{short description of image}  
 

APPLIED MAINLINE ECONOMICS

Matthew D. Mitchell & Peter J. Boettke

 

Subtitle: Bridging the Gap between Theory and Public Policy, Mercatus Center, George Mason University, Arlington, VA., 2017, 167 pgs., index, notes, further reading, paperback

 
 

Reviewer's comments

This is an excellent description of the economics taught at the Mercatus Center at George Mason Univ. It is largely but not entirely based on 'Austrian school' economic theory. I agree with the concepts fully, but do not believe that in current practice by establishment economists this can be considered 'mainline'. I wish it were. I highly recommend the book to students for the points of economic theory it describes. But also as an invitation to students who want to study real economics in an intellectual atmosphere that encourages skepticism about the establishment thinking on economic policy today. For instance, one should read Danielle Booth's book on the Federal Reserve - FEDUP to see the difference.
I mention a few points below.

 
 

1 - An enduring Puzzle

The authors pose the enduring question. "How do human societies work, and how can we make them work better? What methods, ideas and strategies should we use to help us answer these questions"?

They note that economists today have a wealth of 'tools' data. testing processes, and methods to help answer the questions. They state that these have been adapted from the 'hard sciences' and "are designed to disentangle causation from correlation, and they promise to offer us a better understanding of human relationships". They claim these are standard tools of 'mainline' economists.

But, a big but: they also note that unless these tools are employed the way economists at the Mercatus Center employ them in what the authors claim is 'mainline' economic thinking the results will not be worth much. Judging from the vast difference in theory and practice public economists at the Federal Reserve, the President's Economic council, economists supporting Congressional committees and most news paper economists rely upon and the theory and practice advocated by economists at Mercatus, I hesitate to agree with the self definition of the authors that they are 'mainline' - even though they are correct.
The authors continue by noting that their thinking follows a line from St. Thomas Aquinas and the Scottish Enlightenment through Adam Smith and the Neoclassical School. But none of these are evident in the prevailing Keynesian economic theories that pervade current government economic practice.

They cite as their mentors F. A. Hayek, James Buchanan, Ronald Coase, Douglas North, Vernon Smith, and Elinor Ostrom. Adding Ludwig von Mises, Murray Rothbard, Mark Skousen, David H. Fischer, Deirdre McCloskey, Joel Mokur and a few more, these are my mentors as well, but it appears to me that by following them I am in anything but the 'mainline' of economic thought.

They continue: "Mainline economics emphasizes that the market is a dynamic process, that institutional and cultural context shapes that process, and that political institutions are themselves the product of exchange".

Of course I agree with all of this also, but have not found it in the writing of Dr. Krugman, Dr., Bernanke, Dr., Yellen, Dr. Randall Wray or the house economists at the NYT of Washington Post. Seems to me that 'mainline' economists specifically divorced the academic study of economics from political science and sociology around 1880-1900. Mark Skousen is among those who note that economic theory today views the economic process as static. And the concept of 'economic man' separates his motives for economic activity from political or social aims. It treats economic activity as pursuing ends in themselves rather than means for achieving non-economic ends.

Well, they justify their vocabulary by defining their own terms. They can define their theories and practice as 'mainline' and simultaneously term the actual economic theory reality as shown by the Krugmans and Bernankes of the world as 'mainstream', but transitory, merely 'trends'. So with this brief 'nit-pic', we can turn to describe the excellent ideas found in the book.

The authors continue: "We begin with a puzzle that had vexed economists for more than 200 years, and we briefly survey the empirical tools that might answer this question". These naturally constitute the 'mainline economic theory'. They promise to provide examples of how these theories, put into practice, resolve the problems.

"Why are some rich and others poor?"

This, they note, is the perennial question. They mention a few of the more obvious results of the condition.

"Economists have offered many possible explanations"
"What is the source of economic prosperity?"

Note that the question has already shifted from individuals to societies. They cite some of the many ideas espoused over time from those of Adam Smith on.

"How do we test these explanations?" They describe a few of the standard statistical and experimental tools such as 'regression analysis (least squares). And they note the limitations inherent in the available economic tools in comparison with their use by 'hard science'. In 'experimental economics' some leaders, such as Vernon Smith, have devised methods to conduct actual experiments - that is to create observational data that can be analyzed.

"But measurement without theory is impossible".

I am not clear about what the authors actually mean. But I cite David H. Fischer's excellent 'The Great Wave in an appendix to which he denounces the recent establishment academic demand that the student and researcher come up with a theory first and only then seek to find data that will support it. I see the results of this in perusing published articles and presentations at academic conferences. In geodetic science for sure measurement precedes theory. For instance, it was the surprising actual measurement of the period of the pendulum at varied latitudes that enabled development of the theory about the shape of the geoid.

Nevertheless, the authors proceed with pages of discussion from leading economists who insist that "measurement without theory is impossible because data require interpretation".
Well, 'interpretation' is not theory. Perhaps it is this thinking that lead to the classical joke in economics about something being true in theory but not in practice.

"So economists much theorize"
Indeed, the authors note, "The Big Question remains unanswered over 200 years since Adam Smith first asked it. Despite the advent of the Credibility revolution in econometric research, measurement without theory cannot offer credible answers to the question". But good theory will eventually come up with an answer.

The Mercatus center economist, Lawrence White's must read book - The Clash of Economic Ideas: The Great Policy Debates of and Experiments of the Last Hundred Years, was for me an 'eye opener' into what goes on in academic economics between and among its practitioners. I was carried back to the 12-13th century Scholastics, Paris and Cambridge, Franciscans and Dominicans. "Clash" is exactly right, but over what? If nuclear physicists had the same variety of conflicting thoughts about radiation that economists have about money we would never have created the Manhattan Project.

Sorry for being so cynical. The authors continue: "In the remainder of this essay, we aim to acquaint the reader with what we believe are the best theories in economics".... "these ideas are derived from mainline theories that have been at the core of economic thinking for centuries".
Yet we have a popular book by Dr. Professor L. Randall Wray - Modern Money Theory: A Primer on Macroeconomics for sovereign Monetary Systems, in which the author proceeds to describe the financial system of the United States and other countries which description negates all that economic thinking from irrelevant long forgotten centuries.

"Application 1: The Hidden Wealth of Nations"
The topic is why Mexican workers who move from Mexico into the interior of the United States earn more. The answer is that they produce more of greater output value. And the ability to produce more of greater value stems from the entire cultural environment as well as available technology and local institutions.

 
 

2 - The Core Themes of Mainline Economics

"In the following pages, we organize our discussion of mainline economic thinking around three principal ideas: the market is a process, institutional and cultural context shapes that process, and these political institutions are themselves the product of exchange".

OK, fine, lets agree at the outset that these are the actual thinking of the Mercatus Center inhabitants and evaluate them as such without detouring into consideration of whether or not they are the actual guiding theories of the inhabitants of the Federal Reserve or the Treasury or other US government agencies.

"The reader will note that each of these concepts roughly corresponds to a 'school' of thought. These are, respectively, the Austrian school the new institutional economics school, and the public choice school".

Indeed, we immediately recognize von Mises and Hayek among the first, Douglas North among the second, and James Buchanan among the third. And the authors proceed to cite these and others while describing the main ideas.

"Exchange is mediated by human institutions"

"What is economics?" "The roots of mainline economics stretch deep into the past".

But now we cite the aforementioned six noted prize winners.

"Mainline economics can be summarized by three propositions:
1 - the market is a process and it is driven by the human 'propensity to truck, barter, and exchange on thing for another'.
2 - The nature of this human exchange is profoundly influenced by the cultural norms and institutional rules within which it takes place.
3 - Given the right institutional environment, the natural human tendency to exchange will lead to socially beneficial outcomes. But exchange itself shapes the institutional environment, and there is no guarantee that the right institutional environment will evolve".

Greatly of interest, the authors then note that "mainline economics does not, for example assume that humans are perfectly rational or perfectly informed". But this and other of the concepts that 'mainline economics' does not accept are exactly the core principles of 'mainstream' economics as practiced by our financial, economic and political institutions adhere to today. Note also, that Dr. McCloskey takes issue with North's stress on institutions as opposed to cultural factors.

"Individuals - not organizations - act"

Indeed fundamental and often overlooked even when obvious. For instance corporations - businesses - actually do not Pay taxes, only individuals pay tax. But the public is continually led to think that corporations do pay tax.

"Incentives matter"

Good, it seems that even 'mainstream' economics recognizes this truth.

"Given the right institutions, individual actions will serve the common good"

Well, yes and no. Depends. If the discussion is about individual actions versus government actions then yes. But what about criminals, or even anti-social individuals?

"Property rights help us act better"

The authors' arguments here are excellent. I agreed not to discuss what 'mainstream' economists think.

"Both policymakers and researchers should exercise humility"

What a wonderful idea, Please speak to Dr. Krugman about this.

 
 

3 - A Market Process Economics

"Market exchange is a process"

Indeed it is a complex process conducted over time and often space. The authors' note: "The science that studies catalliaxy in he market order falls under the domain of 'catallactics'".

Is that a definitional tautology? Well, no matter. We find catalltics prominent in von Mises' Human Action, a real 'bible' of economic conceptions. That the process is indirect is also discussed by Hayek, and by Skousen in The Structure of Production, and by Mark Spitznagel in The DAO of Capital.

"The 'facts' of the social sciences include what people believe and think"

Individuals make decisions and then act on the basis of their beliefs.

"The meaning that individuals place on things, practices, places, and people determines how they will orient themselves in making decisions. The goal of the science of human action is intelligibility, not prediction - we seek to understand human behavior, no predict it".

"Human action is based on subjective costs and subjective benefits".

"All economic phenomena are filtered through the human mind. Since the 1870's economists have agreed that the value of a good is subjective. But, following the influential British economist Alfred Marshall, many have argued that the cost side of the equation is determined by objective conditions". "He failed to appreciate that costs, like values, are also subjective".

Exactly, 'value' is a subjective psychological appraisal that varies with time and place and a multitude of conditions. Yet we still have reams of investment advice focused on 'intrinsic' value of this and that. We still have books and articles about money being a 'standard of value'. Lets just insist that there is no such thing as 'intrinsic' value. And that 'value' is not an attribute that can be attached to any good or service, material or non-material. Ludwig von Mises understands this in his Theory of Money and Credit.

"Prices signal important information"

"Prices summarize the terms of exchange on the market. The price system signals relevant information".

That is absent government manipulation and controls.

"Competition is a process of entrepreneurial discovery"
"Many economists see competition as an end-state. ,,, "But in the real world of business, the term competition invokes an activity." ... "Entrepreneurs are alert to unrecognized opportunities for mutual gain".

"Social outcomes are often the result of human action but not human design"
"The market economy and its price system are examples of a similar process".

"Not all capital is created equal"
"Capital is the accumulated stock of assets - physical equipment, financial assets, and human knowledge - which helps us make and do more stuff. But how do producers know how to allocate their capital? The price system and profit and loss accounting guide production activities through time. Monetary calculation enables economic actors on the market to sort out from the numerous array of technologically feasible production projects those investments that are economically viable".

"The process of exchange works best when policy is predictable"

The authors mention examples but focus mostly on the recommendations of some economists that the Federal Reserve set monetary policy according to a set of rules that would make it predictable.

"Application 2: Unleashing Dynamic Competition"
Here the authors describe Mercatus economists efforts to define of what useful competition would consist.

"Application 3: The Great Recession"
The authors quote Rahm Emanuel's famous comment about not letting a crisis go to waste. They agree that crises "do often precipitate significant political and institutional change, sometimes for the better and sometimes for the worse". They continue with a discussion of the government responses to the financial crisis of 2008. They believe that some Mercatus research based policy recommendations will help prevent future mistakes. And they demonstrate that government policy choices for financing the private housing market during the years prior to 2008 were responsible for creating much of the financial situation that led to the disaster. And the government policies designed to alleviate the problem made it worse. Turning to the unemployment problem, they cite Casey Mulligan's research that demonstrates that government policies made that worse as well. See The Redistribution Recession.

 
 

4 - Institutions and Culture

"Transaction costs are real"

In this section the authors cite a wide variety of economists including Douglas North, Ronald Coase, Arthur Pigou, John Nye, George Stigler, and Oliver Williamson. The widely cited "Pigovian' solution proposed by that economist in 1920 is to tax polluters for the 'external' costs they create. But this has its critics. Ronald Coase is famous for his concept of 'transaction costs' first proposed in the 1930's. Improvements in organizational structures may reduce costs of production. And he also applied the concept to 'external' costs rather than institute Pigovian taxes.

"Institutions rule"

There are several economists who recently have supported the idea that formal and informal institutions have great causal impacts on economic outcome. Douglas North is a champion of this concept.

"Culture rules, too"

The authors cite their colleagues, Virgil Storr and Omar Al-Ubaydin for their research in the significance of culture as a factor in economic success. And they also mention the now famous work of Deirdre McCloskey on the bourgeois.

"Let freedom ring"

The authors return to Alchian's description of the importance of private property. And from this they move to the Mercatus Center research and publication about international and interstate measures of economic freedom. "there is a solid finding of a direct positive association between economic freedom and economic growth".

"The right rules improve the way the game is played"

The authors begin with: "While individual freedom may be philosophically and economically 'idea', it is by no means guaranteed that political orders will preserve freedom". And, "Not all constitutional rules enhance efficiency or liberty, however". They mention "A subfield of public choice and new institutional economics, known as 'constitutional political economy', studies the rules of politics". And, "With the advent of constitutional political economy, there has been a revival of interest in constitutional design. Much of this was kicked off by two books. The first was Hayek's Constitution of Liberty, .. Two years later James Buchanan and his colleague Gordon Tullock - who with Buchanan, was a founding father of public choice economics - published their seminal book. The Calculus of Consent".

While Hayek's work has been a fundamental reference for me, I have to admit that I was baffled when reading Buchanan's Calculus. More on this subject in a latter chapter.

"A polycentric order is usually a good order"

Here the authors cite Michael Polanyi for his 'mutual adjustment of a large number of centres'. The idea is that a complex system with many systems and centers is best able to enforce socially accepted rules and regulations. Such rule making bodies include the many overlapping levels from family up. Mercatus members have shown that decentralized governance with multiple centers and decision making bodies can be best.
"Many problems that were once thought to require top-down government intervention are actually better resolved through bottom-up polycentric orders".

"In its right form, federalism can preserve markets".

The authors cite numerous economists (many cited earlier) who have demonstrated through research that federally organized major governments have been the best in preserving market economies. They continue: "Perhaps the most celebrated consequence of market-preserving federalism is that it forces lower-level governments to compete with one another over capital, labor and economic activity by developing institutional environments conductive to growth". Unfortunately, "A number of authors contend that US federalism has become significantly less competitive over time".

"Application 4: Institutions, not personalities"

 
 

5 - The Political Process

The chapter is about 'public choice'.

The authors open by crediting Gordon Tullock along with James Buchanan with creating the concept and study of 'public choice economics'. This is the name they selected for the concept that government officials (rulers) actually have their own personal interests at stake when making government decisions. But they describe both the 'pre-public choice' standard view of economists and their new view in different terms.
The authors express this in Tullock's terms thusly: Tullock argues that "economists 'listened' to the market, identifying all of the ways it seemed to fail to live up to an idealized goal and then - without critically analyzing how government would perform in the market's stead - called for government intervention to take the place of market mechanisms". But, "Public choice economics listens to the market and applies the tools of economics to political settings in order to understand how political outcomes are determined".

Seems to me there is more to it than this. The economists who don't 'listen to the market' are supporters of politicians and political agendas that do not want to accept the decisions made by the market instead of their own politically based decisions. So of course they 'don't listen' but instead insist on blaming the market for failing to enable the policies they want - that is policies that favor themselves and/or their supporters. Blaming the market (or better yet, private interests that do 'listen' to market signs) are standard ploys in advocating non-market policies. To them, markets are intrinsically 'unfair'.
Here are two important references - James Buchanan &Gordon Tullock - The calculus of consent - and James Buchanan and Robert Tollison eds. TheTheory of Public Choice II.

"Human nature is the same in and out of government"

The authors write that: "But a great deal of public policy is made with the implicit assumption that humans are stupid, nasty, or venal when they are in the supermarket or the boardroom but wise, angelic, and selfless when they walk into a voting booth or accept a civil service position". And "But there is no reason to start the analysis with a romantic view of political activity".

Seems to me that this idea gives too much credit to the 'romantic' position of politicians.

"Humans are all rationally ignorant"

The authors term this thusly: "No one is perfectly informed before he or she acts. That's because becoming informed is costly: it takes time, money, and effort to acquire information".

Thus, the authors write that it is rational to have personal priorities other than obtaining information about subjects of lesser concern.
But, they add, quoting their colleague Bryan Caplan in The Myth of the Rational Voter, that voters frequently base their selection on really irrational choices.

"There are externalities in politics, too"

The authors note that there are results affecting others 'externalities' that are due to the actions of individuals and that these should (must?) be countered by government action. They note that government actions also create 'externalities"

"The political process concentrates benefits on the few and disperses costs across the many"

The authors claim (is this a surprise?) that the benefits and costs generated by political policies and actions are not evenly spread, benefits go to a small group while costs are born by a large group.

I rather believe that benefits go to a favored group while costs are born by the unfavored group, irrespective of the numerical size of each group. But the authors cite research by their colleagues.

"When humans seek rent, resources are wasted"

First I need to explain what 'rent' in this usage means. because it has nothing to do with renting a house. It comes from the French terms - rentes heritables and rentes viageres meaning, respectively a revenue stream that could be inherited by an heir and one that ended at the death of the purchaser. In other words bonds (securities) issued against debt that were perpetual generators of interest income and bonds that terminated at the owner's death. Now, the British created very successful perpetual bond that was called a 'consol' from consolidated. But the French term due to its disastrous results was used to name rentiers, those who lived on the income from their perpetual interest paying government bonds. And during the Napoleonic wars when British government reached horrendous massive levels, these rentiers became public ogres despite the fact that they were mostly very normal bourgeoise including widows and descendents. Thus the living off of interest income was denounced. And thus it has continued to today. Keynes especially hated rentiers and sought to establish economic policy that would create the "Euthanasia of the Rentier" in Niall Ferguson's words.
So when the Mercatus Center writers claim that of those who seek 'rent' they create economic 'inefficiencies' they are thinking about people who seek to obtain illicit returns for as little as possible and this is mostly possible by obtaining special government favors, such as monopoly over some economic resource. It really has little or nothing to do with the original rentiers.

As they note: "With its monopoly on the legitimate use of force, government can help firms contrive exclusivity in a number of ways; in an offer a legal monopoly; a subsidy; a loan guarantee; protection from foreign competition; a bailout; the promise of a bailout; favorable tax treatment; or a regulation that limits entry, mandates a product's purchase, or raises the costs of a firm's rivals". Further, they write: "Estimates suggest that in the United States, annual rent-seeking costs are between 7 and 23 percent of gross national output".

"Regulators get captured" In this section the authors cite examples of the very common (actually typical) results of government created regulations which then require appointment of regulators to administer them. Namely, that the regulators become 'captured' by those whom they regulate.

It seems to me that it should be amazing that anyone believes this could not be the natural case. Unless one favors regulation by idiots (actually often the case) one should expect that either regulators know less about what it to be regulated than do its practitioners or that regulators have to had personal practical experience as practitioners.

"Politics makes strange bedfellows out of 'bootleggers' and 'Baptists'".

Citing actual cases of these metaphoric stand-ins what the authors describe is situations in which private interests will encourage the regulators to enjoin some activity so that the private parties can make use of this prohibition to exploit it.

"Agenda setters may be able to determine the outcome"

This is another ploy by private interests to manipulate outcomes of rules or even voting procedures by setting the terms (even the words used) that the public will see. They do not mention this specific example but it is well known that the outcome of voting referendums or opinion polls depend on the wording of the documents being read.

"Politics is about exchange"

Here the authors return to citing James Buchanan who described political activities as exchanges similar to economic exchanges.

It seems to me that not only are political activities exchanges but also in reality both political and economic exchanges are interrelated with each other. In other words an economic good may be exchanged for a political good and a political good may be exchanged for an economic good and in fact such exchanges are more common than merely frequent.

"Application 5: Giving voice to diffuse interests"

This is an interesting section in which the authors describe some of the Mercatus Center's efforts to have a positive influence on political public policy. One comment they make: "It does not preclude the possibility that academic ideas can influence the climate of opinion, raising the political costs of bad policy and lowering the costs of good policy".

Certainly true, but it seems to me that over the past 50 years at least the influence of academic ideas has influenced opinion to support the lowering of the political costs of bad policy while raising the costs of good policy. Thus the Mercatus Center has a huge task ahead of its. Among their efforts that they mention is to influence political policy in the effort to abolish the Ex-Im bank, in which they feel successful. We will wait and see, but so far this obvious target still stands.

"Application 6: The Stimulus Debate"

In this section they describe Mercatus Center research focused on three claimed aspects of economic 'stimulus' - being 'timely, targeted and temporary'. They cite several studies that have shown that it was none of the three. But the publicly anounced purpose of the so-called 'stimulus' was to create 'shovel ready' construction projects that would require creating new jobs.

But in my opinion that was not the real purpose of the 'stimulus' expenditure. Rather it was to subsidize union auto workers, union teachers, union local government workers by a massive infusion of cash. In this respect it was indeed timely and targeted, while temporary it put pressure on other actors to keep it from being temporary.

While I fully agree with everything found by the Buchanan cohort called 'public choice' I do wonder about the idea that this appraisal of actual politics and politicians is considered new or surprising. Surely every student of history - at least those who were fortunate to study it several decades ago - will have learned then about the reality of politics and the selfish interest of politicians. For an enjoyable read about Roman politics read Qintus Cicero's How to Win an Election.

 
 

6 - A Liberal Program that Appeals to the Imagination

This chapter is about the origins and development of the Mercatus Center with the names of some of its most influential members. The authors write that it is a response to F. A. Hayek's 'challenge' in 1949 to organize' "to make the building of a free society a deed of intellectual courage". They write that James Buchanan was the active leader in this effort. It is an excellent chapter to read and learn about how a vision can be realized in an active institution.

 

Return to Xenophon.