First-Best vs. Second-Best Economists

Dani Rodrik is one of the most interesting economic voices in the blogosphere.  He also happens to be one of the most interesting economists in general.  There has to be some connection!

But while Rodrik is often penetrating in his analysis of the blind spots of others, he has his own share of blindness as well.  For my rendering of economic disputes he has too much "faith" in the ability of policy makers to get things right, and too little appreciation of how markets actually function in a disequilibrium setting to structure incentives, communicate and utilize information, and spur effective decision making and innovation in know-how and in technology.  In short, the entrepreneurial market process (the real market instead of the text-book version of the market that economists too often use as a benchmark for disputes) is one of continual adjustment to changes and does not rely for its economic justification on welfare theorems of formalistic equilibrium economics, but instead invokes the appreciative theory of the classical political economists, the exchange oriented economists from the non-Ricardian Brits to the Austrians and Swedes to more contemporary theorists such as James Buchanan (e.g., "What Should Economists Do?")

In his discussion of "first-best" and "second-best" economists, Rodrik does not deal with the entrepreneurial/exchange process economists associated with Hayek, Kirzner and Buchanan.  Nor does he deal adequately enough to my mind with the challenge to government control of the economy that is to be found in public choice economics and Hayek's knowledge problem economics.  Independent of this, however, there is an empirical blind side to the argument of economists such as Rodrik --- yes I said empirical.  To clarify let me give an example.  Pete Leeson and I participated at a conference at the LSE over a year ago on the contributions of PT Bauer.  In attendance were Robert Bates, Tim Besley, Robin Burgess, Esther Duflo, James Robinson, Andrei Shleifer, and Barry Weingast -- among others.  At one point in the conference, Anne Krueger summed up what she thought was now the consensus among enlightened economists.  "We are all in favor of markets," she stated.  "But not unfettered markets.  Instead, what we need is markets governed by reasonable regulations that are not capturable by interests."  The reasonable economists, would have to agree with that statement.  I swallowed hard for a moment, and raised my hand.  I agreed with Anne Krueger that her statement was one that any economists would find hard to object to in theory, but I wanted to know an empirical example of a regulation that was both reasonable and non-capturable.  I am still waiting for an example, though in a moment of levity Andrei Shleifer did chuckle and inform me that I should stop being "unreasonable".  And I laughed with him ... to be honest with you to be called "unreasonable" by Andrei Shleifer was a highlight of my career since I consider him to be the best of the best among leading economists.  But nobody has yet to provide me with an empirical example of a "reasonable regulation" that is "not capturable by interests".  Can you think of one?

Rodrik doesn't give an empirical example either.  He presumes that the economic interventions of the Keynesian era, or the existence of anti-trust, or the regulation of pollution, all prove his "second-best" economics point versus the "first-best" economists which presumably would not have a need for any of these policies because the problems of unemployment, externalities, public goods, and income distribution would be non-existent in the world of the first and second welfare theorems.  The policy disputes are all too easy in this framing of the argument --- "first-best" economists are talking about a world that exists in textbooks and on blackboards, it is obvious this world doesn't exist out the window, the "second-best" economists admits the problems with the world and designs policy solutions to those problems.

At some level we Austrians should say "A plague on both your houses" to the "first-best" and "second-best" economists.  It is not an easy argument to win.  I tried to articulate this position in my essay "Where Did Economics Go Wrong? Modern Economics as a Flight from Reality," Critical Review (1997).  The essay didn't seem to have much impact on the professional debate!

Comments

[Rafe Champion]

It was amusing to see Dani drawing on Keynes and polemics against the dreaded "classicals" to support his case because the attack missed the target by a wide margin. As thought the classicals could not understand that free trade could be corrupted by interventions of various kinds.

[Peter Boettke]

See Larry White's very insightful comments on this issue posted at Division of Labor.

http://divisionoflabour.com/archives/003955.php

[Rafe Champion]

There is a third alternative to the simplistic first and second best approach, that is to adopt a more or less sophisticated situational analysis to weigh up the downstream consequences of various policies, not just a supply and demand analysis but an appraisal of the institutional forces in place and the comparative strengths of the different interests. Bill Hutt got hold of this, the responsible economist can give advice on the best option and can also provide a second option if the politician thinks it is too hard to do the right thing - as Keynes thought it was too hard to take on the trade unions in the 1930s.

In Politically Impossible: An Essay on the Supposed Electoral Obstacles Impeding the Translation of Economic Analysis into Policy Hutt proposed a "dual formula" for economists to deal with the problem of unpopular policies. He quoted Milton Friedman on the duty of economists to prescribe what should be done, without courting political approval. He then noted that Friedman had departed from his own advice on occasions.

"Friedman's maxim implies that the economist's role is to do this (the ideal) and not to do that (the expedient). I suggest it is the economist's role and duty (in public policy discussions) to do both. Why should not advice proferred typically take the form of saying to the politicians (and indirectly to electorates) with complete candour, something like the following?"

'In our judgement, the best you will be able to get away with is programme A along the following lines; but if you could find a convincing way of really explaining the issues to the electorate, our advice would have to be quite different. We should have to recommend programme B along the following lines'."

http://www.the-rathouse.com/Revivalist4/RC_Huttachieve.html

"I am not suggesting that economists ought ever close their eyes to political realities. On the contrary, when they are concerned with the practical applications of their science, they ought in every instance to bring voting prospects into the picture - but explicitly."