Economists' Indifference, Straw Men, and the Costs of Regulating Inequality

Cite this Article
Joshua D. Wright, Economists' Indifference, Straw Men, and the Costs of Regulating Inequality, Truth on the Market (August 09, 2006),

I’ve been going back and forth with Frank Pasquale both at Madisonian and Jurisdynamics about economics, consumer welfare, the costs of inequality (and regulating it), and the ability of economics to provide useful insights where “social goods” are involved. At Jurisdynamics, Frank responds to my post on Apple’s business practices by asserting that my tunnel vision focus on consumer welfare ignores important justifications for government intervention like excessive vertical integration. While I argue that the economic literature universally accepts the notion that vertical integration, in most instances, is a procompetitive practice, Frank eloquently refuses to engage in the discussion on economic terms because those terms are not sufficiently “humanistic” (anecdotally citing this guy’s refusal to express his ideas in Rawlsian terms to a group of graduate students) and then levels this attack on economic analysis:

I have no doubt that the Chicago School of economic analysis has made fundamental contributions to our understanding of “brick and mortar” goods, coffee and coffemakers, M&M’s and toothpaste. But in the realm of culture, we need a richer, more humanistic analysis. We cannot simply try to maximize “consumer welfare.”

A simple example can show the fallacy here. Imagine two societies with two different record industries. In the first, a wealthy elite buys lots of music, and industry revenues are in the billions. In the second, very little is spent on music, but there are still thousands of songs created (say, via peer production). Does society 1 automatically “win out” as welfare maximizing? If the measure is so crude as to permit that possibility, what guidance can it give us?

I offer a rather long comment in response because I think Frank’s tactic is to dismantle a straw man version of economics, and in particular, the Chicago School. You can go to Jurisdynamics to check out comment, but my basic points are that: (1) Chicago School economics (and by that, don’t we really just mean applied price theory) is not limited to “brick and mortar goods” (this idea is just silly, and I’ve never heard it before); (2) does not ignore social interactions (see, e.g. Becker and Murphy’s important book on the topic); (3) use of the consumer welfare metric in antitrust analysis is supported by folks from just about every “school” of economics that you can think of.

He returns to this theme in his post at Madisonian where he writes:

What’s interesting to note here is the indifference of conventional economic models to different licensing policies that end up generating the same amount of revenues. If, say, permissions for books are roughly $100,000 per book, and 10 books per year are published, or they are $1,000 per book, and 1,000 books per year are published, that looks about the same economically. But it makes all the difference in the world to art history graduate students, who face almost impossible odds of getting published in the first world, and a much better chance of getting their ideas out in the second.

I have a comment (or two) up in response to this idea at Madisonian, where I note that this description of economics is unrealistic, unfair (see, we economists can too talk about fairness!), and inaccurate:

I don’t know what economic models you are talking about. But I suggest that most I.O. economists would ask the following question: what economic forces lead to these different market structures? Demand for certain types of books? Are the economies of scale? Scope? What does the demand for art history books look like? Of course, shame on me for returning to the willingness to pay metric, but I think it is quite useful. It may not capture everything you are looking for, but it is not because economists are indifferent to the two different market structures in your hypothetical. Consumer welfare does not measure everything, but it measures a lot of important information about what it is that consumers value. Perhaps consumers would be willing to accept higher prices and lower quality for an increase in some unnamed social value. But I dont know because I dont know what the unnamed social value is or how to assess these trade-offs (and we are talking about trade-offs, right?).

Frank’s critique of “conventional economic models” does not describe the economics I know, and Frank’s inaccurate portrayal of economics and economic thought is starting to get a bit old (see, e.g., Kate Litvak’s comment responding to Frank’s mischaracterization of TOTM commenters as having the view “of the market as a meritocracy: that the rules governing transactions are neutral and fair, everyone bargains at arm’s length, etc,” or his claim that economists do not recognize pecuniary externalities in this post (which also claims to identify a fundamental flaw in Hayek’s “The Use of Knowledge in Society” that has something to do with inelastic demand or buying power and perhaps both).

Note that I am not claiming that economics is capable of addressing all of the social concerns that Frank seems to believe justify intervention. To the contrary, I am quite sure it cannot (and believe it should not). But the claim that economics is indifferent to market structures is something that any undergraduate economics student knows is wrong. To the extent that a policy of maximizing social welfare (in the economic sense), or consumer welfare, carries an opportunity cost of decreasing “social justice” (let’s just call it that for now), that’s fine. We can talk about the trade-offs. But as J.B. Ruhl notes in his comment to Frank’s post at Jurisdynamics:

I need to know what we are getting in return before I can say whether the “costs of inequality” are, when all is taken into account, actually costs or benefits, and I need to know the effects of regulating some particular manifestation of the inequality before I know whether it produces a net gain or loss.

Exactly! And this is why it is so important that we confront the trade-offs head on rather than taking the straw man approach. The mistaken assertion that economics has nothing to say about different market structures, and the economic forces that get us there, might lead one to incorrectly conclude that the cost of regulating some “particular manifestation of the inequality” are zero in economic terms. I’m all for discussing the competitive consequences of regulatory efforts as agents re-optimize and respond to incentives. But keeping the discussion realistic will only improve our ability to make sound policy choices.