WorldSys – Austrian Home Study Course, Week 13

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

READINGS: Chapter 15 of Gene Callahan’s Economics for Real People

1 What is welfare economics?

Welfare economics attempts to study the impact of various policies on total, aggregate social welfare.

As you can imagine, Austrians consider this approach to be problematic.

2 What is a positive (negative) externality? Give an example of each.

When a person does something that has an effect on other people we call this effect an externality. If I burn tires in my backyard the smoke and the acrid stench will waft onto my neighbor’s property, creating a negative externality. If, feeling remorseful, I design and build a bleeding-edge air purify which scrubs the atmosphere of the entire neighborhood free of allergens and irritants, that is a positive externality.

From an economics standpoint a problem arises if these positive/negative externalities aren’t baked into the prices of the relevant goods and services. If my shirt factory is polluting a river and I don’t suffer a penalty then I’m producing more than the ‘correct’ amount of shirts. The price of making each shirt is a little bit of pollution, but if I bear no pecuniary responsibility for this pollution than I will make more shirts than is warranted, just as I would if I got the fabric for free.

An inverse problem occurs with positive externalities. If I put up the funds to clean the polluted river then there likely isn’t a good way for me to ‘charge’ people for this service. They receive the benefits of a cleaner river without having to pay for them. What this means is that services of this kind, where costs are centralized and benefits are diffuse, are less likely to be provided because it is so difficult to capture the value created.

3 What was Pigou’s policy recommendation in the case of a positive externality?

A state mandate or subsidy.

4 What was Pigous policy recommendation in the case of a negative externality?

Regulations or taxes.

5 Explain Lionel Robbins’s critique of the Pigovian analysis.

Robbins noted that we cannot simply compare utility between people, as Pigou’s analysis requires. There’s no way for me to determine the correct tax rate for a negative externality by saying ‘everyone everywhere suffers -5 utility from +1% air pollution, so we must tax the local factory at .08%’.

6 What is the Pareto criterion of an improvement in social welfare?

Instead, Robbins advocated for using ‘Pareto improvement’ as a criterion for welfare economics. A given policy is a Pareto improvement if it makes at least one person better off while making no one worse off.

7 According to Rothbard, how can the observer draw conclusions about another’s preferences?

In his 1956 paper “Toward a Reconstruction of Utility and Welfare Economics” Rothbard argue that the only way to deduce another’s preferences is by watching him in action. We cannot do it from our armchairs or with fancy mathematical tools, which means the project of determining the correct tax/subsidy for a negative/positive externality is doomed.

8 What is Ronald Coase’s famous treatment of this issue?

Case noted that externalities can be internalized when transaction costs are low and property rights are clearly defined. In the case of river pollution, if the people living along the river have some sort of property right pertaining to it, then the factory doing the polluting will have to compensate them for their suffering, purchase the right to dump pollutants into the river, shut down, pay people to move, or something else.

Coase demonstrated that developing market solutions to externalities problems isn’t a hopeless, intractable problem.

9 If transaction costs are high, is government intervention justified?

No, the solution is still to have the most crisp notion of property rights possible. It might be hard to negotiate settlements for air pollution, given how diffuse the externality is, but if we have worked out exactly what rights people have to the air on their property we can almost certainly have a third party arbitrate the issue and arrive at a fair payout.

10 What is a (so-called) “public good”? Give some examples.

In the standard analysis a public good is a good whose positive externalities are such that there is no way for the free market to provide them, and instead public action through the intermediary of the state is required to furnish them.

Examples include postal delivery, parts, garbage pickup, museums, airports, roads.

11 What is a free rider? How does it relate to public goods?

A free rider is anyone who enjoys the use of a good while letting other people pay for it. Many believe that free riders are the root cause of the impossibility of provisioning public goods by any means except the state. If I build an enormous air purifier I can’t force people to reimburse me for its use; I can’t cut off the oxygen supply if they refuse to pay me. The State, on the other hand, can simply levy a tax and be assured in advance that they’ll be paid for the equipment.

12 What are some problems with these objections to free markets?

To begin with these objections show an astonishing lack of imagination. On more than one occasion economists who have troubled to look they have found that markets develop robust mechanisms for incorporating externalities into their transactions. Once upon a time a standard example of market failures was the fact that beekeepers and fruit tree growers didn’t have a way to avail of each other’s valuable services. Peach trees could be pollinated and bees could eat if only the State intervened to coordinate things. Of course when Steven Cheung actually examined the relevant markets he discovered that these groups had done perfectly well on their own; in fact, by simply looking in the Yellow Pages one can find multiple ‘pollination services’ provided by beekeepers.

Further, the distinction between public and private goods is rather fraught because most goods have some externality. As Walter Block has argued, we are all spared great discomfort when everyone wears socks. So should we subsidize or mandate socks?

13 How could a free market provide public goods? Give an example from the real world.

Because the public roadways in Britain at the beginning of the 18th century could not handle the increased traffic of the Industrial Revolution the National Turnpike Company undertook to build a private roadway financed by tolls. It didn’t take long for factory owners and other sorts to see that their interests were served by linking into this network, and soon a private transportation system sprung up that was the envy of the world.

14 Does mainstream welfare economics smuggle value judgments into (what should be) value-free economic science?

It does. The idea of subsidizing clean energy, for example, is not based on sound economics but on the value judgment that the world should be moving away from fossil fuels and toward solar, wind, etc.

15 Even if the market provided too little of a particular public good, should we expect government to know better?

No. First, the government faces no real incentive to contain costs and stay on schedule. Second, even if they did want to do these things the mere presence of interventionism begins to distort market prices, making economic calculation harder and harder to undertake.

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