Monday, August 06, 2007

Life Among the Econ

Dani Rodrik expresses something I've taken a whack at a couple of times much better than I ever did:

You can tell what kind of an economist someone is by the nature of the response s/he offers when confronted with a policy issue. The gut instinct of the members of the first group is to apply a simple supply-demand framework to the question at hand. In this world, every tax has an economic deadweight loss, every restriction on individual behavior reduces the size of the economic pie, distribution and efficiency can be neatly separated, market failures are presumed non-existent unless proved otherwise (and to be addressed only by the appropriate Pigovian tax or subsidy), people are rational and forward-looking to the first order of approximation, demand curves always slope down (and supply curves up), and general-equilibrium interactions do not overturn partial-equilibrium logic. The First Fundamental Theorem of Welfare Economics is proof that unfettered markets work best. No matter how technical, complex, and full of surprises these economists' own research might be, their take on the issues of the day are driven by a straightforward, almost knee-jerk logic.

Those in the second group are inclined to see all kinds of complications, which make the textbook answers inappropriate. In their world, the economy is full of market imperfections (going well beyond environmental spillovers), distribution and efficiency cannot be neatly separated, people do not always behave rationally and they over-discount the future, some otherwise undesirable policy interventions can generate positive outcomes, and general-equilibrium complications render partial-equilibrium reasoning suspect. The First Fundamental Theorem of Welfare Economics is proof, in view of its long list of prerequisites, that market outcome can be improved by well-designed interventions. Since they have given up on the textbook model, members of this group have an almost-infinite variety of "models" to choose from as they think of public-policy issues.


Adding a bit of explanation, Rodrik's categories of first and second best aren't a ranking of quality, they're referencing concepts. A first best world is, mathematically, one in which every other condition presumed to be satisfied optimally, so any deviation from optimality is automatically "bad." So anything like the imposition of a tax, or the setting of floor on wages, or whatever, will have efficiency losses.

In a second best world, there are existing deviations from optimality, and so any policy intervention such as a tax or minimum wage can lead to efficiency gains. Two wrongs can make a right, in other words.

But the real issue isn't the technical econ stuff, it's the gap between what academic economists do as their research and how they engage the public discourse. In their public discourse we're perpetually in the first month of Econ 101, even though in their academic research the world is quite a bit more complicated than that.

Culturally I think there's a large bias favoring "first best economists," both within the economic profession and of course in our media generally. Those within the profession should think a bit more about why this is and what the consequences are.

(via crooked timber)