The End of Laissez-Faire: Macroeconomic Instability and Microeconomic Inefficiency

1
The End of Laissez-Faire Macroeconomic
Instability and Microeconomic Inefficiency

• Peter J. Boettke
• Econ 881/Spring 2005
• 14 February

2
Historical Context

• Turn of the Century America
• Poverty Amidst Plenty
• inequality
• Progressive Era Legislation
• Antitrust policy
• cut-throat competition
• Pure Food and Drug Act
• consumer protection from impure products
• Working Conditions
• Exploitation
• WWI
• Interpretation of Imperialism and War Socialism
• Capitalism as cause, socialism as solution
• Great Depression
• Aggregate demand failure (underconsumption)
• New Deal Legislation
• Putting people to work and giving them hope
• WWII
• Greatest Generation

3
Importance of the Soviet Union

• Socialism as a Viable Alternative
• No monopolistic exploitation and now crisis such
  as the Great Depression
• Socialism tamed by Democracy Interventionism
• Nothing in the idea of socialist planning is
  inconsistent with democratic freedom in fact, in
  the 1930s it was often argued that socialism was
  the fulfillment of democracy in economic life.
• Socialist Reality
• Orwell --- Animal Farm --- all animals are
  equal, just some animals are more equal than
  others

4
Why No Socialism in the US?

• Check your premise
• 60 of GDP during WWII was government it is hard
  to argue that your country is not socialist.
• Nationalization vs. Regulation
• Regulatory apparatus was established to control
  capitalist excess
• Union power to eliminate exploitation

See Samuelson, Economics, p. 152-154 185ff,
esp., 186.
5
The Economics of Over Production and Under
Consumption

• Overproduction --- Samuelson, Economics, p. 4.
• Command and Control for Public Administration ---
  ibid, p. 5.
• The Fallacy of Composition --- ibid., p. 9.
• The System as a whole --- ibid, p. 9.
• What is true of one of kind of world may be
  false of another. Similarly, for the modern world
  of unemployment, the conclusions of the classical
  or Euclidean economics may not be at all
  applicable. The important hard kernel of truth
  in the older economics of full employment can
  then be separated from the chaff of misleading
  applications. Moreover, as we shall see later, if
  modern economics does its task well so that
  widespread unemployment is substantially banished
  from democratic societies, then its (i.e.,
  national income accounting) importance will
  wither away and the traditional economics (whose
  concern is wise allocation of fully employed
  resources) will really come into its own almost
  for the first time. Samuelson, Economics, p. 10.

6
Income Expenditure Keynesianism

• National Income Accounting
• Circular Flow and Avoiding Double Counting
• Final Goods Prices (e.g., bread, flour, wheat)
• Aggregate Demand Failure and Depression Economics
• Full employment level of income
• Savings and Investment
• Leakage in the system due to liquidity traps,
  etc.
• Coordination failure between savers and investors

7
The Determination of Price By Supply and Demand

• The Logic of Market Clearing
• Non-economic considerations for blocking the
  price system
• The Structure of Perfect Competition
• Numerous buys and sellers and no control over
  price
• Monopoly
• Complete control over price except as set by
  government regulation
• Imperfect and Monopolistic Competition
• Some control over price

See Samuelson, Economics, p. 492.
8
Income Expenditure
C, I, G
45o
C I G1
C I Go
?G
Y
Yu
YF
Multiplier effect
?G 1/1-b ?Y
9
Microeconomic Inefficiency
MC
AC
P
Pgt MC Profit max --- MR MC Cannot Min AC
PC
D MR
P
Q
QC
PMC Profit Max MRMC Min AC
MC
D
Q
MR
10
Welfare Economics Market Efficiency and Market
Failure

• Character of General Competitive Equilibrium
• Exchange Efficiency
• Production Efficiency
• Product Mix Efficiency
• First Fundamental Welfare Theorem
• An Economy in competitive equilibrium is Pareto
  Efficient
• Second Fundamental Welfare Theorem
• Any Pareto-efficient resource allocation that
  society desires can be obtained through the
  market mechanism

11
When Does This Hold?

• Under conditions of macroeconomic balance and
  perfect competition.
• Absent those conditions due to macro-instability,
  imperfect market structure, or the existence of
  significant externalities, imperfect information,
  and/or missing markets (e.g., public goods) and
  the efficiency properties cannot be achieved.

12
Social Welfare Functions and the Critique of
Welfare Economics
A
?2
SW
Government as corrective device to move from 1 to
2. E.g., Structure-Conduct-Performance
? 1
B
13
Critique of this Idea

• Inefficiencies are an Illusion
• Marginal Costs are not appropriately calculated
• Costs of transition from one state to another are
  not fully considered
• No stable Social Welfare Function
• Arrows theorem and the problems of democratic
  decision making
• Hayek and the Limits of Agreement
• Correctives are Worse than the Problem
• Public Choice concerns with the manner in which
  government policy will be pursued