Securities Mosaic is a fantastic resource for anyone working in the securities field. It provides comprehensive information in six key areas: disclosure, laws, rules, guidance, news, and compliance centers. In addition, the site features SM Blogwatch, which republishes posts from various securities-related blogs, including this one.
Yesterday, I was formally welcomed to the SM Blogwatch family by Peter Schwartz, a smart, swell guy. My welcome, although warm, included a few remarks that I just can’t let lie. The comments concern the Law and Economics “movement,” which we at TOTM purportedly represent.
I first take issue with the claim that the TOTM bloggers “preach[] from the pulpit of Law and Economics.” That comment suggests that we all believe that efficiency should be the goal of the law. Among folks who find economic analysis to be a useful tool for analyzing legal rules (and my guess is that all the TOTM bloggers would put themselves in that category), there’s a good deal of disagreement over whether efficiency should always be our goal. Personally, I embrace “positive L&E” (I think the common law is generally efficient and that economic analysis is a useful tool for analyzing legal rules), but I eschew “normative L&E,” which posits that efficiency is a sufficient condition for favoring a legal rule. I don’t know what my co-bloggers think about normative L&E, but I think a person “preach[ing] from the pulpit of Law and Economics” would have to place a higher value on efficiency than I personally am willing to do.
Now don’t get me wrong. I think positive L&E is incredibly useful, and, all else being equal, I’d always prefer the efficient rule over the inefficient one. I should therefore defend L&E against a couple of other slams in the SM Blogwatch welcome.
First, Peter contends that “[a]t its foundation, the Law and Economics movement has no framework for addressing the concept and reality of power.” I honestly don’t know what that means. If Peter’s claiming that L&E has nothing to say about market power, I’d suggest that he thumb through practically any contemporary antitrust treatise. Economic analysis has lots to say about how market power emerges, what problems it causes, the conditions under which it is self-correcting, and when government intervention is appropriate. If he’s talking about political power (i.e., the power to wield state-sanctioned coercion), I’d say that L&E folks — at least the market liberals among us — are highly attuned to the dangers such power poses and offer the best possible policy prescription for minimizing those dangers: laissez faire.
Peter goes on to criticize the “Law and Economics movement” for
inspir[ing] amongst its members an overpowering zeal and certitude (the Truth be Mine and it can be Thine) that often crosses the line into realms of faith, evangelism, and judgment (if you are not with me, you may also not be against me, but you are probably a liberal and so, by definition, not terribly bright, you poor unwashed soul).
With respect to the Austrian-inspired economic analysis that I personally find persuasive, that characterization is exactly backward.
A fundamental and profound insight of the Austrians (e.g., F.A. Hayek) was that the information necessary to determine how resources ought to be allocated to maximize social welfare is not given to anyone in its entirety. (See, e.g., here.) It is because I am so remarkably uncertain about how production and consumption decisions should be made that I advocate taking the maximally modest position: that which leaves resource allocation decisions to those closest to the action, most aware of their own preferences, etc.
As Josh has previously observed, those who (like Peter) criticize market liberalism for involving an unjustified “faith” have got things turned around. To quote Don Boudreaux once again:
Saying ‘Let the market handle it’ is to reject a one-size-fits-all, centralized rule of experts. It is to endorse an unfathomably complex arrangement for dealing with the issue at hand. Recommending the market over government intervention is to recognize that neither he who recommends the market nor anyone else possesses sufficient information and knowledge to determine, or even to foresee, what particular methods are best for dealing with the problem.
To recommend the market, in fact, is to recommend letting millions of creative people, each with different perspectives and different bits of knowledge and insights, each voluntarily contribute his own ideas and efforts toward dealing with the problem. It is to recommend not a single solution but, instead, a decentralized process that calls forth many competing experiments and, then, discovers the solutions that work best under the circumstances . . . .
While declaring ‘Let the government handle it’ comes across as a solution, it’s no such thing. Instead, it is merely a sign of a simple and baseless faith — a simple and baseless faith that people invested with power will not abuse it; that political appointees possess or will find better answers than will millions of people pursuing solutions in their own ways, and staking their own resources and reputations on their efforts; that only those ’solutions’ that are spelled out in statutes and regulations and that have officials paid to implement them are true solutions.
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Elizabeth, I don’t feel terrorized yet. I’ll tap out when I quit. Until then, you ask whether the definition of social welfare, or lets just say efficiency, necessarily involves a time horizon question that favors short term over long term costs and benefits. I am not sure why. And I have even “thought about it.” You are right to be concerned about such long term costs and benefits, i.e. you write that that one might predict longer term detriment that goes uncaptured by the L&E approach.
To take your insider trading example, I’m confused as to what it is in the L&E approach as you see it that requires ignoring the potential costs of allowing insider trading in terms of market exit? I was going to come up with a clever analogy to tie this to the Diner example, but … let’s just move on. Maybe we’ve just read a different literature on insider trading?
The bottom line: I don’t think the L&E approach suffers from would-be fatal methodological flaw that you suggest here. In fact, I’m sure of it. Let me assure you that economists are very much concerned with the trade-offs of costs versus benefits. Even those that occur in the future. Now, this does not mean that we don’t have to think about how to weigh these effects intertemporally. If I had the same view of L&E methods as you, I would get off the bus as well. But I don’t. Maybe (and this time it is me not trying to terrorize you) you should have stayed on the bus longer? There are still lots of seats.
Thanks, Josh. But what of the notion that that definition begs the question of “when”? That is to say, if the goal is to maximize social welfare, the obvious question is “when”? Some actions might maximize social welfare in the short term (this year, for example). But one could predict that those actions might, in the longer term, have a detrimental effect. How do you account for that longer-term, “softer” cost?
Insider trading comes to mind – it seems that some folks think that insider trading is fine, b/c it least to more efficient markets, which is good, in the short term. But what of the notion that some investors won’t stay in the market if there is a perception of unfairness – if the game is stacked, why bother investing (despite the fact that investors should know enough to know that they are in the market for the long haul, blah, blah, blah)? Perhaps the knee-jerk response is that the market will take care of that issue – the market will penalize the issuers who engage in insider trading to a degree that investors find unfair, as those investors will sell, and the issuer with the many insider traders will reform until it hits some equalibrium.
Well, that SOUNDS good, but I think that that is unrealistic. I think a perception that the stock market is littered with insider trading such that the little guy is always getting the short end of the stick will lead to a withdrawl from the market as a general matter, in addition to some issuer-specific withdrawl.
Think about it: If you read in the newspaper that Nowicki Diner served contaminated rice pudding last week that made five people vomit, and you read a few days later that Nowicki Diner served pork one night and THAT was contaminated, and you read later still that it is suspected that the Nowicki Diner’s meatloaf was tainted, are you *really* going to say to yourself “well, I have not yet seen an article about Nowicki Diner’s baked chicken breast, so why don’t I go to Nowicki’s for dinner and get the chicken breast?” NO, you are not going to say that. You are going to say “I have other options on where to eat, so I will go elsewhere.” One could imagine that perhaps that is how the long-term perception of rampant insider trading might impact the market. Investors might say “I can buy government securities, I can invest in real estate, I can buy CDs, I can invest in a small partnership as a silent partner, etc.” No? (I’m not trying to terrorize you, Josh. I am just trying to glean information from you. (I suppose I am also trying to explain why I stopped riding the L&E bus.))
Social welfare = the sum of consumer and producer surplus.
Thom, OUTSTANDING post. Good for you.
As a fairly regularly TOTM blogger, I would just state for the record that I am not an L&E person. I tried to be, bless my heart; I think taking economics (qua antitrust) with George Hay planted the L&E seed. (I am not saying that George is an L&E wonk, by the way.) But, at some point, I realized that L&E theory does not often play out in practice the way we would have anticipated. And I realized that sometimes the long-term sensible option is not necessarily the most “efficient” in terms of costs and benefits that we can measure today. So, though I still consider things from both the positive and normative L&E positions for purposes of informing my analysis, I have instead become a radical shareholder primacist.
Josh, should we all know what you mean as a technical matter, as a matter of measurement, when you say “maximize social welfare?” That is to say, can you reduce that to one descriptive sentence with which Thom and Don would likely accord?
It wouldn’t contradict the notion that econ analysis provides a useful tool for predicting the consequences of prospective choices.
For what it is worth, I read Peter’s comment regarding “overpowering zeal and certitude” as something like the following: “L&E folks believe, as an article of faith (I believe he used the word evangelism), that the market provides the best solution to maximize social welfare.” I did not read it to open a discussion as to whether social welfare is the appropriate objective function for policy-makers. This reading would be consistent with the common mantra of folks who “disfavor” L&E for whatever reason, and the mantra to which Thom, Boudreaux, and I were responding. I admit, it is hard to know what the sentence meant, exactly. To the extent that the “faith” of L&E types refers to the choice of policy to maximize social welfare, Thom’s response (and mine, and Boudreaux’s) seem spot on.
To the extent that the policy discussion involves a choice of maximand, one could certainly adopt the view that the social welfare function adopted by economists should be modified to “give priority” to the poor. However, even if one were to adopt this position, it is difficult to see how such a view contradicts the notion that economic analysis provides us useful tools for figuring out what the consequences of prospective policy choices will be.
Hi Thom,
Just some thoughts:
If the “overpowering zeal and certitude� of L& E folks, according to Peter, refers to their underlying moral view that the right policy/law is always the one that maximizes economic efficiency, then your response seems off the mark to me. The view you attribute to Hayek, and endorse, is that we cannot be certain as to what means of resource allocation would maximize social welfare, and thus the modest position to take is not to have government try to find the right means, but to let people act on their own preferences on the free market. But, at least on the way you’ve characterized Hayek here, the view already assumes that the proper goal is maximizing good consequences. The uncertainty to which you refer is about the means to the goal; but the “overpowering zeal� to which Peter (either correctly or incorrectly) refers seems to regard the choice of goal to begin with.
Now maybe I’m placing too much on your characterization of Hayek (and certainly, I realize this is a blog, not an article). Maybe Hayek’s view (which I cannot recall) is that we cannot be certain about the proper ends of morality – about the proper ends of law – and therefore the maximally modest view is to let the unregulated market settle all issues. If that’s the view you’re endorsing then I see that it does address Peter’s remark. But then again, if that’s the view, I have to read more Hayek and hear more since I don’t see how the conclusion follows from the premise. One might think that it is very hard to see what the very best policy decision is in any particular case, and so the default shouldn’t be the market, but rather that consideration for the lives of the worst off in society should be given some kind of priority in deliberations about the proper policy.
And finally … I’m sure we’ll be talking more about this … but my guess is that your view is not merely that “all things being equalâ€? you’d choose the efficient policy over the inefficient one. That view, of course, is consistent with deontological views. So I’m guessing that economic efficiency should have some privileged status in normative assessment, on your view.