Bound Together:Two Competing

Visions

Thomas J. Sargent

Covenant University

May 5, 2014

1 / 34

Two Visions

Planning versus unfettered markets

The Tyranny of Experts, William Easterly

2 / 34

Substance and implications of the debate

Intellectual foundations of planning and free marketsComputational methodsIronies abound

I

I

I

3 / 34

An Economy

People of various ages, talents, preferencesNon-human resources like land, air, waterTechnologies for producing goods of various kinds

I

I

I

4 / 34

Economic questions

ProductionDistribution

I

I

5 / 34

Economic questions

How should resources (people, land, water, air) be combinedto produce different goods? (“production”)How should goods be distributed among different people? (“distribution”)

I

I

Karl Marx: “From each according to his ability, to each accordingto his need.”

6 / 34

Who is to decide

Production (allocating inputs) and distribution (allocatingoutputs)?

Competing classic answers:Government plannersNo one – an invisible hand

I

I

7 / 34

Scientific methods for answering ‘who should decide?’

Intuition and English languageMath

I

I

8 / 34

Who should decide?

The invisible handAssertion of faith in good unintended consequences

I

I

9 / 34

Law of unintended consequences

One of Milton Friedman’s favorites

10 / 34

Adam Smith

Moral philosopher – Theory of Moral SentimentsEconomist – Wealth of NationsEach book contains describes the activities of the invisible hand

I

I

I

11 / 34

An invisible hand

By directing that industry in such a manner as itsproduce may be of the greatest value, [the individual] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of society more effectively than when he really intends to promote it.

12 / 34

An invisible hand

It is not from the benenovelence of the butcher, thebrewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages.

13 / 34

Adam Smith

Prices send signals back and forth between producers andconsumersCompetition means that no one sets prices – an invisible hand

I

I

14 / 34

Competition

Decentralization“production” and “distribution” are decided jointlyIncentives and information

I

I

I

15 / 34

Power

No market powerSpontaneous order

I

I

16 / 34

Smith’s list of enemies of invisible hand

Monopolies (market power)Government impediments to competition and support of monopolies

I

I

17 / 34

Proof ?

Smith’s argument was verbal and informal.1776-1939, economists sought to formalize a formal proof forSmith’s ‘invisible hand’ assertionAn effort to understand more thoroughly the “ifs’ that implyAdam Smith’s “then”

I

I

I

18 / 34

Proof ?

The quest for a proof led to many discoveries along the way – rolesof returns to scales, monopolies, monopolistic competitition, number of markets needed to be open, information available to traders, . . .

19 / 34

Proof – the welfare theorems

Pareto, Hicks, Oskar Lange:Method of proof: formulate a grand optimal resource allocation optimizationUnder some ‘ifs’, then . . .

20 / 34

Victory: proof – the welfare theorems

Just as Smith said, a competive equilbrium allocation is good(i.e., optimal), but . . .The same allocation can be obtained by a command economy run by a “benevolent planner” who issues orders to workers and consumers and who don’t see prices

I

I

21 / 34

Two interpretations

Smith wins – free markets, unfettered competitionBenevolent socialist wins – command economy

I

I

22 / 34

Ironic consequence

The cases in favor of ‘planning’ and ‘free markets’ are tied togetherintellectually and not easily divorced

23 / 34

Caveats

The ‘ifs’ are importantInformation available to people and the plannerNature of technologies – returns to scaleNature of the goods – private or public, ‘rival’ or ‘non-rival’

I

I

I

24 / 34

Followup – a great debate

Planning versus complete trust in free markets and unfettered,unplanned competition

An important but tenuous debate because of shared intellectualfoundations

25 / 34

Examples

Friedman and free bankingSocial security – government or private?

I

I

26 / 34

Hayek’s attack

Hayek objected to the ‘welfare theorems’ because they ignoreddifficulties of private and disparate information, dynamic processes of learning, experimentation, trial and error.He doubted whether there could exist a benevolent, knowledgeable, and disinterested planner – a harmful fictionHe said that existing mathematical formalisms did not capture what a free market economy accomplished, and doubted that mathematics ever would

I

I

I

27 / 34

Accepting Hayek’s challenge

After 1950, modern economic theory accepted Hayek’s challengeto add dynamics, disparate information, conflicting interests – many ‘incentive constraints’ – to social allocation problems. Mathematics a key tool.

Irony: through modern versions of ‘mechanism design’ andpost-Hayek ‘welfare theorems’, the intellectual cases for free markets and planning remain intricately linked.

28 / 34

Computation and another irony

Relation to planning in WWII – linear programmingUsed to compute competitive equilibria in scientific modelsComputationally challenging

I

I

I

29 / 34

Another irony

Distributed computing – break one big problem into manysmaller problemsStarts to look like a decentralized competitive economyCurse of dimensionality

I

I

I

30 / 34

Reallocation

Creative destruction

Exits and entries – firms in US Job creation and destruction

I

I

I

31 / 34

Banks

Time, savings, projects, ideas, matching savings to ideas andprojects

32 / 34

Incentives

33 / 34

Adaptation versus design

Return to Easterly book Tyranny of Experts

34 / 34