Nothing new here. Think of this as a teaching post. Partly for the people of the concrete steppes, but for others too. I'm just going to talk about different ways that expectations can affect what happens. The main distinction is between multiple equilibria and unique equilibrium.
1. Multiple Equilibria
Here is one simple model of multiple equilibria: Y=E(Y)
Let Y be something that people do. Let E(Y) be people's expectations of what people do. The simple model Y=E(Y) says that people do whatever they expect other people to do. Expectations are totally self-fulfilling. People can expect anything they like, and it happens, just as they expect. There is a very large number (a continuum) of equilibria. Anything whatsoever can be an equilibrium. Or almost anything, if Y=E(Y) is only true over some range.
Here is another simple model of multiple equilibria, but where not everything is an equilibrium. Y=[E(Y)]2 + X, where X is some exogenous variable. This model has two equilibria. For any given level of X, there are two different levels of Y at which expectations will be self-fulfilling. But if people expect some other level of Y, their expectations will be falsified by their actions. And if X changes, both equilibria will change too.
It is easy to construct a model with three, or four, or any number of equilibria. Depending on how people form their expectations, and how they adjust their expectations if they turn out to be false, some of those equilibria may be unstable, and others stable.
Examples of multiple equilibria are all around us.
I use the word "cat" to mean cat, because I expect other people
around me to to do the same. (But when I'm talking to some other people
around me, I use the word "chat" to mean cat, because I expect those
people to do the same). There is no reason why we couldn't have a
different equilibrium in which we all used "cat" to mean dog, and "dog"
to mean cat. Almost any word could mean cat.
Another example is
which side of the road to drive on. Here, Y can only take on two values:
"left" or "right". If you expect everybody else to drive left, you
drive left, and if you expect everybody else to drive right, you drive
right.
Most people obey the law and follow the leader because they expect everybody else to obey that same law and follow that same leader. If everybody thought the law was a different law, or the leader a different leader, they would obey that different law and follow that different leader. The law is whatever people expect to be the law. The leader is whoever people expect to be the leader. Many different things (though perhaps not anything) could be the law, if people thought it was the law. Many different people (though perhaps not anyone) could be the leader, if people thought that person was the leader. The constitution, which is supposed to tell us who gets to make the law and who gets to be leader, wouldn't be the constitution if people didn't think it was.
2. Unique Equilibrium.
Here is a simple model with expectations and a unique equilibrium. Y=E(X). It is not X that determines what people choose to do; it is people's expectations of X that determines what people choose to do. It is not rain, but our expectations of rain, that determine whether we carry an umbrella.
Here is a slightly more complicated model. Y = 0.5E(Y) + 0.5X. What people choose to do depends partly on some exogenous variable X, and partly on what they expect other people to do. But there is only one level of Y, given X, at which people's actions will confirm their expectations of others' actions. Most static economic models are like that.
Now lets complicate that model slightly, by introducing time. Y(t) = 0.5E(Y(t+1)) + 0.5X(t). What people do today depends partly on X today, and partly on what people expect people to do tomorrow. Most dynamic economic models are like that. And you need to say something about how people form their expectations in order to solve those models.
One assumption is rational expectations. People's expectations are consistent with the model. Taking that same equation and leading it forward one period gives you Y(t+1) = 0.5E(Y(t+2)) + 0.5X(t+1). If people expect that that is how people will choose tomorrow, then E(Y(t+1)) = 0.5E(E(Y(t+2))) + 0.5E(X(t+1)). We can substitute this solution for E(Y(t+1)) into the first equation, repeat again and again, and get the equilibrium as:
Y(t) = 0.5X(t) + 0.52E(X(t+1)) + 0.53E(X(t+2)) + etc.
[Somebody please tell me politely if I've screwed up the math, as I usually do.]
The solutions to almost all modern macroeconomic models look like that. If X is some policy variable, then it is not just current policy that matters, but people's expectations of the whole path of future policy.
If you make a different assumption about expectations you will get a different solution. But if people think that policy affects what people do, and also think that expectations affect what people do, you will still get some sort of solution which looks something like that.
In that example, I used "0.5" as a numerical parameter value for both E(Y(t+1)) and X(t). That means that Y(t) is determined 50-50 by current policy and by expected future policy. If I had originally measured time in years, and then switched to measuring time in 6-month periods, I would need to change those parameter values, and make the model (roughly) Y(t) = 0.75E(Y(t+1)) + 0.25X(t). And the solution would now become:
Y(t) = 0.25X(t) + 0.752E(X(t+1)) + 0.753E(X(t+2)) + etc.
[Damn. i've screwed up the math there, haven't I. I need more coffee, or some help.]
Now Y(t) is only 25% determined by current policy, and 75% determined by expectations of future policy.
As we shorten the time-period still further, we approach a solution in which Y(t) is 99.99% determined by expectations of future policy.
3. Counterfactual conditional expectations matter too.
I do not break the speed limit. (OK, just assume I don't.) I do not expect the police to give me a speeding ticket. But I do expect the police would give me a ticket if I did speed. Which is why I don't speed. So in equilibrium I do not speed. And I don't expect the police to give me a tcket.
What people do in equilibrium is in part determined by people's counterfactual conditional expectations of what other people would do away from the equilibrium.
4. Monetary policy at the ZLB.
New Keynesian macroeconomic models have solutions that look like:
Y(t) = 0.25X(t) + 0.752E(X(t+1)) + 0.753E(X(t+2)) + etc.
Except:
4.1 For quarterly data, it's a smaller number than 0.25 (and so a bigger number than 0.75) and so expected future policy matters a lot more than current policy;
4.2 The policy variable X(t) is interpreted as a nominal interest rate, but the nominal interest rate is not exogenous. It is determined by a feedback rule so that it depends on Y(t). This means that people's expectations of policy can be described [I should have said "and must be described"] as beliefs about the parameters in that feedback rule, rather than expectations about the nominal rate of interest itself. In all New Keynesian models, if the central bank announced and stuck to a time-path for X(t) that was not a feedback rule, (and so did not depend on Y(t)), the model would have multiple equilibria, with nearly all of those time-paths for Y(t) leading to an explosive or implosive path for the inflation rate. (If expected inflation were to increase, that would reduce the real interest rate for any given nominal interest rate, which would increase demand for goods, which would increase inflation, which would increase expected inflation, and so on.) What prevents those explosive or implosive paths happening are people's expectations about what the central bank would do if one of those paths were to happen (it would increase nominal interest rates by enough to stop it happening). This means that counterfactual conditional expectations matter too in New Keynesian macroeconomic models.
Even if you think about monetary policy as New Keynesians do, as setting a counterfactual conditional feedback rule for the nominal interest rate, this does not mean that monetary policy cannot be loosened at the ZLB. If people expect that at some future time, however distant, the economy will escape the ZLB and the central bank will want to raise interest rates to prevent the inflation rate rising too much, monetary policy can still be loosened today. The central bank can commit to delaying the time at which it would otherwise increase the nominal interest rate. It could commit to keeping interest rates "too low for too long". A better way to communicate that commitment might be to commit to a higher price level or NGDP level in the future feedback rule for monetary policy. And it might be better still to stop talking about monetary policy in terms of interest rates, and describe the monetary feedback rule in terms of a setting for some asset price as a function of an NGDP target.
I don't have great hopes for this post persuading people to change their perspective on expectations. But one can only try.
Worthwhile Canadian Initiative 
Hume appealed also to what he called the “habit of obedience”, which is not the same things as a convention. The stability of empires and kingdoms and commonwealths is a complex phenomenon depending on alliances, fear, shifting calculations of self-interest, spontaneous coalition-building in response to perceived threats to interest, etc. Convention is only one part of the mix.
Nick Rowe,
“W Peden: because we stupidly let our enemies appropriate the word “social”. Which is why my gut reaction, when I hear the word “social”, is to reach for my shovel.”
Quite so. Hayek taught us to be wary of the use of ‘social’ in front of things that are intrinsically social (justice, ethics, policy etc.) and that the word ‘social’ often just means ‘not’ (most blatantly ‘social liberalism’ when people mean ‘left-wing democrats’).
Economics became labelled at the ‘dismal science’ for telling racists like Carlyle what they didn’t want to hear and “overstepping their bounds” on issues of race, rent etc. Economists should remember that they’re practicing social science and the rest of us should remember that the economy is an aspect of society.
W. Peden
Had Marx not personally been a blatant counterexample (among many) to class consciousness, people might have taken the idea a little more seriously.
I hope I am not the only one who sees this comment as insane. Marx was taken very seriously and made a huge impact. Just not by economists, which is a shame. In terms of Marx not exhibiting class consciousness himself, there is no answer capable of capturing the stupidity of the remark. It must stand by itself in silence, as a type of example of what can go wrong on internet comment feeds, particularly when people accidentally pick up a used copy of The Road To Serfdom and treat it as a serious essay, rather than a psychedelic travelogue akin to “Around the World in 80 days”.
The interesting thing about class warfare is that it must be constantly waged. You never “win”, and Paul Krugman has a great column about it. I also recommend J.W. Mason’s You Eat Mitt Romney’s Salt.
Nick,
I just read the beginning of your book and wonder why you can’t be a rebel and post a full copy online. I think it would be a good read. I did read the David Friedman essay, but both of these are not convincing as evidence that economics is escaping its autistic reputation. Nothing matters until you put this stuff into the same models that informs your macro policy advice. Until you do, it doesn’t matter that an economist or two writes an essay about this or that.
I’ve seen consumption habits in models but there is the persistent foundation that humans are creatures who orient their behavior solely around consumption in some form. There is no notion of a white shop keeper refusing to sell to a black patron, or of a firm shutting down a profitable plant because the plant has unionized. Or even of Rockefeller buying up medieval european cloisters and shipping them over to the U.S. stone by stone, re-assembled, and then buying up 70 acres of prime Manhattan real estate so that his cloisters can have unobstructed pastoral views in NY city.
Is that consumption or savings? And if it is savings, what was the return to Rockefeller? What euler equation motivated this?
To me, a zero-th order approximation would be to acknowledge that there is a whole hierarchy of needs, of which consumption might be one. In that case, the utility function should be modified to include wealth in the utility as a proxy of all the things that people do with their resources that has nothing to do with consumption or savings. Monument building what fall into that category, as would throwing away profitable factories because they offended your sense of the natural order of things. This would also be the pool of resources from which Ford hired his army of thugs.
But if we have a utility function in the form of u(C) + v(W/p) — similar to what was proposed by Carrol, then the models will predict something very different. For example, you may not get a lot of inflation if interest rates are too low, provided that the majority of the wealth goes to a few hands. And you might get inflation merely by lowering wealth inequality while keeping interest rates the same.
I would be happy just with that zero’th order approximation. Maybe a first order approximation would be to include habits, not only for consumption, but also for investment.
The general point being that you can’t, on the one hand, pretend that humans are more than individual consumption optimizers while at the same time keeping the consumption only utility functions in the popular models.
Keyens, as ever, was insightful on this matter: (describing Das Kapital) “an obsolete textbook which I know to be not only scientifically erroneous but without interest or application for the modern world.”
W. Peden,
Marx’s influence was not limited to Lenin, but to all of the western social democracies that sprung up in an attempt to diffuse the class conflict with social bargains. The sad thing is that this necessary agreement — e.g. pensions, health care (first started by Bismarck in response to communist movements), labor regulations, progressive taxation — is not seen as necessary or important by the models. It is seen as dead weight losses. The fact that some individual economists may believe that grand bargains overseen by government to limit class conflict are necessary only highlights the disconnect between the model and reality. And sadly, my impression is that it is old timers such as Nick who are more aware of the importance of these types of grand bargains.
Grand bargains? More like an attempt to keep the working classes placated as the politically connected classes escape out the back door with the loot. I think you should have taken a closer read of Hayek, it’s pity you think it a drug induced fantasy.
(I love this tangent btw)
rsj: “Nothing matters until you put this stuff into the same models that informs your macro policy advice. Until you do, it doesn’t matter that an economist or two writes an essay about this or that.”
Understanding the microfoundations of social institutions is very hard. Macro policy is very hard. Putting the two together is extremely hard. Whenever I’m yammering on about social constructions and strategy space and fairies and stuff like that, this is what I’m trying to do. And the people from the concrete steppes, who have reified the existing monetary (dis)order, are my bourgeoisie!
Funnily enough, some of the best people in that amorphous literature are neo-marxists (I would say they are ex-marxists, because their thought has evolved so much beyond Marx into rational choice and game theory) like Herb Gintis, and Jon Elster. But there are also ex mathematicians/philosophers like (Frances’ old prof) Ken Binmore. And there’s a whole slew of them coming out of the George Mason public choice approach like Viktor Vanberg
I’ve always found it interesting that people think of economics as having a right-wing bias, when I see it as a discipline that is inherently liberal or left-wing. People are autonomous consumption units: isn’t this the modern understanding in a nut-shell?
vimothy: I would tend to agree. Traditional conservatives, who emphasis that people are part of families, churches, villages, tribes, nations, cultures (and yes labour unions) etc. would have much more to complain about the methodological individualism of nearly all economics. Plus the importance they would place on history and tradition, vs the economists’ forward-looking “bygones are bygones”. (In some sense though, that traditional conservative perspective has been partly taken up by the left, in recent times).
Nick: That’s right. For traditional conservatives, man partakes of a temporal order that reflects a cosmic order. When RSJ writes that, “class war must constantly be waged”, what he means is that this order mus be overthrown. The goal of this revolution is for man to become an autonomous consumption unit more perfectly. In this RSJ, Marx and mainstream economics all seem fairly well aligned, with some minor disagreements over method.
Vimothy,
An interesting point. A society without the division of labour and where chickens fly ready-cooked into people’s mouths (Robert Owen’s phrase rather than Marx’s, but essentially the same post-scarcity idea) is very appealing to a radical individualist. On the other hand, in the Smith/Hayek view of the economy, our ability to enjoy any sort of decent standard of living is NECESSARILY dependent on a wide and unknown invisible hand/spontaneous order. In other words, for economists like Smith and Hayek, not only are we necessarily interdependent, but we cannot even fully comprehend the spontaneous order on which we depend.
One can’t take this too far (Smith and Hayek are methodological individualists and Marx is the arch-methodological holist in economics) but this might explain the curious phenomenon of Nietzschean Marxists and the curious absence- in my experience- of Nietzschean Hayekians.
(When radical individualists do come to the Austrian School, they tend to find the Rothbardian wing more appealing. Randian and Nietzschean myths of supermen make little sense if we live in a spontaneous order in which our accomplishments are dependent on evolved social practices and institutions.)
Nick Rowe,
I remember reading a book by a left-wing critic of liberalism who found himself repeatedly and uncomfortably having to note that he agrees with conservative philosophers on one matter after another. In both cases, there’s a great danger of spillover: if people aren’t to be trusted to make their economic, sexual, religious, marital, and other decisions, then presumably they can’t be trusted to make their political decisions, which if anything are more important and more prone to manipulation/corruption. And there’s the road to serfdom once again, only it can (I emphasise CAN) follow as logically from a conservative standpoint as a left-wing standpoint.
In contrast, it’s an unpleasant but inescapable logical consequence of classical liberalism that racist/authoritarian political parties like the Nazis and the Bolsheviks should be tolerated and given an equal platform, however much some classical liberals like Karl Popper rebelled against this idea. Once you get into the habit of assigning individuals responsibility and tolerating those tastes/opinions you disagree with, it’s very hard to stop.
Vimothy is further correct as far as mainstream economics goes, because theoretical frameworks like perfect competition and externalities (and I’m keen on the latter) open up the door to intervention by enlightened elites as surely as concepts like false consciousness and class struggle.
Vimothy,
No, when I say that “class war must be constantly waged”, I mean that when you have a society with large and unequal distributions of property, you need to constantly wage the war in order to prevent redistribution. If there was a village in which one person owned 90% of the wealth, and everyone else owned 10%, the community in this village would need to be constantly educated about the superiority of this one man, of the hell that would break out if property was shared more equally, and why this is the best of all attainable arrangements. Because it is so unnatural. And each generation would need to be indoctrinated into this state of affairs. Maintain large levels of inequality requires continuous effort, and economists are recruited into this effort by describing the dead weight losses that would be obtained if the man was taxed, about how the community as a whole would produce less, etc.
rsj
1 person owning 90% of property is unnatural? Well those exact numbers may be, but does the point hold generally?
All historical record says otherwise. Some 5% of all men in Central Asia carry Changez Khan’s Y chromosome. The median Y chromosome has been wiped off the genetic record. THAT is natural. The concept of the equality of men (and women) and egalitarian exchange – whether of the capitalist or the Graeber/Proudhon style – is deeply unnatural. And a constant war has to be waged to preserve this deeply unnatural state that we have convinced ourselves is the right path for humanity. And economists, mainstream capitalist ones at that, are on the same side of this war as Marx.
In a truly ‘free’ world, you will not see the 99% wage justful rebeliiion (well you will, sometimes, but that’s not the ordinary state) against the 1%. You will see 9% (or the 19%, maybe) ganging up with the 1% and subjugating the 90%, sometimes beyond deprivation. A cursory familiarity with nations where the state was founded on enlightenment principles but the society is still deeply feudal – like India – is enough to disabuse one of the notion of the strength of the 99%.
Ritwik,
Your counterexample that the rich must always wage a war against the poor is Genghis Khan? You don’t think of him as waging a war?
It’s not just about waging a war. It’s about waging a war and winning! The ‘poor’ don’t need to be indoctrinated about the just-ness of it all because whenever the ‘rich’ truly wage a war against them, they (the rich) win. Most wars with uncertain outcomes are fought between the competing rich, not between the rich and the poor. Changez Khan is an extreme example- he dominated the poor AND the competing rich. But in most feudal societies, the poor usually submit. Every once in a while the rich will wage a war, to ensure that the equilibrium continues. After all, one must exercise a limb. Even if sporadically. But there’s no need for constant indoctrination.
The real indoctrination is one in which Locke and Proudhon fight on the same side. In which we indoctrinate the rich and the powerful that freedom, not force, is the ‘natural order’ of things.
RSJ,
In war, two (possibly more) sides fight. The class war fought on behalf of the rich is the same war as that fought on behalf of the subaltern. I.e., these wars differ in sense but not in reference.
But there is also an older, deeper war…
This war is fought against the natural order on behalf of reason. The natural order is expressed in hierarchy—hierarchy is the natural state of man. That’s just the way things are on Planet 3.
The traditional understanding of this natural order invests it with moral significance. Mainstream economics rejects that understanding. It wants to tear this natural order down. In its place it wants to leave man, ordered around the market and the state. You object to the precise mix of market and state. There is too much market and not quite enough state. You do not object to the war on nature. In this war, you and the economists are on the same side.
Vimothy, I’ll believe it when I see it in the models.
From my vantage point there is concentration of wealth due to inherited social privilege, incumbency due to prior ownership of scarce resources, concentration due increasing returns, asymmetric bargaining power due to concentration, and class solidarity or coalitions.
Until you put this into the models and wrestle honestly with it, I don’t see economics as being on the same side as modern civil society.
I see economics assuming all of that away, and then declaring that capital income is not income, so only wage income should be taxed, that everyone is paid at least as much as their MVP, and that the optimal solutions are obtained via voluntary exchange.
In other words, I see all of the important stuff pointing out the inadequacy of viewing the world through the lens of voluntary exchange ignored, and all of the advantages of viewing the world through voluntary exchange emphasized.
Now you are right that nothing in principle requires economics to fetishize voluntary exchange.
We could live in a world in which economists fetishize on modeling production, and then pay some lip service to the act of exchange just we pay lip service to production now. Or we could focus primarily on the endowment — on coalitions, incumbency, etc, and pay lip service to production or exchange just we pay lip service to heterogeneous wealth distributions now.
But right now you are focusing on voluntary exchange and paying lip service to everything else. So you have nothing constructive to say about policy, about what types of deals government should broker between coalitions in order to move things forward.
You (e.g. the orthodox wing of the profession as a whole) could have a lot to say, but that would require thinking about the important issues of incumbency, coalitions, and power asymmetries with the same seriousness as you think about “CB communications policies”. I’m not holding my breath.
Somehow I am an army of one fending off a gaggle of smart bloggers.
Ritwik,
It’s not just about waging a war. It’s about waging a war and winning!
No, it’s about choosing to have a larger piece of the smaller pie, or a smaller piece of a larger pie. Society as a whole loses when the incumbents always win.
You may have noticed that there wasn’t a lot of economic growth for most of human history. We view democracies as better and more wealthy than aristocracies. And we view social democracies with a large middle class as more stable and better than highly unequal societies.
Those of us sympathetic to Keynes really believe that you need a lot of redistribution and a stable middle class to avoid periodic implosions of the economic system, and to moderate implosions when they do happen.
And once you throw mass production and increasing returns into the mix, you really need a large pool of middle class customers who have sufficient employment, health, and retirement security that they are willing to make large purchases and supply demand. In aggregate this is a richer society than that of a small pool of aristocrats funded by armies of servants.
With increasing returns, which is the world we are living in, those nations with the largest endowments are the ones with the largest endowment of aggregate demand — those with the best forms of redistribution and the most vigorous limits on coalitions.
Because in the industrialized world, it is lack of demand that keeps us from enjoying large surpluses and the fruits of more efficient means of production.
Why does China send us so many real resources? Because they have solved the problem of production, but have not solved the problem of demand. That is purely a sociological problem, one that the queen of the social sciences refuses to tackle. It is not a problem of physical production, it is a problem of 1% of households taking delivery of 40% of household income. That’s why the nation that produces such enormous quantities of goods cannot afford to purchase its output and must sell that output to someone else.
rsj
I agree with almost all of what you say,esp. about the Chinese problem being a demand problem. But that’s not what we were debating, were we?
The question is – why should incumbents care about society as a whole? Partially, they have realised that caring about society as a whole makes them better off as well. But they are wont to lapse into old modes of thinking. And anyway, if wealth accumulation is as zero-sum as SRW eloquently argued, then they should actively try to preserve the old world order. And there’s no ‘we’ in the old world order, not as you understand the term. The ‘we’ is the rich.
I was specifically debating the claim that if the market and the state were not in the business of actively protecting property rights, the common masses would rise periodically and ensure a more just distribution. I was making the claim that what would happen, by and large, is that the rich would gang up and protect their property rights anyway. And every once in a while, would eliminate signs of dissent, brutally if possible, to ensure that the old world order continues.
They’d indoctrinate, yes – ‘the divine right of kings’ being a good example. But mostly, they’d not need to indoctrinate. I’m making the claim that we have a very visceral understanding of power and powerlessness, and that if the broad swathe of history is anything to go by, the poor have typically accepted their powerlessness and gotten by.
The real indoctrination, one that we as ‘liberal democrats’ take for granted, but is actually deeply counter-intuitive, is that we should all somehow care about aggregate utility, whatever it is. That the rich and the incumbent should be willing to sacrifice relative status for absolute luxury. And that 1% owning 40% is NOT ok.
The current order is not just. But it is more just than the natural order. And economists’ models are incomplete, perhaps hazardously so. But in broader ethical/political game, they’re on the right side.
The question is – why should incumbents care about society as a whole?
They may or may not care. The more enlightened incumbents care while others don’t.
But society as a whole should care because an expanding middle class leads to expanding production and consumption possibilities.
And as far as the elite are concerned, perhaps Bill Gates would be worth only $5 Billion instead of $50 Billion. I don’t see him as suffering too much. Particularly when a large component of the utility of wealth in those stratospheres is relative — i.e. he would still be the richest man, even with that 90% confiscatory regime for top brackets.
I do not believe that wealth is zero sum, and I don’t think this was the argument that SRW was making.
I was specifically debating the claim that if the market and the state were not in the business of actively protecting property rights, the common masses would rise periodically and ensure a more just distribution.
Agreed. But at the same time, people would stop shopping periodically, and radically reduce the value of the equity claims of the wealthy, forcing real wages up via deflation. Without bargains, the ultimate counterattack of the non-rich is to spend less and watch as firms liquidate wholesale, driving real wages up. But that strategy has a lot of collateral damage. A much better strategy for both sides is an agreed upon redistribution.
Note that this is a different state of affairs from most of society living on a subsistence income and the aristocracy consuming the surplus. A post malthusian economy does not have this type of equilibrium. The wealthy are wealthy because of equity claims on means of production that are profitable only if the great mass of people continues to shop. This, in and of itself, would suggest the value of government not in enforcing property rights but in negotiating bargains between classes.
And the ironic thing is that a GE model assumes a fairy auctioneer does this coordination, but whenever someone suggests that the government play this coordinating role and brokers (and then enforces) bargains of high wages in exchange for steady demand, cries of interference with the market rise up. But someone needs to play this coordinating role in order for us to reach the good (non-malthusian) equilibrium.
But in order for mainstream economics to have something constructive to say about this, the most important job of government and the most pressing problem of macro economics, it needs to realize that
A) There are classes with different interests, which should be modelled
B) There needs to be a coordinator who strikes and enforces bargains and Mr. Walras doesn’t exist
C) The bargains need to be periodically updated
That agenda of A) B) C) is what we should be focusing in during the current downturn. Not CB communications policies, which are irrelevant to whether we can get out of the current low employment equilibrium.
rsj
This, in and of itself, would suggest the value of government not in enforcing property rights but in negotiating bargains between classes.
Ok, but the classes are not static. The pensioner is a wage slave, but also a capitalist. As a capitalist, he’d want his capital to be defended as well. A system that prevents the wage labourer from becoming a capitalist is perhaps more unjust than one that does not negotiate a grand bargain between labour and capital.
And speaking of grand bargains, don’t you think that given the distribution of wealth, international grand bargains are of several orders of magnitude more important than local grand bargains? Developed world wage labour lives a lifestyle that is superior in consumption and production to many (most?) third world elites. One reason I find it difficult to get excited about far(ish)-left strains of thought in the western world (despite their intellectual appeal) is the lack of sufficient internationalism in their thought. People debate freedoms (like dress codes) in the workplace, celebrate union victories for public school teachers and talk about reducing the work-week and debt jubilees for underwater households. To someone from the ‘third world’, it all seems absurd. Caplan-esque views of first world poverty don’t just resonate with first-world elites. They’d resonate with almost everyone from the third world. Especially the non-elite, were they to be told what ‘poverty’ in the first world means.
For many of us, the grand bargain between free exchange and feudalism is so fragile that we don’t really bother much about the grand bargain between labour and capital. As a matter of practice, that is. Intellectually, it’s fascinating.
Anyway, I’m sure we’re way off topic here. And we shouldn’t take so much advantage of Nick’s generosity. 🙂
Ritwik: No worries. We have all wandered way off-topic. But the topic got covered pretty well in the earlier comments.
I’m not sure if there is a “natural order of things”, but your vision of what it might look like seems to me to be, if not strictly “natural”, at the very least an ever-present danger. Bill Gates (only it would be someone very thuggish who had never actually help produce anything that people wanted) wouldn’t just be able to buy a lot of stuff, he might be more like Ivan the Terrible. (There are worse candidates than Ghengis Khan, I think.) Feuding warlords.
rsj: “Somehow I am an army of one fending off a gaggle of smart bloggers.”
That’s how I feel a lot of the time!
Nick
Thanks! I invoked Changez (I’ll stick with the Indo-Iranian rather than the Anglo-Saxon version 🙂 ) not because he was spectacularly brutal. Simply because he was spectacularly successful, ‘naturally’ speaking. And there are local Changez Khans all around us.
Marx and Smith had different ideas about how a just outcome might be achieved, but their ideas of a just outcome do not differ very broadly. Smith and Rothbard even had different ideas of what a just outcome might be, but their differences are superficial compared to the difference between Rothbard’s and Changez’s idea of a just outcome. That we have managed to limit the debate to the Marx-Smith-Rothbard spectrum is itself quite curious (and a big achievement) to me. The escape from Changez is more fragile than we care to admit.
Now try to model that!
Ritwik,
The pensioner who invested well wants his capital protected. But why should he pay a lower tax rate than the elderly worker who did not invest well and is forced to earn his consumption via supplying labor rather than renting out capital?
This would be my agenda:
1. don;t distinguish at all between labor income and capital income. Tax them both at the same rate.
2. Heavy taxes on land rents. Say the 10 year rate, paid each year, on the market value of land.
3. Universal health insurance, paid for out of taxes.
4. Prompt enforcement of labor violation laws
5. Dis-intermediate banking system from basic household deposit and credit functionality. E.g. allow households to do internet banking or in person banking at post-offices for free, with very basic services. Extend credit to households at the policy rate with a credit line given to each household. Repayment would be ensured by the tax system. Investment banks can lend to businesses, etc.
6. An employer of last resort role, so that should households decide to go on a shopping strike when consumer goods get too expensive, this will not rebound to them in the form of massive involuntary employment. This will help even the scale.
7. Fully equal trade agreements. If firms are allowed to outsource production of goods to where labor is cheaper, we should be able to re-import goods from those nations where goods are cheaper. Presently, it is illegal to buy a DVD sold in a low income country and re-import it into a high income country. We have one way trade. Same for medical supplies, etc.
8. Highly progressive tax rates without kinks. e.g. 70% on marginal income over 200,000, no taxes on income below $30,000. Again, make no distinction on how that income is earned.
9. Eliminate general corporate income taxes, with the exception of externally taxes, which can occur during production. Tax only income not expenditures, and be agnostic as to the source of income.
All of the above is completely consistent with enforcement of property rights and the ability of entrepreneurs to make money or even become wealthy.
Rsj, your proposals are all sound and I am sure if you were dictator we would live in a prosperous society. The problem with your view is that you model government as some exogenous factor that can come in and return order to society when it strays from your particular vision. The core research program of Hayek was to get both the left and the right to understand that government is an endogenous process to the inequal distribution of wealth. The government doesn’t remove us from the state of nature it IS the state of nature when you have a peaceful society that still wants to compete over resources but just doesn’t want people to die in the process.
The rich have larger shares of income to a large degree because the government hands them special priviledge and protects them from competition. Economists study deadweight loss because it mainly occurs when special interests draw rents from the economic system. The problem with the left is that they support special interests that are crappy at winning the competitive game they think supports their ends. The fact is that no matter what system you put in place some people are going to be better at drawing a greater income from the system. If you truly want equality then the best thing to do is to remove a system of income distribution that is so easily turned against the poor and put in its place a system that allows the poor have real economic opportunities and leaves money in the hands of the middle class to voluntarily help those that fall through the cracks.
Totally off-topic: Could somebody please do me a favour? Leave a comment on Steve Keen’s latest masterpiece, telling him yes, amazingly, I am aware of the possibility of unstable equilibria, and quote from this post to illustrate:
“It is easy to construct a model with three, or four, or any number of equilibria. Depending on how people form their expectations, and how they adjust their expectations if they turn out to be false, some of those equilibria may be unstable, and others stable.”
(I tried to register to post a comment, but that stupid site refused to recognise my Canadian postal code, which was rather frustrating.)
Thanks!
The ‘poor’ don’t need to be indoctrinated about the just-ness of it all because whenever the ‘rich’ truly wage a war against them, they (the rich) win.
I know this is way off topic but what a horribly depressing and willfully blind view of history. It’s hard to come up with meaningful numbers for wealth and income distribution in premodern times, but it is undeniable that socially, politically, in terms of health and esteem and life chances, modern societies — while still grossly & unjustifiably unequal — are vastly more egalitarian than almost any settled urban society before the 20th century. (Simple societies are a different story.) Overwhelmingly. And why? Because the rich have not always won in the wars against the poor.
Ian,
I don’t think anything is exogenous. But in the market, you have one dollar one vote. By definition, the market solely reflects preferences in proportion to wealth.
It is up to non market forces, whether religion, social mores or government in more formal dressings to reflect other preferences.
Letting the market decide each person’s endowment is nonsensical and unsustainable in an environment of increasing returns. Small differences in opportunity snowball into very large differences in wealth, which then feedback into even larger differences in opportunity and even larger differences in wealth. That leads to collapse of the middle class.
Those wanting a sustainable economy need something to counteract this mechanism, a recycling mechanism that works in the other direction, attenuating the accumulation of wealth that is the natural outcome of private ownership mass production society. Non market forces, specifically government, is how we do this, and it is the only way we have done this.
JW
I’m not sure where you’re disagreeing. I was saying that we have indeed managed to create a more just world order (even though not just enough), but that this just world order is profoundly counter-intuitive and unnatural (premodern history being my example), and that the escape from feudal structures is hard fought and fragile. And in this escape, the mainstream economists fight the good fight alongside Marx, not against him.
rsj seemed to be of the opinion that without indoctrination of the poor (powerless), the world would tend naturally towards to a more just order. I was arguing that actually without constant indoctrination of the rich (powerful), the world would slip back into pre-modern states of distribution, because that’s what is ‘natural’. My evidence was the same bleak pre-modern history you cite.
“But in the market, you have one dollar one vote. By definition, the market solely reflects preferences in proportion to wealth.”
But the government is able to take dollar “votes” from some and give them to others. This is based on whoever is best able to control government to their demands, in most cases this is the rich. If the government is giving the rich more dollar votes then the market outcome is going to be biased. The problem you want to solve is caused by the solution you recommend and you havent clearly stated a way to differentiate between good government behaviour and bad government behaviour and how we get the government to engage in the good behaviour when many of our current problems have been created by a government that constantly has good people trying to change it to the purposes of the good.
Ian Lippert,
One could add that, in a market, one can only get richer by providing something that people want, whereas those able to control government are able to get people richer (including themselves) without regard for people’s desires.
However, the entire debate is misleadingly structured: what matters are inequalities of power, which may or may not correspond to inequalities of wealth. In terms of power, Hitler’s Germany, Stalin’s USSR and Mao’s China were the most inequal societies in the 20th century. The richest man alive has a fraction of the power these men had. Nevertheless, the argument that wins me over to government-funded schooling and (some) controls on campaign financing are that they are the best ways to address the inequalities of political power (albeit the least objectionable kind of power i.e. persuasive rather than coercive power) that the market produces in a liberal democracy.
“… the best ways to address the inequalities of political power that the market produces in a liberal democracy.”
How does the market produce inequalities of political power? In my mind its seems like successful market actors are merely using what political power already exists to further amplify their ability to acquire wealth. The support for political power precedes its use by market actors and it comes from everyone that wants the government to do something for them.
You end up with a bunch disparate groups that want reasonable uses of government (like schools) that in aggregate creates a power structure that can be used by those that want unreasonable uses of government (like corporate bailouts). I think people underestimate how much power the government has because they are limited in their view by the small slice that the government gives them which is further amplified by the fact that the slice given to them is usually their most desired preference.
Ian Lippert,
“How does the market produce inequalities of political power? In my mind its seems like successful market actors are merely using what political power already exists to further amplify their ability to acquire wealth.”
Precisely my point. A liberal democracy is a society where persuasion is power, and persuasion is a lot easier with money.
“The support for political power precedes its use by market actors and it comes from everyone that wants the government to do something for them.”
I fully agree and I don’t think that we’re going to change in this regard, because the instinct to seek favours from the powerful is part of human nature. What IS within the bounds of human nature is to have a polity with sufficient critical intelligence to potentially resist each other’s self-serving persuasions. Such a mindset, when it is widespread, encourages a very liberal social contract: we won’t use the coercive power of the state to get you to do what we want, if you don’t use the coercive power of the state to get us to do what you want. Insofar as laissez-faire has ever been approximated in human history, it has been on that basis i.e. enlightened self-interest and an implicit tit-for-tat game theoretical strategy, rather than fundamental moral or constitutional safeguards.
(There is absolutely no case for a government monopoly of state-funded education, however, anymore than there’s a case for a government monopoly of security services or basic foodstuffs or shelter or arbitration.)
As Hayek and Hume would tell us, we have to take human nature as it is, but that doesn’t mean that the human condition is beyond improvement.
Cool, thanks for the clarification