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Thursday, October 6, 2011

Paul Krugman Has Learned Some Undergraduate Economics, but Only Halfway

Regarding Paul Krugman's Markets Can Be Very, Very Wrong:

Krugman, discussing air pollution caused by coal-burning power plants, says,
It does not necessarily say that we should end the use of coal-generated electricity. What it says, instead, is that consumers are paying much too low a price for coal-generated electricity, because the price they pay does not take account of the very large external costs associated with generation. If consumers did have to pay the full cost, they would use much less electricity from coal.
To this, I say:

Wow, Krugman has discovered the tragedy of the commons[1]! I'm glad he's finally learned some undergraduate economics.

So far, everything Krugman has said is perfectly true, if rather banal. But then, he goes to make a crucial error, which will occupy the rest of this essay:
At one level, this is all textbook economics. Externalities like pollution are one of the classic forms of market failure, and Econ 101 says that this failure should be remedied through pollution taxes or tradable emissions permits that get the price right.

...

So if you really believed in the logic of free markets, you’d be all in favor of pollution taxes, right? Hahahahaha. Today’s American right doesn’t believe in externalities, or correcting market failures; it believes that there are no market failures, that capitalism unregulated is always right. Faced with evidence that market prices are in fact wrong, they simply attack the science.
The truth is, no one denies that externalities (i.e. the "tragedies" of the commons, i.e. the "public goods" which lack private ownership and personal incentives) exist. No free-market economist says that externalities are nonexistent, and that the tragedy of the commons is a fiction. Krugman creates a straw-man, by discussing a position that no one believes in.

The issue is this: Krugman says the externalities should be solved by taxes and regulations. The problem is, who will impose these taxes, and how will the tax-rate be set? It's very easy to say, oh the government should tax air-pollution so that the nominal price of coal rises to include the true cost of the externality-pollution that coal imposes. That's right nice, but it fails to answer the question of who will impose those taxes, and what the rate will.

First, as for who: Public Choice school economist James Buchanan notes that far too many political philosophers will specify what the government ought to do, but fail to ask, what will make the government do this? Great, so the government ought to impose taxes to make the cost of coal include its externality, i.e. to make the market price of coal-supplied power pay not only for the cost of the coal itself (which is not an externality, because everyone pays personally, on his own electric bill, for his own personal usage, meaning that incentives and prices will be internalized, not externalized), but also for the cost of the pollution (an externality / public good / tragedy of the commons). Okay, very nice. So go make the politicians do this, and maybe 500 years from now, you'll succeed in convincing them. In the meantime, the politicians will use energy-taxes as a means of enriching their friends and despoiling their enemies. We will get graft and corruption and cronyism. Great, so we've replaced tragedy-of-the-commons with theft. Thank you, Dr. Krugman!

In fact, it is more ironic and pathetic than that: Krugman has merely replaced one commons (with its attendant tragedies/externalities) with another! The air we breath is one commons, that is clear. But government is also a commons. The whole problem with government is that politicians can act with others' money, creating a moral hazard (lack of personal incentives for responsibility) in which they will not use the money carefully or responsibly, because it is not their own. In other words, in the eyes of the politicians, the government's money is a commons.

Meanwhile, the politicians themselves are a commons from the perspective of the voters: the entire government affects every citizen whether he wants it to or not, but he does not own the government, and he is bound not only by his own electoral decisions, but also those of his neighbors. Just as the air I breath is polluted not only by myself but also by others (and so one has either the ability or the proclivity to fix the problem, because someone else will go off and ruin all your hard work), so too government. This tragedy of the commons reduces incentives (moral hazard): why should I do my best to keep air clean, with onerous labor, when someone else will sully it anyway? So we get a race to the bottom, or, in game theory, a prisoner's dilemma and the voter's paradox.[2]

So again, we have two commons: the money is a commons to the politicians, and the politicians are a commons to the people. So in trying to solve one commons (polluted air), you created two in its place!

Krugman has learned about externalities and the tragedy of the commons, and he is so giddy to apply his new knowledge, and advocate government intervention, that he has failed to heed Frederic Bastiat's lesson, in "That Which is Seen, and that Which is Not Seen", that "Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee." Government can eliminate the commons that is the air we breath: that is seen. But exactly such a government intervention, introduces new commons just as morally hazardous as the one just eliminated: that is what is unseen. Krugman would do well to learn Bastiat.

Secondly, as for the tax-rate: how, just how, will you set the rate for the tax on air pollution? How do you price clean air? In a free-market, economic calculation is possible, because consumers demonstrate their subjective values by paying prices. A consumer will pay only that price which does not exceed his own personal subjective value for that commodity. Thus, for example, if a consumer wants clean air in his own home, he will spend money on an air filtration system, but only if the cost of the system is less than his desire for clean air. But in an un-free market, this is impossible. The government has no way of knowing how much consumers value clean air, so it has no way of knowing how to set the rate for the tax on pollution. Is the pollution of a given coal-burning power plant worth $1 million to the consumer? $1 trillion? Only a penny? The government has no way of knowing. Thus, in a socialistic system, the entire economy shuts down, as all prices, as set by the government, become entirely arbitrary, as Austrian School economist Ludwig von Mises shows in his book, Socialism, which predicted the collapse of the Soviet Union decades before it occurred (originally published in German in 1922, in English in 1936), while everyone else was proclaiming socialism as the wave of the future.[3] By contrast, Krugman has not yet learned about the marginal revolution of Austrian School economist Carl Menger (as well as others simultaneously, namely William Stanley Jevons and Marie-Esprit-Léon Walras), which showed that all value is subjective, and that it is therefore impossible for the government to calculate economic value. According to the marginal theory of value, all government intervention into the economy is fruitless and destructive. The marginal theory of value is a subject of undergraduate economics, but apparently, Krugman has not yet reached that part of the curriculum.

In short: Krugman has learned well about market failure, but he has not yet reached the part of the curriculum where one learns that every attempt to solve market failure, merely introduces a government failure every bit as - if not more - disastrous as the market failure it attempted to solve. It is like trying to eradicate one invasive species with another. Krugman errs in stating that his opponents deny the reality of externalities and market failures. No, that would be like saying they deny the existence of foreign, invasive species. It is only that unlike Krugman, they realize that government failure, introducing a second invasive species to eliminate the first, is hardly a suitable solution to an admittedly very real problem.

But okay, I have pointed out Krugman's flaws, and showed that his solution is none at all. But do I have an alternative? Well, notice: the tragedy of the commons is solved by eliminating commons, by privatizing them. What worked for the farmland of England, works for everything else. The solution is more private property rights and more privatization. If commons are exploited, and externalities result, due to moral hazard, then privatization, by incentivizing responsibility and long-term planning, solves the tragedy of the commons. I confess, I do not know how to privatize air, but the point is, privatization is the only solution. It may not work in every case, but there is no alternative.

[1] The tragedy of the commons, is the observation that publicly-owned grazing land is overgrazed, because no one farmer has an interest in preserving the value of the land. He realizes that even if he takes care to preserve the land and avoid overgrazing, his fellows will not do so. Likewise, if one coal-burning plant stops polluting, the rest will keep on polluting. However, the tragedy of the commons observed, as soon as grazing land was fenced, i.e. de-commonized and instead privatized, the tragedy ceased. When someone has his own private property, for which he alone is responsible, and of which he alone eats the fruits, he guards it more carefully. If everyone had his own private air supply, no one would pollute the air. (return)

[2] In the prisoner's dilemma, two prisoners cannot communicate, and both are offered the choice of either being silent or ratting out the other. If both are silent, both do relatively well, say +5. If one is silent and the other rats him out, then the silent one loses immensely, say -10, and the ratter-out gains immensely, say +10. If both rat each other out, both lose a little bit, say -5. Now, logically, they both ought to be silent, and each get +5, right? The problem is, they cannot communicate! Each one, fearing the other will rat, himself rats, so they both get -5. After all, if you don't rat, he will. So the problem is essentially the same as the tragedy of the commons. But just as the tragedy of the commons is solved by privatizing land, so that it is not common anymore, so too, the prisoner's dilemma is solved by restoring communication between the two prisoners, so that they can cooperate. As for the voter's paradox, that states that voters will not have an incentive to vote wisely, because for all the effort it takes to learn the issues at stake, you get only one paltry vote. Should you spend 10 hours every day, for years on end, learning politics, just so you can contribute one vote? Of course not. You will instead have "rational ignorance". But if your vote were to affect you and only you, meaning your vote would be one vote out of one vote, instead of one vote out of millions, then you would indeed take the time to learn. Again, it is a tragedy of the commons. (return)

[3] Mises's friend, Historical School economic Max Weber, also conceived of his same problem of economic calculation, and likewise doubted socialism for the same reason as Mises. Weber was an odd fellow: his own Historical School was pro-government and pro-bureaucracy, the opposite of Mises's own Austrian School, but Weber himself was a methodological individualist, recognizing - as the Austrian theory of praxeology, "human action" does too - that as an objective fact, all of society comes down to individuals. Weber was anti-liberty, but he still knew that economic science comes down to individuals, not collectives and aggregates. (return)

6 comments:

Larry Lennhoff said...

So the solution is to accept the lesser failure, and just allow the economic externalities free rein? Because by definition any attempt to solve them will be worse?

Mikewind Dale (Michael Makovi) said...

Bingo!

But notice: the tragedy of the commons is solved by eliminating commons, by privatizing them. What worked for the farmland of England, works for everything else. The solution is more private property rights and more privatization.

I confess, I do not know how to privatize air, but the point is, privatization is the only solution. It may not work in every case, but there is no alternative.

Ioana said...

No comment.

Andrew said...

"every attempt to solve market failure, merely introduces a government failure every bit as - if not more - disastrous as the market failure it attempted to solve."

You have not proven by any stretch of the imagination that the negative factors of corrupt politicking involving pollution taxes are worse for society than pollution. Just saying it does not make it so, and given that this is the crux of your entire argument, you might want to try putting this into numbers, just as the study Krugman cites does.

Anonymous said...

"What worked for the farmland of England, works for everything else. The solution is more private property rights and more privatization.

I confess, I do not know how to privatize air"

It appears your latter statement contradicts the former. Privatization is not the answer for every common good.

Anonymous said...

So the crux of your argument is to solve the tragedy of the commons through privatization. Now, the commons I this particular instance is ... Air!

You "confess" you don't know how to privatize air, but wait, that's because it can't be done! Some things have to be commonwe have to figure out a way to treat it as ... Oh no--something other than a commodity. To preach religiously of the infallibility of privatization and then admit that in this particular case it is logically impossible is to also "confess" to not being intellectually thorough; to being careless; to devoting yourself to a flawed philosophy.

If people like you weren't being so recklessly irresponsible with your fundamentally flawed fundamentalism, maybe we could be more constructive in solving the human health impacts of bad air. Let alone the imminent anthropogenic sixth global mass extinction of Earth.

Or we can all live in privatized mini bio domes with clean air, isolation, nostalgia, and private guards protecting the gates against against poor peasants who couldn't afford clean air and who have been mercilessly relegated to the miserable and inhospitable commons.

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