Should Libertarians Embrace ‘Left’-Heterodox Economics?

Recent posts by Noah Smith, David Henderson and Daniel Kuehn on the relationship between economics, ‘free markets’ and policy in general got me thinking about libertarians and how accepting they should be of marginalist economics, as well as how open they should be to non-marginalist alternatives. It seems to me there is an unspoken bond between marginalist economics and libertarianism (even Austrianism shares some major features with neoclassical economics), and so there may be a tendency for libertarians to have strong priors against post-Keynesian, Sraffian, Marxist, Behavioural, Ecological and other types of economics that dispute this general framework.

Let me note that I’m not accusing libertarians of being generally hostile to heterodox economics – I’m sure there are some who are and some who aren’t. Instead, I’m just warning against such a possibility, and offering some heterodox ideas to which libertarians might be receptive.

Behavioural/post-Keynesian consumer theory: behavioural economics sometimes elicits rebukes from libertarians, as it seems to imply that ordinary people are not able to make decisions rationally, and therefore that  policy makers should help them along their way. Naturally, libertarians object to this idea, questioning the experimental methods of behavioural economics, pointing out that policy makers are themselves imperfect, and so forth. I’m not going to comment on the efficacy of these arguments here – sometimes they are fair, sometimes less so. Instead, what I want to point out is that while some behavioural economics implies a role for activist policy, it’s not necessarily the case that a view of consumers which differs from the optimising agent renders the agent somehow irrational and therefore ripe for intervention.

One such example is a version of the mental accounting model, used in post-Keynesian consumer theory, in which consumers organise their budget into categories before making spending decisions. Consumers will not spend money in one category until they have had their needs in a more ‘basic’ or ‘fundamental’ category satisfied, which creates a Maslow-esque hierarchy of spending – starting with necessities such as food & shelter and culminating in yachts & modern art. This means relative price changes do not have as much of an impact on the type of goods bought as implied by the utility maximising model; instead, the amount spent on different types of goods is primarily determined by the consumer’s level of income.

On first inspection, this might seem to imply a tirade against the efficacy of the price system for coordinating preferences and scarcity, as well as a comment on the ‘wastefulness’ of inequality (and perhaps it could be interpreted as such). However, this doesn’t necessarily make the theory generally ‘anti-libertarian’. In fact, one major implication is that placing high taxes on something low in someone’s hierarchy will not have much impact on their spending, and hence ‘sin taxes’ – which are a major expense for the poor – will not reduce their consumption of  alcohol/smoking substantially; instead, these things will simply take up more and more of their income (which is pretty consistent with available evidence). This implies that paternalistic tax policies aimed at the poor will generally fail to achieve their aims.

The Market for Lemons (TML): George Akerlof’s famous paper explored information asymmetry, using used car markets as its primary example. Akerlof was trying to understand what buyers do when they face a product of unknown quality, and argued that since they are unsure, they will only be willing to bid the average expected value of a car in the market. However, if the seller is selling a ‘good’ car, its value will be above this average, so the seller will not sell it at the price the buyer offers. The result is that the best sellers drop out of the market, creating a cumulative process which results in the market unravelling completely.

Though theoretically neat and compelling, this ‘seminal’ example of market failure has always struck me as incredibly weak, for the simple reason that used car markets do not actually fall apart. Why? Maybe people aren’t rational maximisers etc etc (for example, in another nod to behavioural economics, it may be that buyers’ irrational overconfidence leads them to go ahead with a purchase, even if it’s statistically likely they’ll get a ‘lemon’). Ultimately, though, I’d argue the answer is that capitalism – or if you prefer, ‘the market’ – is a network of historically contingent institutions and social interactions, rather than abstract individuals trading in a vacuum where outcomes are mathematically knowable. The reason used car markets work ‘despite’ information asymmetry is due to hard-to-establish trust and norms between buyers and sellers, and due to intermediaries such as auto trader, who spring up to help both sides avoid being ripped off. I’ve not seen anyone provide an example of the process TML outlines actually occurring, so I don’t see why it adds to our understanding of markets.

To be fair to Austrians, they have been talking about ‘the market as a social process’ for a long time, and in places have disputed the Lemons Model on similar grounds to the above. Hence they have something in common with old institutionalists, Marxists (to a degree) and perhaps even hard-to-place heterodox economists like Tony Lawson, who argues economics should primarily be a historical, rather than mathematical subject. To put it another way, while heterodox economists typically advocate a move away from marginalist economics to understand why capitalism doesn’t work, such a move may also be necessarily to understand why it does.

Mark up Pricing: Post-Keynesian, Sraffian and Institutionalist economics typically subscribe to the cost-plus theory of prices, which states that businesses set prices at their average cost per unit, plus a mark up. Furthermore, they avoid price changes where possible, preferring to keep their prices stable for long periods of time to yield a target rate of profit, varying quantity rather than price, and keeping spare capacity and stocks so that they can do so. The problem libertarians might have with this is that it implies prices are somewhat arbitrary, do not usually ‘clear’ markets, and do not adjust to the preferences of consumers especially smoothly. However, while these things may be true, they do not mean mark up pricing comes with no benefits.

In my opinion, one such benefit is stability: I’m glad I can rely on prices only changing every so often, and that if there are a lot of people at the hairdressers he doesn’t raise the price to ‘clear’ the market. Furthermore, the fact that firms keep buffer stocks and can adjust quantity instead of price allows them to deal with uncertainty and unexpected demand more easily, making them more adaptable to real world conditions than if they always squeezed every drop out of their existing capacity. While I’m not going to pretend post-Keynesian pricing theory doesn’t imply some anti-libertarian policies (particularly with regards to price regulation), but it’s certainly not a one sided idea, and its policy implications are open to further interpretation.

I generally prefer to refrain from immediately linking everything to policy as I have done above, because, well, there are enough people doing that. However, the examples I’ve given actually help to demonstrate a point about the relationship between economic analysis and policy: theories with premises that seem to imply a certain policy may not once you’ve followed them through to their conclusions. What’s more, the same analysis can seem to imply different policies from different perspectives (at its most extreme, Austrian Business Cycle Theory seems to imply that even a teensy regulation will send capitalism off the rails, which could be interpreted as a damning criticism if you were a leftist). This means calls for pluralism in economics should be embraced by all, even if on the surface some ‘alternatives’ to mainstream economics seem to conflict with one’s world view.

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  1. #1 by Jon Finegold on May 20, 2014 - 8:18 pm

    Austrians who dispute the Akerlof’s Lemons paper simply haven’t read it well enough. I make that case here. But, we shouldn’t be surprised that Mises.org would publish such a poor criticism.

    • #2 by Unlearningecon on May 20, 2014 - 10:04 pm

      You make a good point, but I still have a couple of issues:

      (1) Not all used car markets have these kinds of institutions behind them.

      (2) Clearly, institutions can help people (consumers) overcome uncertainty about what they’re getting. But this can be the case without an actual ‘Akerlof-spiral’. I’d be interested to see at least some investigation into how these institutions formed, what happens without them and whether or not this is all consistent with Akerlof’s theory.

      I had my reservations about linking to Mises.org, but to be fair to them I don’t think that article was especially weak. There’s a difference between a criticism being weak and being wrong.

      • #3 by Jon Finegold on May 21, 2014 - 1:32 am

        Anderson writes that Akerlof’s solution is “more government intervention.” No, that’s not Akerlof’s solution. I’m sure that’s a solution Akerlof has in mind, but he also spends much of the paper talking about the institutions I stress in my summary. This part of the paper is rarely discussed by Austrians, and it suggests that many of them haven’t carefully read it (many have, because when other Austrians bring up the same criticisms, they suggest reading the fifth part of the paper).

        For the same reasons, this is false, “According to Akerlof and others, market participants, facing the realities of imperfect information, have little or no incentive to gain more information for themselves.”

        Ironically, Anderson goes on to talk about institutions his buddy car salesman had to help overcome asymmetric information. But, he doesn’t mention that Akerlof talks about this exact same thing in his paper! He, in fact, acts as if Akerlof never did!

        He then writes that Austrian analysis is “far superior.” That’s a vague and misleading argument. I have never read Mises or Hayek or Rothbard bring up Akerlof’s lemons problem before Akerlof. That some Austrians are so hostile to the idea suggests that these prior Austrians did not discuss the issue. So, clearly, in that narrow sense, Austrian analysis is not “far superior” — it doesn’t talk about the issue at all.

        If Anderson turned that into me as a student, I’d probably give it a C, with a big note at the top telling him to re-read the paper, because he obviously didn’t read it carefully.

      • #4 by Unlearningecon on May 21, 2014 - 10:59 pm

        Well, I’m not going to sit here and disagree with you about a criticism of William Anderson! In any case, it was just really an example of an Austrian making a similar point to me. I suppose at this stage I have such low standards for Mises.org that I largely ignore all the anti-government ideology.

  2. #5 by Philip Leclerc on May 20, 2014 - 8:38 pm

    Menger was of the Austrian school and a key developer of marginalist theory, right? Seems less unspoken and more like a key figure devoted to and influential within both veins of thought.

    • #6 by Unlearningecon on May 20, 2014 - 8:47 pm

      The ‘unspoken’ referred to libertarianism and marginalism, rather than austrianism and neoclassicism. In any case, libertarians can be resistant to both points, which you’ll find if you look at the comments/subsequent posts to which I link.

      • #7 by Philip Leclerc on May 21, 2014 - 2:03 am

        Oh, hm.

        I guess I think of Austrians as a subset of libertarians; it is easy to imagine a libertarian who is not Austrian (or, hell, even has any idea what Austrianism entails). But it is hard for me to imagine an Austrian whom is not libertarian; it seems an economic philosophy basically tailor-made to justify non-interventionism.

        But I think that helps me see what you were trying to say? An unspoken bond between libertarianism and marginalism could make sense, in my understanding, if it is primarily between non-Austrian libertarians and marginalism. If that was the intent, then I think I understand.

      • #8 by Unlearningecon on May 21, 2014 - 10:57 pm

        But it is hard for me to imagine an Austrian whom is not libertarian; it seems an economic philosophy basically tailor-made to justify non-interventionism.

        These days, and especially on the internet, it is. However, they do exist: for example, Ludwig Lachmann, who endorsed numerous interventions and thought ABCT was only one of a number of explanations for the business cycle. Also check out George Selgin, and Jonathan below, both of whom seem to endorse key tenets of Austrian theory but are not ‘strict’ libertarians or Austrians.

        An unspoken bond between libertarianism and marginalism could make sense, in my understanding, if it is primarily between non-Austrian libertarians and marginalism. If that was the intent, then I think I understand.

        Well, that’s only part of it: I also think Austrian economics has a connection to neoclassical economics which is often overlooked. But maybe we’re just getting muddled in the various labels and definitions at play here.

      • #9 by Philip Leclerc on May 21, 2014 - 2:04 am

        p.s. Can’t seem to reply via G+; keep getting the same error repeatedly, no matter how many ways I try. Weird.

  3. #10 by cmamonetary.org (@CmaMonetary) on May 21, 2014 - 7:38 am

    Usually the truth is somewhere in between. Cant people understand there is limitations to all theories? No theory is completely true or completely wrong. I think what is obvious is that some people get into economics so they can have something to argue about and take sides with and they aren’t truly into economics to understand it on a profound level. Its like sport, some people follow the Chicago bulls just to cheer for something but not necessarily because they love basketball too much.

  4. #11 by Magpie on May 27, 2014 - 4:17 am

    Unlearning,

    Glad to see you posting again: you are the person who can help me (the timing is just unbelievable).

    I’m very interested in Post-Keynesian mark up pricing. Would the following text qualify as an accurate example of Post-Keynesian mark up pricing?

    “Suppose a particular car has a retail price of $10,000. The cost theory would explain this market value by pointing out that the producer had to spend (say) $5,000 on the engine, $2,500 on the metal and plastic for the frame, $1,000 on the glass for the windshield and windows, $500 for the tires, and $500 for the labor and depreciation of the machinery needed to assemble the vehicle.
    “The direct cost of production of $9,500, coupled with a retail price of $10,000, allows for a healthy return on the invested capital: the mark up.”

    In other words, the Post-Keynesian mark up is in essence the accountancy mark up?

    Thanks!

    • #12 by Unlearningecon on May 27, 2014 - 12:14 pm

      That’s somewhat accurate but I doubt that it would be that reductionist: for example, firms would be more likely to include replacement costs than ‘depreciation’ as defined by neoclassical and Marxist theory. Clearly, many costs are not per unit (machinery, bulk orders) but are aggregate, and so the average cost per unit would be calculated by total costs (note that unlike neoclassical theory, this includes fixed costs) divided by the expected output. The mark up would also be a target rate of return and the individual price would emerge from aggregate decisions, rather than ‘cost per unit plus mark up per unit’.

      Also, though I realise it’s just an example, your mark up looks too small!

      • #13 by Magpie on May 27, 2014 - 7:53 pm

        Great! Thanks. Much appreciated.

        “so the average cost per unit would be calculated by total costs (note that unlike neoclassical theory, this includes fixed costs) divided by the expected output.”

        I suspected as much but I wanted to confirm my suspicion by asking someone knowledgeable and impartial.

        “Also, though I realise it’s just an example, your mark up looks too small!”

        Indeed! That’s because it’s not my example. :-)

        It comes from this article (http://mises.org/daily/5297/Problems-with-the-Cost-Theory-of-Value) which I’ve seen negatively commented in a well-known PoKe blog and I wanted to see how fair that negative comment was.

        Have you read that article before? If so, what do you think about it?

      • #14 by Unlearningecon on May 29, 2014 - 8:41 pm

        The whole thing just seems to be an exercise in circularity, or even tautology, to me. If we reason backwards from market prices as Murphy suggests, asserting at every stage that the price is set by ‘what consumers want’, then conclude that prices are set by what consumers want, we’ve not proved anything. Similar problems apply to a pure cost based theory, as obviously costs and prices are at least partially the same thing.

        No theory so far can actually predict prices in the real world, and I doubt one ever will be able to. Cost-plus pricing, however, doesn’t really pretend to be a theory of value; instead, it just describes the real-world process of how prices are set and what influences them. In many ways Murphy’s article is irrelevant to this point.

  5. #15 by Blue Aurora on May 29, 2014 - 3:59 am

    Unlearningecon: Although you don’t mention it…is it just me, or do Austrians and libertarians seldom discuss the Ellsberg Paradox?

  6. #16 by Magpie on May 30, 2014 - 4:46 am

    @Unlearning on May 29, 2014 – 8:41 pm

    “If we reason backwards from market prices as Murphy suggests (…) Similar problems apply to a pure cost based theory, as obviously costs and prices are at least partially the same thing.”

    That’s the beauty of Murphy’s story: as you correctly say, the “prices explain prices” applies to markup/cost-plus. But, as Murphy himself admits (see his **footnote**), his cricitism does **not** apply to the LTV.

    To put it graphically: Murphy is throwing the cream pie at markup’s face, not the LTV.

    That’s why PoKe authors claim (with no argument whatsoever!) that Murphy does not understand markup pricing (which he obviously does) and that his criticism actually addresses the LTV (instead of markup): they know he’s got a point, so, as in the old Three Stooges routine, they try to duck, hoping the pie hits someone else’s face, in this case the LTV’s.

    The Three Stooges – Pie Fight .

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