Markets Fail. . .And Libertarianism Still Works, 10/16

Jason Furman recently gave a talk in which he described how he teaches economics. He says that early in the course, he describes perfect competition. This is when the free market is most likely to be optimal. Then, over the course of the semester, the students learn all of the preconditions that must be assumed in order to have perfect competition. Since these preconditions are almost surely not satisfied, market failures will occur, and students learn how government intervention can produce better outcomes. (His talk began four hours into the conference, and the remarks that I am paraphrasing are at about the 4:15 mark.)

Furman comes close to making what I call the straw-man argument against libertarianism and for technocracy. That argument goes:

Libertarianism relies on markets.

Markets are optimal only under conditions of perfect competition.

The conditions for perfect competition are rarely satisfied.

There are many instances of market failure.

Therefore, libertarianism does not work.

This argument constantly emanates from economists of Harvard and MIT and their disciples. Students and journalists, who are inclined to resent markets and despise libertarians, feel vindicated when they hear this argument. They come away believing that markets are never any good, even when professors who teach this way, like Jason Furman, are less dogmatically anti-market.

What is wrong with the argument? Step (2) is a swindle. It sneaks in the assumption that markets have to be optimal in order to be preferable to government intervention.

Instead, long ago I offered the aphorism Markets fail. Use markets. That is, I readily concede that the market economy is not at some theoretical optimum. The question is what will lead to improvement. I believe that government intervention will often make things worse. Meanwhile, entrepreneurial innovation and creative destruction tends to solve economic problems, including market failures.

Suppose you see conditions in a current market (say, the market for electric cars) and think society deserves something better. To advocate government intervention is to assume that the intervention will achieve your goal.

Instead of thinking in terms of a one-time intervention relative to current conditions, libertarian economists look at markets and government intervention as processes for changing economic performance. We compare one process to another, not one set of market conditions to some theoretical outcome.

As a process, markets tend toward improvement, because business profits ultimately depend on satisfying consumers. As a process, government intervention is unreliable, for many reasons. The interests of government officials often diverge from the interests of voters. The disciplinary forces of competition and the profit-and-loss system are absent. The internal processes of bureaucracy tend to reward conformity and repression of innovation.

If market fundamentalism is the belief that markets are perfect, then I do not know anyone on the libertarian side who is a market fundamentalist. Economics professors do not have to spend a whole semester arguing against this straw man. I wish that they would spend more time discussing government fundamentalism, which is what you are guilty of when you assume that government intervention consists of wise, technocratic solutions.

At the conference where I heard Furman talk, the last speaker, Douglas Holtz-Eakin, gave an impassioned argument against government intrusion into economic decisions. He argues that intervention leads to corruption and polarization. His talk begins about the 7:40 mark. Recommended.

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Markets Fail. . .And Libertarianism Still Works, 10/16