What’s the “MIT” approach to economics, and what’s wrong with it? Is economics a hard science? What is an economic model? What are some of the problems with thinking of the world this way?
Arnold Kling claims that the economy isn’t like one big machine with a single purpose that can be fine tuned and regulated by experts. In this week’s episode, he presents an alternate way of thinking about economics, one you won’t find being taught in most college classrooms.
Show Notes and Further Reading
Kling’s new book, Specialization and Trade: A Re-introduction to Economics is available in paperback and as a free .pdf, Kindle, or .epub file.
Kling and Burrus mention one of our recent Free Thoughts episodes with Thomas Leonard on his book, Illiberal Reformers: Race, Eugenics, and American Economics in the Progressive Era.
Aaron Ross Powell: Welcome to Free Thoughts from Libertarianism.org and the Cato Institute. I’m Aaron Powell.
Trevor Burrus: And I’m Trevor Burrus.
Aaron Ross Powell: Joining us today is Arnold Kling. He’s the author of Specialization and Trade: A Reintroduction to Economics, the new book from Libertarianism.org and the Cato Institute. Given how much the field of economics has been covered, how many introductory texts there are out there, why do we need a reintroduction?
Arnold Kling: Because I’m afraid that economists have not done enough with specialization and trade. Even if you take an economics course, what you get is a picture of bilateral exchange, so the classic example Ricardo where one country – the whole country produces cloth and a whole other country produces wine and they trade with each other.
But that’s really not the way it works in the real world. It’s not bilateral exchange. It’s one worker performing a very narrow set of tasks and then exchanging that for goods and services that are produced by millions and millions of different specialized jobs, by millions of workers throughout the world.
That really changes the way or ought to change the way we think about really how society is organized, why we have markets, why we have a financial sector, why we have a government – or maybe not why we have our government but what a role government can play and how it would sometimes misplay that role.
Trevor Burrus: So would you say that in some sense, or at least reductive sense, that this is a problem of oversimplification, that we’ve been learning economics and maybe looking at too many discreet, small units, when actually we need to start thinking about huge systems that are ecological more than …
Arnold Kling: Yeah, the economic approach has been so focused on modeling and mathematical modeling that it has produced oversimplification. So when we later get to the topic of how macroeconomists think about things, they think about the entire economy as a single GDP factory with a couple of simple inputs producing this homogeneous GDP output and if that is not an accurate description of the economy, which it’s not, and it misses a lot, then that whole field is misguided and similarly, even microeconomists, because they’re so focused on getting things down to a few equations, are representing a misleading picture of the economy.
Aaron Ross Powell: The book is written as an argument against and a response to what you call the MIT approach, which is where you got your PhD. So what is that MIT approach and what’s wrong with it?
Arnold Kling: So it starts right during World War Two and if you think of what the economic problem that the countries fighting World War Two faced, they had some key resources like steel, rubber, petroleum and they had to allocate them to different military goods as it were, ships, planes, tanks and that is what’s called a constrained optimization problem. They’re trying to optimize their ability to fight a war, that they’re constrained by their resources.
So MIT developed a lot of tools for that and they got very heavily funded particularly after the war and so they became a dominant department by looking at economic problems as constrained optimization problems. That is useful to some degree but ultimately leads to the kinds of oversimplification that troubled me and led me to write this book.
Trevor Burrus: So to clarify the constrained optimization issue, would this be – it’s also kind of a simplification but the conditions of war do that, that the actual “goals” of the country or the people become much more focused and much – as opposed to widespread. So you have different economics if you say – but there are only two things you want to do or there are only four things we want to do. Like we all want to do them. It changes. Is that kind of what you’re saying? It changes the economic situation if there are only four things you choose between. So let’s just defeat Germany or not. That’s very – optimizing the problem.
Arnold Kling: Another way to look at it is that the Soviet economy did reasonably well at stopping the Nazis just by building T-34 tanks. I mean just – that one product was sort of the key to stopping the Nazi invasion. When they get to the post-war period and the world gets more complex and we’re worried about how consumers can consume a lot of different goods and services and we’re not in a war time economy, all of a sudden we see that that economy is a failure, that that kind of central plan of the Soviet economy didn’t work.
Trevor Burrus: But it matters – the goals. I just wanted to clarify it because it seems there’s a – the constrained optimization is related to almost a Hayekian point that – like the nation is generally not for one thing. It doesn’t have one goal except for maybe in war time where it kind of seems like it’s for one thing. But in normal times, everyone has different goals, which make economics maybe more difficult or at least different.
Arnold Kling: Yeah, it’s more complex. So – you’re getting to the point that sort of MIT economics is war time economy economics which doesn’t apply as well when we’re thinking about an economy at peace time as it – as you say, people having different goals and different tastes.
Trevor Burrus: But maybe they supplanted GDP. It’s just like now the goal. We had …
Aaron Ross Powell: Instead of building tanks, we want to build GDP.
Trevor Burrus: Yeah. So we have a singular thing.
Arnold Kling: Yeah. So a lot of the project evolved into trying to aggregate all the multiple different tasks that people have and all the multiple different outputs into single things. So GDP became the output and they – we still talk about aggregate labor in input even though that ranges from doctors performing surgeries to people picking up trash to people doing dishes, to people flying planes. We just count that all as labor because of that sort of war time economy habit.
Aaron Ross Powell: So you are opposed to thinking of the economy as a machine. How does that fit in with the other idea that you’re arguing against which is seeing economics as a science?
Arnold Kling: Well, there are kind of two related views. One is that – so think of economics as engineering and that’s the sort of machine notion. So an engineer can build a model of a tank, write down some equations and probably improve the design of a tank.
But the economy is not that simple, not that straightforward engineer. That’s one point and then the point about science, I think there’s a – that maybe goes back further in that – the progressives. I just recently read Thomas Leonard’s book and …
Trevor Burrus: Who was a guest out on Free Thoughts earlier, so we can link that on the show notes.
Arnold Kling: Yeah. He points out that the progressives took the view that there would be something called policy science and that they would – it would be as – like any other science and there would be experts and they would be able to handle it.
Then economists sort of jumped in and said, “Oh, that’s us. We’re these experts.” I make a point that it’s not going to be a science like a physical science for a variety of reasons, one of which is that there are many causal factors at work and that you can’t sort them out and you can’t run controlled experiments. So a lot of the scientific methods don’t apply and so really what that point, the claim of science, really becomes a claim of status. It’s a claim of expertise that isn’t really backed by the type of knowledge that – and the type of process for demonstrating knowledge that scientists actually have.
Aaron Ross Powell: Does this mean that economics is not a science in the sense that it can’t attain the level of precision or predictive ability that we might see in say physics, which is that – you know, or a typical science or does it mean that it’s even further than that and that it’s actually more like a pseudoscience?
Arnold Kling: I guess I would say that it’s further away from being a science. I would say that it’s a discipline but not a science. So history is a discipline but no one is going to say that they found a science of history – or people who have made that claim tend to look silly saying oh, every 50 years, this happens or revolutions always follow this pattern.
You’re going to find exceptions to that and so there are no – no one talks about equations that can govern history yet economists throw around equations all the time as if they were – as if they actually were doing that. So I think it’s better to think of it as analogous to history than analogous to physics or maybe even analogous to playing the violin. It’s a discipline. People who have studied it probably have better intuition and better skill at it than people who don’t. But it is not a – something where you have proven knowledge and reliable knowledge.
Trevor Burrus: I think that the – one figure that we should bring up just because he is important in the entire 20th century discussion, but Paul Samuelson you talk about as part of the sort of MIT thing. But in his influence, who was he and why was he so influential?
Arnold Kling: Well, he sort of literally began the MIT graduate program. I think the story is that he was this wonder kind, the young economist that everyone thought was amazing. His PhD dissertation was called modestly foundations of economic analysis and it basically presented the view that you could look at everything as a constrained optimization problem and repeatedly because of anti-Semitism, he wasn’t hired at Harvard. So he goes down the – or wasn’t given a tenure type position at Harvard. So he goes down the road to MIT and ends up recruiting other top economists and builds the MIT department into the leading economics department.
So as of – around 1950, he had these foundations of economic analysis which every professional economist had to read. He had the leading textbook in economics and he had – was on his way to building a leading department in economics.
Aaron Ross Powell: This is a bit of an aside but it’s – I think it’s interesting and maybe not what our audience thinks about the way that academic disciplines work. But this story of Paul Samuelson and creating the MIT economics program and then the influence that has had. How common is this sort of thing that you have, what we think of – you know, people – lots of economists across the country would say this is just what economics is.
But the story that you’re telling is this was an extremely contingent – like you have one guy who creates one program and that program is among the top and there’s not that many top programs in the country. The top people tend to go to the top programs, which is this very small community. They’re all being kind of influenced by a core set of mentors. Is that story influential broadly? Is that how things tend to work? Because if it is, it seems to cut against the notion that like these broad academic disciplines are just the truth or the embodiment of knowledge.
Arnold Kling: Well, I can’t speak for all disciplines. I think it may have held in economics more than others. But I caught the Genghis Khan factor that – you know, so many people are descended from Genghis Khan and when – the way that can work and sometimes economics is – I think in general, PhD programs – that the top PhD programs product most of the people who then go into academics. So it’s certainly in economics. If you’re not at one of the top 10 or 15 programs, your chances of getting a high level academic job are nil and the chance of getting an academic job at all are not all that great.
So it’s possible for just a few departments to be the source for most of the PhDs of our generation. Then once that happens – so let’s say MIT sends out the top macroeconomists in the late 1960s. Well by the 1970s, those people are now – permeate the top 15 departments and so nobody is going to come out of any of the top 15 departments with a view of the world that’s different from MIT’s.
Trevor Burrus: When we start trying to crack this nut, as we said, the MIT nut for the shorthand and the – get inside this machine, this metaphor problematic and economics as a science. It seems that you on one level revisit Adam Smith and sort of basic observations. But I mean how do we start I guess getting inside of the – or conceptually thinking about it in the right way. Where do we begin?
Arnold Kling: Well, the argument I’m making in this book is to focus on specialization and trade and in particular again to not treat it as bilateral exchange, but to pay attention to the fact that it’s – you’re doing a few jobs. What you produce is nothing you could consume. Most of us produce intermediate goods and services or things that are intangible, not things that we can put in our mouth or wear on our bodies or put over ourselves.
Meanwhile almost anything that we use requires millions of tasks we’ve performed and some of those tasks were performed years ago as people dug mines or built factories.
Trevor Burrus: And this gets us to important implications about many other things in the economy. We start there.
Arnold Kling: Yeah. I think if you start there, then you start to understand for instance why you need a market. You don’t need a market for me to exchange bananas for coconuts with you. But if we’re going to have these millions of tasks performed just to get me a bowl of cereal in the morning, then we need – that’s a difficult thing to coordinate. We have to think about how can we coordinate that and that’s where markets come in and that’s where prices come in and profits come in.
Trevor Burrus: But it’s interesting. One of my favorite lines, when you get – was getting into why we need a market and what markets are capable, you’re very good at comparing politics and markets in the real sense and as you write at one point, you say entrepreneurs are often mistaken and new businesses often fail. By the same token, economists and policy makers are also capable of making errors.
What we should be comparing is not the existing market configuration with an ideal based on a simple model, but the market process of error correction with the political process of error correction. Can you expand on that a little bit?
Arnold Kling: Yes, the – in – when there’s a – we observe a problem and people want to come up with solutions. I sometimes say that there are kind of three steps. There’s sort of experimentation, evaluation, and evolution. So first, somebody needs to experiment with the solution. You don’t automatically know the solution is going to work and then you have to evaluate and say whether it has worked and then ultimately the evolution means that you keep the things that work and throw out things that don’t.
So when you’re comparing markets and government, I’m saying that you should compare them in terms of how they implement these processes of experimentation, evaluation and evolution. The market’s process for experimentation is that start-up and there will be more experiments if you have more smaller start-ups. Large organizations, whether they’re corporations or government, have very limited capacity to undertake experiments. It’s just for a variety of reasons that I get into in the book and – so markets have the advantage there. When it comes to evaluating, the market evaluates them very straightforwardly on profit and loss.
So if something loses money, it didn’t work. It didn’t solve the problem. Something makes money, it did. With government, in principle, people could evaluate cost and benefits. But that often doesn’t get done and then finally evolution, when something doesn’t make a profit, the business goes away. When it does, the business makes a profit, the business stays or expands. So the evolution process works naturally. With government programs, it’s – rarely does a government program get cut because it fails.
So even if government programs were to fail less than markets, the evolutionary process would still be working better in markets because the government does a poor job of determining things that they have found not to work.
Aaron Ross Powell: One of the arguments that – when people are criticizing this, we should let markets experiment and figure things out versus have the government totally plan or at least more plan, is that yes, markets can experiment and yes, start-ups can try to solve problems. But maybe the kinds of problems that they try to solve – because say they’re – their motivation is to make a buck. When you’re starting your business, you see an opportunity to make money, not necessarily an opportunity to improve the state of the world or help people. So we can chase frivolous things or …
Trevor Burrus: Like Pet Rocks, you mean?
Aaron Ross Powell: Like Pet Rocks or cosmetic over more important health-based medicine or …
Trevor Burrus: Bad food over good food.
Aaron Ross Powell: Bad food over good food and so we end up with a lot of action in areas that don’t necessarily help whereas the state can say – you know, looking down, like this is what people really need and this is what would really help them. So we’re going to either push in that direction or at the very least subsidize, like green energy.
Arnold Kling: To be able to say something like that, you have to say that that there are experts who know better than sort of the weighted average of consumer preferences, what people should be doing. So on something like smoking, you could maybe make an argument that if people make their individual decisions on smoking, they will make mistakes, government should come in and do something.
But I think for the vast majority of things, you want to say – you want to respect people’s preferences and once you do that, then you’re back to letting entrepreneurs decide how to satisfy those preferences.
Trevor Burrus: That might be a lot of the game because a lot of people just simply don’t want to respect other people’s preferences it seems like or you have the behavior economics thing which tries to tell you that your preferences are actually different than what they seem to be.
Arnold Kling: Yeah. One of my lines is – not in the book but that I use is that it’s easy to have fear of other’s liberty or fool and I think to the extent that the people accept reductions in liberty. It’s not because they want – they say, oh, you need to restrain me. It’s the – you need to restrain this other person and that’s kind of the trap that I think leads us to sort of more regulation than I think is right.
Aaron Ross Powell: So maybe this is backtracking a little bit. But we had mentioned economics models and one of the interesting parts of the book is where you talk about what’s wrong. Not necessarily specifically with the model of the economy as an engine but with thinking that we can model the economy in the first place. So I was wondering. Can you tell us what it means to have – what economic model really means in the first place and then what are some of the problems with thinking that way?
Arnold Kling: Wow. OK. So an economic model as done consists of trying to represent a – some aspect of the economy as – actually, let me backtrack. Let me give a – a standard economic model as an example is one that’s used micro, macro, everywhere. It’s the so-called production function and they will write down an equation. Y is a function of K and L.
What they’re saying is that you get output depending on the amount of capital and labor that you put in. So that’s an example of a model. It’s an example of a model that fails tremendously to explain things and that the most famous result about it – you know, it’s supposed to say that you can explain labor productivity in two different places or across time by different amounts of this K factor, capital. What they consistently find is it doesn’t explain very much and so the – and what it doesn’t explain is called the residual and there’s a whole industry of talking about this residual and they call it a total factor productivity.
They talk about the change in total factor productivity. So they’re basically saying – based on what this model doesn’t explain, let’s describe how our economy is performing. It’s kind of bizarre.
Trevor Burrus: So what do economists do or economists – or the kind of type you’re criticizing or commenting on? What do they do in the face of model failure? Because you compare it to Kuhnian, kind of, paradigm stuff. Because when the model fails, they don’t throw it out.
Arnold Kling: Yes. But that’s largely because models hold other things equal. So when you see that you’re – the capital ratio isn’t explaining productivity differences, you all of a sudden can think of hundreds of reasons why it might not. Oh gee, maybe that labor isn’t really homogeneous labor after all. Maybe it’s that these workers are more educated. Maybe the organization of the economy matters. So the institutions matter. Maybe innovation makes a difference. You could have a certain amount of capital in 1800 and it’s not – doesn’t produce as much as it would be in 2000.
So the models hold other things equal. Other things are never equal and so you always have the opportunity to assert that the model is actually correct. It’s just that there was this other weird factor that came in and messed things up.
Trevor Burrus: Which gives economists an out it seems from being predictably wrong at least.
Arnold Kling: And it also makes it very difficult to settle arguments because often you will – you will have one side say up. I’ve got this one fact and that refutes your model. But you take an asymmetric approach and someone says, “Well, I’ve got this fact that refutes your model.” You say, “Oh, no, wait a minute. That’s a violation of the other things equal. That’s just an exception. It doesn’t refute the model.” So you can have people with very different viewpoints quite convinced that they’re right and that the other people are being dogmatic.
Trevor Burrus: So is there a – and this may not be totally related. But you mentioned the Akerlof paper at one point, which is not exactly a model but the difficulties of – is it that Akerlof – and I would like you – if you can then fill in what the things are. But is he doing economics wrong when he did his famous lemon paper and then wasn’t actually looking at the way specialization can work and solve their problems or maybe we can use the lemon paper to talk about different approaches to the used car market?
Arnold Kling: OK. So the lemon paper, Akerlof says that suppose that most of the people who are trying to get rid of cars in the used car market are trying to get rid of them because they know that there’s something wrong with it, that’s hard for buyers to see. Well, if buyers adjust to that, they will pay very low prices for used cars and if you happen to have a good car that you want to sell, you know that you can’t get a good price. So it ends up being a market for lemons. That is the only people who will put used cars up are these people who have the bad car.
Again that’s a great – it’s a great story but it holds other things equal. So it assumes that there’s nobody out there who can inspect cars and actually tell you when you have a lemon and when you don’t, that there’s nobody who’s tracking cars like Carfax does or that – and there is no one who can come in and offer a guarantee about a car, a used car.
So in the real world, there are all these solutions that the market comes up with. But if you just stick to the model, it looks like, oh, this is a – the market is going to fail unless the government comes in and does something.
Trevor Burrus: Yeah, and the weird thing about that paper, when I first read it, was that – I mean it’s not – he asserts that these things – and it kind – these can exist – what the used car market is going to be like. But he doesn’t like open up a window and look outside and see, oh, look, there are used car dealers. I wonder what they’re doing. He does it in a really a priori sense and it’s like incredibly frustrating. Now if you actually know that George Akerlof is in the – which is basically criticizing markets and people in market – his Fishing for Fools book, which is – just things that they fail all the time and experts need to fix it. He seems to be paradigmatic of what you’re talking about in many ways.
Arnold Kling: Yeah.
Trevor Burrus: Yeah.
Aaron Ross Powell: Is there still a value to this kind of thinking? So like these models, like the used car market model, is it just completely worthless or is it that there is a value there but we’re construing it too broadly or misapplying it?
Arnold Kling: Probably there is a value, but I think it – often the value could better be exploited by entrepreneurs. So Hal Varian notices that Google’s situation with relying on advertising is a two-sided – could be a two-sided auction market. He – they work out this two-sided auction thing and Google is successful. That’s fine. But when you say based on my model, this market can’t possibly work and we need to have a government regulation. You’re ignoring the possibility that somebody out there could come up with an entrepreneurial solution.
Aaron Ross Powell: So we’ve got the one model. Let’s look at this in real world terms. We’ve got the one framework for interpretation as you call them of the economy is the machine and when we say get bust – boom and bust cycles, like aggregate demand drops and so what we need to do is step on the gas by increasing aggregate demand and that will boost the economy back up.
Then we’ve got your story which is this pattern of sustained specialization and trade. So how does your story say explain something like a – the housing bust or financial booms and busts?
Arnold Kling: So there are several questions embedded in that. In the book, when I talk about the financial sector, I talk about how it’s necessarily opaque. So people after the financial crisis said, “Oh, we need more transparency in the financial sector.” Actually, once you have complete transparency, you don’t have a financial sector. If people can see through the bank and say, “Oh, I know exactly what those assets are,” then they can just buy those assets directly themselves. They don’t need a bank.
So there’s necessarily some opacity in the financial sector and because of that, it tends to rise and fall based on confidence. There’s just necessarily – when people believe that banks are sound, that they know what they’re doing, they’re going to put more of their money in the bank and it’s more complex than that because the financial sector is more complex than that. But that does make it subject to booms and busts as people get confident and then they become overconfident and then maybe all of a sudden, they found oh, whoa, maybe I shouldn’t have been that confident.
So that’s sort of my story of the financial sector and how it’s subject to booms and bust and then because it’s embedded in so many patterns of specialization, trade and economy as a whole, it’s plausible that those booms and busts kind of reverberate elsewhere.
Trevor Burrus: One of the things you point out too, I just want to clarify, which I think is a brilliant observation the way you put it is that the existence of the financial sector is itself a product of the mass specialization and attenuation from product essentially. It’s almost a necessary core. They have to exist together.
Arnold Kling: Yeah. If you think of a farmer having to – they’re going to plant a crop next year and so this year, they’re going to need to borrow money for seeds. They might borrow money for equipment and so on. The equipment supplier needs to be paid today. The farmer is not going to have the money until a year from now. He needs some kind of financial intermediary to deal with that.
Trevor Burrus: And then – so the interaction, going back to Aaron’s question, which when you have stalls or this lack of a gas pedal in Keynesian, whatever, it looks – to you, it looks more like what?
Arnold Kling: To me it looks like maybe a combination of a couple of things. But the main underlying thing is structural change in the economy, what Joseph Schumpeter called “creative destruction”. So if you look – if you take a long term view of the American economy, sort of male, low skilled workers have been having lower rates of employment and lower relative wages for 40 years. The percentage of workers doing production line manufacturing has gone from maybe 25 percent at the end of World War Two to less than five percent today.
So you have this ongoing structural change. We know the factors involved, shifting from manufacturing to services, the global competition automation. We know all these factors at work.
Overlaying these is this long term trend – overlaying this long term trend are these sort of financial euphoria and phases of pessimism and when you put those together, the path of getting from a – we’ve gone to a much higher share of women in the labor force relative to men. The path of getting there gets sort of bumped up and down by these financial swings.
Aaron Ross Powell: So if these changes in the economy then are – we had one sustainable pattern and that enabled the economy to function in a certain way for a while and then things happened either abruptly or over time to make that pattern no longer sustainable. So now we need to – the hard times when we were trying to figure out the new sustainable pattern. What does that say about say the movements that we see in the world right now of – there are Trump supporters who are kind of the economic nationalism and the nationalism nationalism and you see a bit of it in the arguments for England leaving the EU, that – is this – in that story, does this basically mean that what they’re trying to do is – we don’t like the new pattern because it’s hard on us.
So what we would like to do is somehow reverse those trends and move back to the prior sustainable pattern. Is that even possible?
Arnold Kling: Yeah. So we’re all natural born hypocrites when it comes to competition. So – and the explanation again goes back to the way specialization trade works. You only do a few tasks and you consume things based on millions of tasks. So let’s say something new comes along. Elon Musk says we’re going to try to sell Tesla cars directly to consumers and get rid of dealers.
So as a consumer, you read that newspaper. You say, “Hey, that’s interesting. It might be cheaper to buy a car direct. That looks interesting,” and you put it down.
The auto dealer picks up that and says, “All right. I’m calling my congressman. That is not happening. We’re not getting rid of dealers.” So there are white collar professionals who are generally protected from disruption. You’re not going to find accountants suddenly deluged with lots of people who don’t have CPAs competing for their jobs.
Blue collar workers have not been protected in that way and so in England if they perceive that part of their problem is they’ve been deluged by workers from Poland and Hungary, they may have a desire to lash out. So I think there is some possible relevance to that politics.
Trevor Burrus: So if we take these professionalized economists with this one way of looking at the world, the machine metaphor and everything we’ve discussed and we have given a bunch of Nobel Prizes and we put them in positions of government, and we ask them to tell us how to do things and they look at markets as failing, and we have the market failure discussions and these GDP pump priming discussions, it seems like we’re creating a snowball effect of a way of – is it pretty much always bad when they’re probably pushing these pumps?
They’re always looking at the wrong way of looking at this because they’re living in a kind of group thing paradigm or are you just constantly skeptical of their solutions for things that are going – how to fix the economy from the top down or from the Fed for example?
Arnold Kling: Yes. I’m completely skeptical.
Trevor Burrus: And therefore – I mean but the question is I guess that people always ask me too is like so is the solution to do nothing – because you think government should be doing things and you think libertarians take it too far. So on one side, it sounds like you would be saying, oh, well then, fire all the economists. First thing we do, kill all the lawyers.
Trevor Burrus: Let the prices run everything and we won’t even have economists do anything except for writing interesting papers about pirates and economic history or something.
Arnold Kling: Yeah, I guess the key is to try to calibrate sort of knowledge and power, something I’ve talked about before, that the problem is the economists believe they know things that they actually don’t know. So they can step in and make errors based on that. One example I will throw out is that a lot of economists, when the housing market crashed, said, “Oh, the solution is to write down people’s mortgages. We’ve got to have this …”
Then their programs came out like this called HARP and HAMP to try to – you know, mortgage relief was the solution and as someone who had worked in the industry, I could tell right away that it wasn’t going to work, that in many ways, you were setting these people up to fail again and that it was a misfit relative to the institutional arrangements.
They’re confusing the seller of a mortgage with a servicer of a mortgage. These are items in the appendix of the book. But it was just clearly going to fail and it did fail. But that’s a case of where you’re sitting down and you’re writing a model and the model says you should do this and it just doesn’t apply in the real world and that’s I think a constant danger.
The other danger is that they mischaracterize the way government works. So they think that government is going to deal with market failures and when you look at market failures, what you typically want to do is you either want to increase the quantity of the good if it’s – if there’s this positive externality, as it’s so called, or you want to decrease it if it’s a negative externality. So if you think vaccines are good, you want to have more people vaccinated.
If you think that pollution is bad, you want to have less things that cause pollution. But the actual public choice, the way government goes about making policies, they don’t – they do what I call the “subsidize demand and restrict supply,” so that doesn’t necessarily raise or lower the quantity. It definitely raises the price. It raises the cost to consumers.
Again that goes back to concentrated interest workings. So if you think that auto dealers are – that not allowing Elon Musk to sell directly to consumer, it’s a restriction of supply. That’s not regulating him and saying he can’t do that. It’s not solving the market failure but it fits in perfectly with the public choice theory, which is government is going to attempt to restrict supply and stimulate demand.
Aaron Ross Powell: So then given that and given those problems in I guess making good policy, what’s wrong with the take it to the extreme libertarian position of like anarcho-capitalism and say, OK, so if government is going to do all these things and the people who are running it have these wrong ideas about how the economy works, then what we do is scrap the whole thing and let purely emergent processes figure out the correct patterns?
Arnold Kling: My reason for being skeptical at that goes to the fact that this really complex pattern of specialization and trade requires a tremendous amount of trust. The example I use in the book – because I’ve just done it. I had ordered some biking gloves from Amazon – one of Amazon’s sellers over the internet and you think about all the trust that’s involved and then believing that I’m going to pay them and then me believing that the gloves are going to be what I ordered and that they will be delivered and they won’t be taken off my doorstep.
I think that ultimately all these layers of trust work better if people are really confident that people who violate that trust are going to be punished. I think that’s kind of the purpose in a lot of people’s minds of government, that they know – if nothing else, there’s this government there that’s going to punish people who violate trust. I think it’s not as simple to eliminate that as the sort of libertarian model as it were thinks.
Aaron Ross Powell: Well, you give the example of the – how the market can punish breach of trust in the sense that you talk about how important reputation is and a violation – if your reputation declines, that’s basically because of a breach of trust of some kind. So wouldn’t that model work? Like if – yes, someone might steal your gloves or yes, the seller might keep your money and never ship them in the first place. But then you’re not going to do business with them again and you will tell your friends not to.
Arnold Kling: Yeah. So there’s some protection of sellers but the question is, is that – first of all, is that sufficient in people’s minds? And second of all, is that workable in all instances? Sometimes somebody can take advantage of just a one-off transaction to rip people off and they don’t have to worry about their reputation or people could just, for whatever reason, fear that the reputational thing won’t work.
I think reputation is a key alternative and maybe the key market alternative. I suspect that it’s not sufficient to create the kind of trust that people need.
Another example that I think is difficult to solve from a libertarian perspective, if we live – we all live in cities that have sewage and water treatment. That’s very hard to negotiate collectively among individuals without somebody just putting their fist down and saying, look, this is the way it’s going to be. So government has that fist.
Trevor Burrus: Before we close out, I want to cover because you mentioned earlier macro, which we’ve alluded to in different ways. But one thing I sort of get from this is macroeconomists are doing some sort of weird type of formalistic voodoo, like just sort of looking at outputs. I mean is there any value in macro? For actual truth about the world and predictive capabilities.
Arnold Kling: I’m going to say no. That’s a radical position but the Keynesian view is just look at spending. Spending creates jobs. Jobs create spending and that view doesn’t make sense for many from a basic economics point of view.
Even not with the monetarist which makes – puts me sort of out of sync with a lot of libertarians. I don’t blame everything on the fed. I don’t think the fed has a magic bullet either. I think the fed or the central bank is just another bank. It would be absurd to talk about Citigroup controlling nominal GDP or employment. I think it’s absurd to think that the fed is doing that.
Again, that puts me at loggerheads with just about everybody including a lot of libertarians.
Aaron Ross Powell: Well then I will ask I guess fairly bluntly. If you’re so smart, why do all these people disagree with you? Or to put it a different way, if we had in the room the kind of – representative of the kind of economic thinking you’re arguing against, they would – what would they tell us about why they’re right and your story is wrong?
Arnold Kling: They would list all of the episodes in history that they think confirm their view. I would list episodes that I think disconfirm it and we would go back and forth and that’s the problem is we don’t have controlled experiments. We can’t say, all right, let’s take the US economy as it was in 2008 and let’s try these four alternative policies. Let’s do it not just once but let’s do it like 100 times the way a physicist would do it.
If we could do that, then we could settle these arguments. Meanwhile it’s just different people’s opinions and you – if you want to believe that consensus dominates regardless of whether there’s any solid proof, then you can believe that. I think that’s – I don’t think that’s sort of majority rules or consensus rules. It’s really equivalent to sort of scientific experiments and that sort of proof.
Aaron Ross Powell: Well then just to wrap up speaking of majority rules, we’re heading into a contentious presidential election. We’ve got lots of candidates saying lots of things. So for our listeners, who should pick up the book and read the whole thing, what do you see as – what’s your core lesson to – or the core message you hope that they would get heading into the election and the kinds of things that you wish people were thinking about going forward?
Arnold Kling: I guess the core lesson is to doubt that technocrats are in a position in terms of knowledge or in terms of being able to work with the political system to solve the problems that they claim they can solve and that the market process does a better job of the experimentation, evaluation and evolution that actually solves problems. Compare the two processes. The market process will tend to work better.
Aaron Ross Powell: Thank you for listening. If you enjoyed today’s show, please take a moment to rate us on iTunes. Free Thoughts is produced by Evan Banks and Mark McDaniel. To learn more, find us on the web at www.libertarianism.org.