What and How

Mr Adam Smith

It is not just an article of faith among economists (such as yours truly) that markets allocate resources most efficiently under a set of set of assumptions; it has been mathematically proved by theoreticians and empirically demonstrated in thousands of well-documented instances. However, that does not make the proposition that markets work better than other mechanisms – such as command and control – any more intuitive or easy for people to appreciate. It is easy to misunderstand, misinterpret, and often misrepresent.

When the set of conditions required for the market to work are not met, the market fails to grind out the optimal solution. The market failures and how they are to be dealt with are also fairly well understood by economists. The meta-failure is the failure of economists to clearly communicate their understanding to the general public in layperson’s terms. There are exceptions of course. In the popular press you can read economists such as Paul Krugman, Kaushik Basu, Jagdish Bhagwati, et al. But then they are not as widely read as they should be. I say “should be” because too many people are only too ready to make pronouncements from a position of partial understanding on matters economic. Somehow it appears to them that economics is a matter of opinion and should not involve any deep thinking or questioning before they take up a position. These same people would not dream of holding opinions on say radio-astronomy or nuclear physics. But economics is fair game.

Hardly Economics

Economics is hard. And I am not making a self-serving statement because I myself find it hard, and at the risk of sounding vain I claim to be a pretty smart cookie. Which reminds me of a passage from Robert Heilbroner’s book The Worldly Philosophers: The Lives, Times, and Ideas of the Great Economic Thinkers (1953).

Keynes was having dinner with Professor Max Planck, the mathematical genius who was responsible for the development of quantum mechanics, one of the more bewildering achievements of the human mind. Planck turned to Keynes and told him that he had once considered going into economics himself. But he had decided against it – it was too hard. Keynes repeated the story with relish to a friend back in Cambridge. “Why, that’s odd,” said the friend. “Bertrand Russell was telling me just the other day that he’d also thought about going into economics. But he decided that it was too easy.” (pp 250-51)

[Put TWP on your reading list if you are the least bit curious about the people who have had, and continue to have, a profound effect on our world. One needs to have at least a passing familiarity with those worldly philosophers. I am sure that many more of us know who Einstein was and what his claim to fame is than who Adam Smith was and why he matters to us.]

Coming back to the auxiliary fact that I was attempting to make: that economics is not very clearly communicated to the general public by economists. In general they are too busy talking amongst themselves. The public is lucky to have great popularizers in many other disciplines. Where are the Carl Sagans, the Richard Feynmans, the Richard Dawkins of economics?

What versus How

What brought this line of thinking on? Despair. I despair when I see Adam Smith’s ideas misrepresented. I am not going to attempt to explain Smith’s position here, of course, as I am neither the most competent writer nor an authority on Smith’s work. What I want to do here is point out a simple distinction between what and how.

“What should be done” is an entirely different matter from “How should it be done.” If you ask me, I will answer the latter question with: “Let the market do it. If, however, there are reasons to believe that the market will fail because of such and such reasons, then we have to use mechanisms to correct for the market failures. Take care to make adjustments and corrections but let the market get the job done.” The market is a mechanism, a means to an end. What that end should be, however, is something that you have to decide. The market does not auto-magically determine the end to which it can be employed. Saying that the market will decide the goal is like leaving it up to your car to decide where you should be going.

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The post on Tata’s Rs 1 Lakh Car mysteriously provoked a few to challenge my free-market credentials. It is as if I had advocated controlling the economy through socialistic planning. I had done no such thing. I had merely pointed out that cars are not the most efficient means of solving India’s transportation needs. I think Indian cities would profit from modern efficient public transportation systems. In those cities that are already so far gone that you cannot actually put a great public transportation system without impossible costs, I suggested that at least the new cities (that should be built) must have public transportation systems planned from the beginning.

I risk being a bore but let me reiterate that (1) I am for letting the market figure out the solution, (2) if there are market failures, then mechanisms must be used to correct them, and (3) what should be done is a decision that people make, not markets.

Before going any further, let’s just briefly touch upon one source of market failure in the context of transportation. Remember that market work to grind out the optimal solution subject to some set of conditions. Well, one of the conditions is called “No externalities.” In the case of private transportation, it is full of negative externalities such as air pollution and congestion. So unless that externality is internalized, the market will grind out a sub-optimal solution, and it does as seen in cities around the world.

Leadership and Vision

The answer to the question “what should be done” has to be given by society. The agents of society who have that job are the leaders, political or otherwise. They have to have the vision and the ability to do arithmetic. I should add that leadership is endogenous – it arises from within the society.

Ratan Tata is the “leader” in question when he decides that he will make the cheap car. Now he could have led alternatively. For instance, he could have called Mukesh Ambani, Aditya Birla, and other assorted movers and shakers of Indian industry and academia and said, “Guys and gals, let’s figure out what we need to do to solve India’s transportation problems. Let’s do the arithmetic and figure out which way we should go. And having figured it out, we push for that public policy to set that goal. And then we fight it out in the market to see who is most efficient and able to create the system. May the best companies win.”

I am not advocating socialism. What I am saying is that we should sit and think and talk and cogitate for a bit before we go off doing things. We should not do anything until we are reasonably convinced that it is a good thing to do.

My Car

Since I was asked, here’s my position. I don’t own a car. During my 20+ years of living in the US, I had to have a car because where I lived there was no public transportation system. Had I lived in NY City, I am sure that I would not have had a car because it is much more efficient to take public transit. But in California, you cannot survive without a car. That’s just the way it is. And had I been living there now, I would have bought a hybrid (most likely.)

I don’t own a car in India because I like cars too much and like driving too much. I feel distress (I am serious) when I see cars drive through torture test tracks (which is another description for Indian roads) and feel even more distress crawling around in bumper to bumper traffic in the cities.

Finally

I believe that the self-interest of people will make people use public transit systems – but they have to have that choice. Making that choice available is first a policy matter, and building that system is what the market is good for.

Author: Atanu Dey

Economist.

10 thoughts on “What and How”

  1. Thanks, Atanu. This is the first time I’ve read a blogging economist talk about internalizing external costs (is that the elephant-in-the-living-room in the economics world?). Since I come from the green/environmental angle [neither Red, nor Saffron, nor whatever color goes with Congress/Socialism] and firmly believe the economics needs to evolve to green economics – or at least the way it is practiced. Even though I’m not an economist, based on my reading of food issues in the US, it’s pretty obvious that the current economic models need to internalize many of the (currently externalized) costs, especially when it comes to environment and pollution – the costs of which are mostly covered by tax-payers’ money, or through subsidies to businesses. Have you read ‘The Ecology of Commerce’ by Paul Hawken? Something along those lines.

    More questions. Why should pollution etc. be a problem? Wouldn’t the health/medical/pharmaceutical industry benefit from the sick people coming in for treatment (asthma, stress etc.)?
    How about the industry that builds roads? Surely it’s more business for them as they repair roads or construct new ones to accommodate increased number of cars.
    How about increased jobs provided to workers as they build more cars? Mechanics as they will need to repair more cars? Increased sales for businesses that provide car accessories – trinkets, audio systems? And then we’re talking about the second-degree of separation industries that provide raw materials for all these industries directly linked to a car, and will benefit economically from more cars produced.

    I actually think that a well-functioning and efficient public transport is the best way to take care of transport needs, but I’d like to play the devil’s advocate for a while. 😉

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  2. Seconded.

    I always thought the reason free markets are so effective at distributing resources is the same reason a well organized republic is good at holding a country together.
    It is, as Schumpeter would call it, the “perennial gale of creative destruction.”
    In a free democratic society, when ideas become stale or ineffective, they will soon be voted out of office. So long as all players respect the rules of the game, we get stable and orderly transitions and changes of power without the messy backstabbing and wars of succession we would have had if we subscribed to some other political system.

    Likewise with the distribution of goods and services. People select good stuff at a good price. It’s a natural and organic mechanism for figuring out what needs to be produced and how. As a result, the bad, shoddy made things fall by the wayside and the drive towards innovation and improvement elevates us to new heights. And we get to do all this without all the trouble of planning commissions and review boards, bribes, lines, and endless applications.

    Like any machine, the more moving parts you have, the more difficult it is to maintain and the more prone it is to breaking down. When it comes to building an apparatus of state, you would want as few moving parts as possible.

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  3. Wouldn’t the health/medical/pharmaceutical industry benefit from the sick people coming in for treatment (asthma, stress etc.)?

    I think this is a basic misunderstanding on how economists think. Economics is a highly utilitarian discipline, it’s all about generating the greatest good for the greatest number of people. Unfortunately, economists tend to measure “good” in terms of money or GDP since more abstract concepts like “happiness” or “utility” aren’t easily quantifiable.
    But we should never lose sight of the fact that what we’re trying to do is create as much utility for people as possible. So while some pollution may help an extractive industry or a pharmaceutical company, it also imposes severe costs on us. The quality of everyone’s life is materially diminished and the people who end up sick as a result of the pollution are all folks who might have done some good for society if only they weren’t wasting away in a hospital bed.

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  4. Atanu, I told you people will cry foul, but did not realize that it will happen so quickly. 😉 This, nevertheless, an educating piece. Thanks.

    OT:
    @Pavan: yes, economists are necessary (in fact very much necessary) but not sufficient to run this world. 🙂

    -Mike

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  5. Perhaps, I am duller than the rest of your erudite readers…but I can’t help wondering why “common sense” is not so common at all.
    Atanu, as (almost) always, an educative and provoking post.
    Namsate and Salaam to all during these auspicious days.
    Jayant N.

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  6. PS
    Have to agree with Pavan on this one. Economists = multiplcation of quantifiable resources (no soul involved). And if they do include the so called human element, it makes even less sense.
    Unfortunately most “economists” preach water and drink wine.
    Ergo – the world needs more good oenologists!
    Jayant N.

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  7. Most of India is rural/semi rural.
    There is a significant portion of folks who can own(and increasingly do own) vehicles there.
    The tata experiment will succeed or fail there.
    I have several aquantances in Mumbai who could afford a car(s) and didnt do so for daily commute as other options were available.
    I know several people in and around hoshangabad who bought used cars(mostly mahindra and tata “SUV” there SUV is a big oxy moron there as there was nothing remotely sporty and the utilitarian aspects were added by small auto body workeres.

    As a %age of the income it was a bigger chunk of money out of most of the hoshangabad residents
    The residents economized as per there needs.
    Given the nature of indian economy there is a huge untapped market, it will be interesting too see if they can deliver.
    I personaly despise Tata,Birla,Ambani et all for the most part they arent innovators
    with that said Its upto them to do what they decide is in their best interest.
    I mean look at the silly movies being made in india one could argue that the a percentage of money spent there should be used into making public educational films.
    Public infrastructure involves government being able to deliver on its plans.
    Its too easy to start listing the failures of indian government in that sense.
    Societies get the public infrastructure they want. Its the indian society that really didnt want it, if they did they would demand to see how the tax money is being collected(really interesting process in india) and being spent(no mystery there).

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  8. Unfortunately, economists tend to measure “good” in terms of money or GDP since more abstract concepts like “happiness” or “utility” aren’t easily quantifiable.

    Pavan, yes – how to quantify joy, happiness, peace of mind etc. – that is the question, since two people will give you two different answers as to what gives them joy. And as I said, I was playing the devil’s advocate. 🙂

    People select good stuff at a good price. It’s a natural and organic mechanism for figuring out what needs to be produced and how.
    But isn’t there an implicit assumption in there that the customer has (or will have) all the information about the good available to him before he buys it (when we very well know that corporations obfuscate on purpose)? As an example, Ganesh statues made of plaster-of-paris and using toxic colors are causing a lot of pollution in Mumbai and Pune. So, there is a move to switch back to mud (traditional) or paper statues. Now, when a common man goes to buy a statue, he probably won’t have the information about the negative impact of statues available to him. Even if he does, if it doesn’t affect him directly, then he will take into consideration the impact on his wallet and go with p-o-p statue if it is cheaper. Yes, over the long term (5-8 years), the market will probably stop making p-o-p statues, but by then, there’ll be pollution costs to pay.

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  9. Atanu, thanks for writing this post. I was taken aback by the jabs at free markets by some at the 1 lakh car post. Apparently, some people don’t want to believe what they see with their own eye and experience what socialist government management of market – any market – can do. I am sure there is a word to describe it.

    With regards to public transportation, I can give an example – Hyderabad. When Chandrababu Naidu was around he took active interest in and made possible commuter trains within Hyderabad for all the same reasons you mentioned in your 1 lakh car post. Although they pretty much go to all the major intersections and are clean, they run empty now. No one in Hyderabad uses them. The market has rejected the new public transportation. The buses are still full with people standing, sweating and with children suffocating and getting crashed during rush hours (I know what they are feeling). It’s one thing to travel in US or European public transportation whether on buses or trains. It’s another thing in India. Let the market place decide if they want 1 lakh car or take a suffocating bus to work or school. The choice is easy. There are more externalities then pollution and oil prices in jam packed Indian cities.

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