Tuesday, September 14, 2010

Richard Serlin on the Optimal Size of Government

Richard Serlin has a great post on the optimal size of government (HT Brad DeLong). He talks a lot about the sort of pervasive "market failures" that aren't immediately obvious - he mentions asymmetric information specifically. I've talked here before about what I call "temporal autarky", which distorts any sort of intertemporal calculation. The point isn't to drop the market, of course. The market is still by far the best resource allocator available. But there are major underinvestments that we'd expect to characterize the market, which means that even in a market economy a minimalist state is completely unviable.

Serlin also makes some great points about data insufficiencies that I think Mattheus and Jonathan could appreciate after recent discussions of the adequacy of GDP. I still think our output measures are fine and important - as long as they're used for what they are designed for - treatment as a "national income and product account". But Serlin, quoting Paul Romer, notes that there are a lot of other important things to look at that are a lot harder to measure. Romer sounds a lot like Deirdre McCloskey in the sections that Serlin has quoted. If any of you are familiar with McCloskey's work on statistical significance you'll know exactly what I'm talking about.


  1. I wasn't too impressed. Pointing out that markets are imperfect isn't necessarily a criticism of markets (those imperfections are necessary to the functioning of markets, and he seems to disregard the dynamic nature of markets), certainly isn't a criticism of a free society (Elinor Ostrom, for example), and definitely is not an argument for government intervention per se (he's far too confident in his or the government's ability to a) find the right answer and b) do the right thing). It was intelligent, but somehow silly at the same time (especially the speculation on how mcuh society is really happier than it was in 1978--that was lame).

    This definitely won't persuade anyone who doesn't already agree. To me it wasn't even particularly interesting.

  2. Well right - I don't think anyone is out to "criticize markets" as you say. It's a question of whether markets achieve optimal investment levels on their own. And obviously no one is trying to criticize a free society. You are right, at least, that Ostrom's work is central to this sort of question.

  3. Insofar as there is a trade-off between government and markets, supporting government intervention is an implicit criticism of markets. Furthermore, asserting that markets might achieve optimal investment levels is clearly a criticism of markets, though not necessarily a wrong one.

    Hmm...what does optimal mean? Armen Alchian, whose works I'm going through, uses "optimal" (well, "optimal distribution" in contrast with "maximal (distribution)" He was talking about profits at the time--he criticized the idea that firms maximize profits because imperfect information clearly makes that impossible. Instead they optimize profits--they do the best they can. Fortunately, due to an evolutionary mechanism the market economy displays, the assumption of profit maximization leads to pretty accurate results, even if the assumption is technically incorrect.

    In that sense of the world "optimal," firms doing the best they can given all of the imperfections in the system, and the market correcting for mistakes, I'd say it's pretty clear that markets almost certainly achieve optimal investment levels, though that does allow for the possibility of government improving upon the system, yet it also introduces new complications into interventionist theories--they need to be careful not to disturb the market's evolutionary mechanisms. If optimal is mean to be something more along the lines of perfection, markets easily fall short of the mark, but things also become harder for interventionists who must be held to the same standard (indeed, if both market and government failure are clearly demonstrated by some very simple economics, then you have to wonder if those terms aren't deeply flawed, or else admit that the world is just broken).

    Here's a link to the essay by Alchian that I referenced because it is totally awesome: http://www.cbe.csueastbay.edu/~alima/courses/4520/Alchian1950HiQuality.pdf

  4. Teenageeconomist -

    You might want to read this recent post on Coordination Problem: http://www.coordinationproblem.org/2010/09/agent-failure-and-market-failure.html

    It discusses market efficiency in the presence of imperfections. As I explain in more detail in my comments, I think Steve Horwitz is wrong on the market imperfection part, although right on the agent imperfection part. I don't think you can talk about "the imperfections of the system" and just leave it at that. There's a big difference between an externality - for which there is not a market solution - and asymmetric information, for which there may very well be one. When you leave it vague it's hard to evaluate your position.

    And for the last time no one is criticizing the market - drop it.


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