I’m an economics professor, and I thought you might all like to know why a vast majority of my colleagues are supporting Obama. Basically, what I want to tell you is that Republicans have a decent grasp on what I’ll call Econ 101, but completely miss the boat on Econ 102.
Econ 101: Markets do some amazing things.
This idea goes back to Adam Smith, who published "The Wealth of Nations," fittingly, in 1776. A fun example was given by Tim Harford in his great book "The Undercover Economist." He asks "Who coordinates the bread supply to London?" It sounds like a daunting job until you realize the answer, of course, is no one! That famous invisible hand results in each store owner ordering just the amount he expects to sell, etc., so that the amount supplied is very close to the amount demanded. The decentralized market works so well that it allocates resources better than the most brilliant centralized planner. Markets not only work, their evolution is so inevitably tied to human nature that they arise "underground" when governments try to prohibit them (e.g. not only Soviet Russia, but ticket scalping, the illegal drug trade, etc.)
Republicans do seem to have taken Econ 101. Maybe many times. In Fall 1994 I was a couple of months into my freshman economics course when I saw Mitt Romney debating John Kerry in the Massachusetts Senate race. Mitt seemed to have an excellent grasp of the free-market principles I had just been learning, and I was impressed. It seems fitting that I was a few months too young to vote in 1994, for I would soon advance a little further, and learn...
Econ 102: Markets don’t do everything. At some vital tasks, they can fail completely.
By the way, I learned most of the following in my introductory course, which was taught by Martin Feldstein, chief economic advisor to Reagan. It’s not what a few liberal professors think. It’s what all intellectually honest economists who have thought deeply and carefully about these issues agree on.
Failure 1: Markets underprovide, or fail to provide, public goods.
Stephen Colbert put this brilliantly when he interviewed small-government advocate Grover Norquist, who was predictably going on about how horrible it was that government would tax and spend our hard-earned dollars. True to character, Colbert responded (roughly) "Yes, I get so mad about government spending, I refuse to drive on any public roads. I just drive around and around my own driveway."
Basically, since the benefits from a public good are spread around, no one person has the incentive to pay for it. So we as a society must enter into an agreement that everyone will pay, so that we’ll all be better off. Taxes aren’t evil. Oliver Wendell Holmes called them the "price of civilization." Anti-tax extremists should take a hard look at parts of the world without a functioning government.
Now, yes, we need to be very alert to wasteful government spending. While some government spending is vital, there are surely many boondoggles out there. But, I’m not sure I can put this better than Obama: "We need a scalpel, not a hatchet." Did everyone notice the exchange in the third debate when McCain brought up autism research? Obama pointed out that was the kind of thing McCain couldn’t fund with his hatchet of a spending freeze. Checkmate, I thought. But, completely oblivious, McCain had the snide comeback, "Do you notice how he’s always talking about spending?"
It’s like a professor debating a C student*. You may have met the type: an overconfident C student who either thinks he actually knows something, or just knows if he keeps talking confidently enough, the part of the class who doesn’t follow the arguments will think he’s scoring points. I was relieved to see in the post-debate polls that most of the class was with the professor.
*Of course, it also is a professor debating a C student. To be more precise, a failing student who got C’s because of family connections.
Failure 2: Markets for health insurance unravel due to "adverse selection."
One of the most ridiculous things we’ve heard from McCain is the conservative canard that health insurance should be left to the free market. He’s counting on voters not to think beyond "freer is better," but theory and overwhelming evidence both make it clear free markets just don’t work in this case.
Suppose a company charges a premium equal to the average health expenses for all citizens. Well, roughly, the sicker among us will think that’s a good deal and sign up, while the healthiest will opt out – that’s called "adverse selection." Average costs will be higher than anticipated, and the company will start losing money. They will have to raise prices. But now, even more people towards the healthy end will drop out, average costs will go up again, leading to higher prices, etc., etc. Eventually prices will be sky-high, and only the very sick will pay them – the rest will go uninsured. Of course, that’s not really insurance at all. This isn’t just theory – this is why non-employer-based health insurance is hugely expensive, and many of the self-employed are uninsured. So much for the supposed Republican love-affair with small-business owners! Good luck if you get sick, Joe!
Failure 3: Markets don’t account for externalities
An externality is the impact of a transaction on people who took no part in it. The leading example is pollution. Bob makes an individual decision of how much gasoline to use at the going price. Bob and ExxonMobil agreed to this transaction. The rest of us had no say. But, we all feel the consequences.
The economist’s solution (due to Pigou) is to tax gasoline at a rate that roughly reflects the damage from pollution, so Bob pays for the harm he’s inflicting on everyone. McCain actually seems to have acknowledged that we should fight global warming (not that I trust him to go about it intelligently,) so I’ll let this one rest here.
Failure 4: Markets do not necessarily distribute wealth according to the true contributions of individuals to society, or by any reasonable standards of fairness
I loved how Warren Buffett put this, as related by Obama in "The Audacity of Hope." Buffett explained that while he has certain valuable skills, they are valuable only in the context of an advanced civilized society: "I don’t run very fast, and I’d probably get eaten in the jungle." Every dollar he makes comes from the combined efforts of (1) his skill at allocating capital to efficient businesses, (2) the management and workers at those businesses, (3) the public infrastructure without which businesses don’t run. His friend Bill Gates’ wealth comes from (1) his administrative skills, (2) a few ideas about software he had (or stole,) (3) the ability and labor of his employees to further his ideas (and create new ones which Gates then owns,) (4) the productivity of countless other businesses which makes it profitable for them to buy Microsoft software, and (5) public infrastructure which lets all of these businesses run.
In an advanced society, there is no such thing as a dollar you made entirely yourself. All business relies on our heavily interconnected economy – even the local barber relies on the roads and cars and gasoline that transport his customers. Everyone’s wealth is partly due to their own effort and talent, and partly due to the resources and labor of the economy as a whole. Crucially, furthermore, financiers and CEOs make a far greater percentage of their wealth by piggybacking on the entire structure of society than ordinary workers and small-business owners. So, if we tax them a little more, and tax workers a little less, it’s only "redistribution" relative to the skewed standards that have developed during the Bush administration. They are just being asked to pay a little more towards maintenance of the civilized society without which they wouldn’t make a dime.
Yes, Marxism is a failure, and we do need incentives for private businesses to grow. But Obama’s tax plan is about as Marxist as a molehill is Mount Everest. CEOs will still do just fine. Do we really think they will stop trying to expand their businesses because the government takes a few percent more? For the super-rich, money is more about keeping score than anything else; a higher score is still higher even if it’s scaled down a few percent.
Buffett has the perfect answer to those who cry class warfare: "There’s class warfare now, and my class is winning."
I may talk about other market failures in a future posting. I haven’t directly addressed the housing and banking crisis, which I could say a few words about. But, for now...
Conclusion: Free markets do some great things, but "free markets" as a slogan is used to perpetuate policies that just don’t work, in cases where economists understand perfectly why free markets don’t work.
As Obama has put it, our current state of affairs is the final verdict on trickle-down economics. "Prosperity didn’t trickle down; pain travelled up."