make everybody better off, without anybody feeling 'coerced'.
How exactly can theatre management prevent panic and disaster in a theatre other than lying to people that everything's okay when it is not? The analogy to government is indeed right on the money.
ReplyDeleteHowever rules of traffic are not to prevent a stampede and no individual is better off by ignoring them (ie micro advantage = macro advantage) so that analogy is rubbish.
Then again stampedes in financial markets can only occur with fiat money so government has to create such environment in the first place, ie the usual thuggish shtick of creating a "problem" so they "hire" you to "prevent" it.
"How exactly can theatre management prevent panic and disaster in a theatre other than lying to people that everything's okay when it is not? "
ReplyDeleteIf the panic is caused by a rumour, then theatre management can reassure people by communicating that information to them.
If there is a fire, management can direct security to oversee an orderly evacuation by rows etc, not a stampede.
"Then again stampedes in financial markets can only occur with fiat money so government has to create such environment in the first place"
LOL.. So I guess there were no panics in the 19th century?
Yet theatre management does not need the right to kill and tax to do its job right?
ReplyDeleteFiat money is simply 100% virtual, but virtual money is not exactly 20th century discovery, fractional reserve banking of specie money serves exactly same purpose. It is basically enough to grant anyone (in practice, a bank) an exception in paying off their debts, which governments have amply done in the 19th century, hence the panics.
"Yet theatre management does not need the right to kill and tax to do its job right?"
ReplyDeleteAn idiotic appeal to emotion fallacy.
Tell me: when are people killed in, say, Western nations for not paying taxes?
And progressive taxtion is easily morally justified by a large number of ethical theories - Rawl's human rights ethics, utilitarianism, Kantian ethics, etc.
Basically, one of the few moral theories that might be used against tax is natural rights/law theory, which you (if I remenber rightly) reject.
Amd not only taxation is easily justified morally it is widely accepted by the voting public - indeed many people see paying their taxes as a duty and moral thing to do, in order to get public goods in return.
The traffic analogy is very valid:
ReplyDeleteMicro: "If people just get to drive as fast and however they would like, we'll get faster to work in aggregate."
Macro: "If people get to drive as fast and however they would like, externalities would happen and we'd get to work slower in aggregate."
A typical "regulation is needed"-situation, that is.
Also - the concepts money, government and taxes belong together. It's a way to keep track of social obligations and what counts as fulfilling them. The concept money is so much more than a medium of exchange. It's an institution for democratic allocation of resources in an economy.
Progressive taxation is not only morally justifiable, but also serves as a means to reduce differences in propensity to consume, as well as a break on inflation (earnings rising in aggregate, tax brackets staying the same).
LK, people do prefer paying taxes to getting killed, otherwise the threat of killing if you don't pay taxes would be useless in the first place. So w/o the monopoly to kill the government would merely be a comedy show to lough at, at best. I'm all for the monopoly, but the analogy to theatre management is rubbish.
ReplyDeleteYou keep forgetting we both share the same moral theory, the utalitarian one. We merely differ in assumptions and conclusions, ie one of us is wrong what administration serves people's well being best.
"people do prefer paying taxes to getting killed, otherwise the threat of killing if you don't pay taxes would be useless in the first place.
ReplyDeleteI repeat: what Western nation has the death penalty for not paying taxes?
Answer that question - but of course you won't, because you are an idiot.