Vaughn’s ‘Economic Policy for an Imperfect World’

Summary                                                                                                                                                                                                                                    Although the title implies that the paper is going to be about specific policies advocated by Vaughn, this paper is not really about policy, or at least it is not the ‘meat’ to this paper (the closest thing that she says about policy is that she views the market as a default position). Rather it is about the flaw in deriving economic policies from neoclassical models, more specifically, models that contain general equilibrium and/or perfect competition because these simple models assume away some of the key characteristics of the market and imply that market imperfections are horrid. She implies that the models only answer why the market fails, but the neoclassical definition of market failure is flawed because to neoclassicals it means something that prevents the market to achieve the equilibrium state. Instead of answering why the market fails, she rather ask why the market works in the first place. That is to say, in a world with constant change, imperfect knowledge, different preferences, different expectations, etc. it is much more of a puzzle to figure out why markets work in the first place than to figure out why they fail. The odds tend towards failure but nevertheless the market still works. Or as Clower questions: how do we get so much order as we do knowing as little as we do?

Vaughn states further that market ‘imperfections’ are in fact in argument for the markets and not for government intervention. We all know that we all have different knowledge and when we engage in the marketplace, some of the knowledge is ‘shared’ but Vaughn goes much further than just using knowledge as a characteristic in the market. The fact that we are temporal beings implies that we live in a world of Knightian uncertainty, that is, we make plans but we do not know if they will be successful in the future. Which it follows that the market is a discovery process. But there is not an end point to this, it is a continuous process. Without the market, information would be even more ‘imperfect’ and there is not a reason to believe that government can mobilize more relevant knowledge than can market processes. Once we start to explain markets, rather than engineering them, we can ask better questions about events. Instead of asking when monopolies should be regulated, we can ask what role monopolies play in economic development, and what are the competitive forces that may or may not undercut long run monopoly. Instead of stigmatizing about differential and specialize information, we can ask not only how markets allow people to profit from and generating differential information, we can also ask what role concealing information plays in economic development. When we analyze events like this, equilibrium is useless.

She concludes that in thinking like this, old ways in thinking about policy are pointless. What is the point about talking about the rate of regulation if you admit that you do not know what the equilibrium rate should be? What is the point in antitrust when the consequences of monopoly are unpredictable? What point is there in outlawing collusive practices if talking to competitive rivals might be a good way in sharing information? Nevertheless, this is not a total argument for free markets,  for there are cases where it might be necessary for governments to intervene. Economic action takes places within a structure of property rights and contract and within legislation, and there needs to be more work on this. While there is already work on this with subjects like ‘Law and Economics’ and ‘Constitutional Economics,’ they primarily focus on incentives in a legal or constitutional regime but recognizing time and ignorance suggests another focus.

Key Points
1) Simple models (general equilibrium/perfect competition) serve as arguments for free markets AND government intervention. This is key because people like Joe Stiglitz like to always talk about how free market advocates always assume the basic models, but so does the other side, for example those same simple models also demonstrate that free markets are not sufficient in bring about equilibrium.

2) If market failure is defined as ‘something preventing the market to obtain equilibrium,’ then it is an illusion. Market ‘imperfections’ are not a failure of the market but rather it is the very thing that makes the market work in the first place.

3) One has to take in consideration that there is such thing  as government failure. That is to say, the inability of government to satisfy voters’ preferences. There are unintended consequences in the formation and execution of economic policy.

4) The economist who proposes policies to fix up the deficient world because of its failure to achieve perfect efficiency in perfect equilibrium is in many respects similar to the physicist who builds a model of a perfect vacuum and then judges the world inadequate because feathers don’t really fall as fast as lead balls when dropped from the leaning tower of Pisa. Of course the analogy would only be complete if the physicist would also join a commission to devise policy tools to eradicate the earth’s imperfect atmosphere. Obviously, physicists don’t do that because they realize that the simplified model of a perfect vacuum is not a normative description of what the world should look like, but a first approximation that helps them to understand the more complex phenomena of the real world. Friction is not a defect of the world. Friction is an integral part of a complex physical reality that enables us to walk around on the surface of the earth, among other useful things. Market ‘imperfections’ are also integral features in the social world.

5) It is much more puzzling to figure out why markets work in the first place than to show or describe why the market fails. How do we get so much order with knowing the little that we know?


2 responses to “Vaughn’s ‘Economic Policy for an Imperfect World’

    • Because to call something imperfect, like the market, implies that there is some state where it can be perfect. For example, the perfection in neoclassical models are 1) equilibrium and 2) perfect competition where you have the ‘optimum’ rate of competition where they are perfect in the sense that economic develop cannot go further to improve the system, prices= marginal costs, and economic profits are zero. But in reality, this state is impossible, even if the government attempted to achieve this state. There is no such thing as a ‘perfect’ market in this sense, thus to call the realities of the market ‘imperfect’ is pointless and seriously misleading.

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