Markets Attack!

Abstract: Revisiting the markets vs planning debate, but this time from a position of moral and intellectual superiority.

First, this post would be better titled, “Planning vs. Markets (Or, Why Plan?),” but for now I am sticking with the more iconic Hollywood/military imagery. Second, kindly enjoy this typically pithy comment on planning thought, action, and scholarship by USC’s Krieger (in which, among other things, I learned the word elide):

This Week’s Finds in Planning, by Martin Krieger

 

Date: Sun, 16 June 1998
Subject: Planning and Markets

I have just read an essay by Ann Markusen where the markets ideal is compared to the planning idea. Thirty years ago when I first got involved with this business, that is how planning theory was taught, as if planning received its legitimacy from market failure, and in any case markets could be set up to do planning work (Oskar Lange). It is sort of treating a woman as a non-man, Not very illuminating.

Of course, markets and “freedom” are no more natural than centrallized tyrannical regimes, both reflect peculiar political solutions. The deep questions were the ones that Adam Smith worried about, as did Marx, about how do your arrange things for both political stability and economic growth. And what is most interesting is the variety of solutions that are available for doing so. See Scale and Scope, by Alfred Chandler, comparing the industrial/commercial realsm in US/Britain/Japan/Germany.

When one is preaching, one has to elide over fine points to get the message home. Real scholarship is about the fine points. Hence what is most interesting is not whether cities ought be compact or not, or health care be private or not, but under what regimes does eachmake sense, and what are the costs of each, and what actually works. That is why Marx, Smith, and Chandler are so preoccupied by particular examples and cases, why historical material is vital for them.

In general, I never take academic ideologizing too seriously. It is the luxury of the tenured classes: tenured professors argue for free markets but do not expose themselves to it; other tenured professors argue for more planned regimes, but are quite willing to try to bid up their salaries by seeking competitive job offers. There is no reason to believe professors are especially good at such ideologizing, since they are selected for their narrow technical competence, and their capacity to get along and brown-nose.

Your job as scholars is to get at the nitty-gritty details, how things actually work, the ironies and the peculiar successes. Look at Hirschman, or at Smith et al, or Business Week. Or the front pages of The Wall Street Journal–no one wants to buy an ideologically desirable company that is in trouble. Historians have done a great deal on various planning regimes, in particular cases.

Markets are no more opposite to planning, than a fish needs a bicycle.

MK

I can’t easily locate the Markusen essay, where she may defend planning against economics, fish against bicycles, or vice versa, or both or neither. But her baseline appears to be that government intervention is justified when markets fail (where failure is defined with respect to either the Pareto or a specific equity criterion).

Krieger suggests this is a false dichotomy, implying the dominance of substantive nuances in the debate. He is hardly alone in this view. My former neighbor Alex Alexander is particularly crisp on this theme in his 2004 JPER article, “Capturing the Public Interest: Promoting Planning in Conservative Times.” The context is the so-called conservative attack on planning, discussed by Calavita and Krumholtz, Sanyal, and others. From page 103:

Associating planning with the state, and the juxtaposition of planning against the market, are long-standing prejudices both among planners and planning’s enemies. Conventional explanations of planning in welfare economic terms (Moore 1978; Klosterman 1985) explicitly or implicitly associate planning with government intervention and state action, juxtaposing the (planning and planned) public sector with the “free” market. Other discussions of planning and markets reveal the same dichotomy, contrasting “market-” and “plan-rationality” (Dahrendorff 1968), comparing “synoptic planning” to an incremental political market(Wildavsky 1979), or identifying planning with the public domain (Friedmann 1987, 38).

But more advanced theory and observation suggest that this dichotomy is no longer correct, and if it ever was, it has outlived its usefulness. Many definitions of planning (e.g., as rational choice, as anticipatory coordination, or as the attempt to control future actions) are so general as to transcend it. Increasing complexity has also blurred the boundary between the public sector and the market.

In its place, Alexander offers up transactions cost theory (TCT), which (1) emphasizes, Krieger-like, specific cases over general forms, (2) refutes the mutual exclusivity of state v. market, and (3):

TCT also offers a third way to argue for planning. Besides deflecting attacks on planning that are really critiques of public intervention, TCT provides an authoritative theoretical base and a set of conceptual tools for responding to attacks on public planning itself. It does this by moving the debate from the arena of broad generalizations to the locus of situational specifics.

Neoclassical economists’ attacks on public planning (Markusen 2000, 265-69) are the easiest to refute. TCT rebuts their unqualified advocacy of privatization; instead, it demands close institutional analysis of the specific case to determine the most appropriate form of governance. Such analysis can conclude that the public bureau is the most effective for a particular purpose, as Williamson (1999) did for the U.S. State Department, or that public planning and regulation may often be the best way of ensuring an efficient market, as Alexander (2001a) did for land-use planning and development control.

TCT also demands abandoning neoclassical economics’ narrow focus on the goal of economic efficiency. It recognizes a broader goal of effectiveness in its criterion of minimizing parties’ and stakeholders’ transaction costs. In institutional analysis to review alternative modes of governance, this can replace the simplistic Pareto optimization on which neoclassical economists base their opposition to public investments and their case for privatization and deregulation.

Alternatively, USC’s Gordon and Richardson have long argued that market failure is often exaggerated, with the cure worse than the disease. From their 1993 JAPA article, “Market Planning: Oxymoron or Common Sense?“:

One argument in support of planning is based on the concept of market failure. This position states that since monopolies are rampant and restrictive, externalities are ubiquitous, and some goods are consumed in common, the allocative efficiency of the market system is rarely achieved. Hence, planners must intervene to put things right. An alternative, slightly more promarket argument posits that markets achieve a high degree of economic efficiency but often at the expense of equity. This view holds that since most allocative choices involve a tradeoff between efficiency and equity, planners must intervene to achieve an appropriate degree of redistribution. In this view, the market attends to efficiency, while planners look after equity.

Neither of these arguments is fully sound. Both greatly exaggerate the prevalence of market failure. Both fail to recognize that the abstractions of perfect competition and pure monopoly rarely exist.

 

Their position is usually to argue in favor of (a) market-based allocation schemes over top down planning but, where they agree that planning can improve markets, in favor of (b) incentive-based planning strategies over regulatory strategies.

These are only a sample of views on these issue but, hey, life is too short for too long blog posts and these set the stage for my points just fine.

My main points
My main main point is that I somewhat disagree with everybody quoted here. Making neoclassical economists out to be bad guys because their story of (a) how the world goes round includes (b) an awkward normative assessment, is almost entirely missing the point. Let’s break this down into these two parts.

1. Neoclassical microeconomics is largely a positive story of rather rational individual behavior. Parts of the story may be disputed, especially the rather rational part, but you’d better have a better tale to take its place. It says that when costs rise at the margin, people back off. Put another way, people evaluate their alternatives by comparing what they like versus what they don’t like.

In the simple version we explain in class, there are a number of assumptions in play. Most of these can be dropped without challenging the underlying story, which then gets more complicated. Leaf through any recent game theory text. Again, the value of this framework is in anticipating behavior, not in judging it.*

2. On the other hand, the “invisible hand” theorem is an explicitly normative take on competitive market equilibrium. It says that markets of independent individuals, looking out for their individual interests only, (a) are much more orderly than you might expect, tending toward relative stability and, more to the point, (b) “succeed” in the weak sense of the Pareto efficiency criterion; namely, if a long list of critical assumptions hold, no mutually beneficial transactions remain.

If any one of these assumptions are violated, markets are said to “fail.” In principle, this means that to restore Pareto efficiency (i.e., given public goods, externalities and equity problems), individuals will need to coordinate their actions instead of exclusively operating atomistically. This is the primary rationale for planning in the economics literature — to restore market efficiency — and the standard answer to the question, “Why plan?”

However, market failure is hard to correct under the most favorable circumstances. Here is the crux of the debate: Market success is easy if all goes perfectly, but correcting market failure requires information, agreement and coordination, all of which are challenging at best.

The reality, therefore, is that we live in a world of market failure, which is in turn really hard to fix. And there is no obvious criterion for what we mean by fix anyway. Hence planning tasks, generally speaking, tend toward the troublesome and onerous.

So any comparison of private vs. public sector efficiency should, first, recognize that the public sector has the more arduous job. (Again, this is a quite general characterization. Addressing market failure is by definition a more complex undertaking, fraught with informational and coordination challenges, than participating in a well-functioning market as a competitor. That indeed is why markets fail in the first place.) Second, as Gordon and Richardson emphasize, just because there is an argument for public solutions doesn’t mean they will improve things in practice. Which everyone knows.

Planning can be good but hard

To summarize, there are many ways to address the why plan issue. Economists rely on the market failure story, which says in some cases the market works better with collective decision making. But collective decision making is hard, making planning hard. Which we knew.

In particular, there is no mainstream neoclassical argument than there is no role for planning in a market economy, except in hypothetical situations that planners are rarely concerned with. Rather, the more typical complaint is that planners have overstepped their bounds or made mistakes. To repeat, this is substantively different from saying there should be no planning or that planning is generally bad.

The logic that a given market would do better if subject to less planning takes 3 main forms: One, how respect for or a reassignment of property rights can correct many market failures; two, how hard it is for planners to get all the information they need to make the right decisions; and three, a complaint about the resulting redistribution of resources or property rights. These can be extremely valid points, especially in any specific situation. However, they do not in general imply that less planning is better.

Krieger and Alexander say the details matter most. Well, we all agree they matter more than we’d like. Alex also says that economists overstate the general problems of government provision and the advantages of private provision. No doubt some do, but that is painting the whole school of thought with a fairly broad brush. As a planner, I find that the tools of economics can sometimes clarify the applied problems of cities and their hinterlands tremendously. It makes no claim to comprehensiveness.

The only time the normative content of economics comes up in my work is when justifying why planners do what they do, where I think it makes a compelling argument. The rest of the time, the normative has to come from somewhere else; economics has little to say on that point. As to how we do what we do, and how to do it well, a good understanding of how markets tend to work is mighty handy.

So when markets attack, or go bad, we should roll up our sleeves and fix them without doing more harm than good. If critics on the right have a problem with that basic principle, they do not understand basic microeconomics. If critics on the left have a problem with the normative implications, they mistake a story about behavioral determinants for a statement of values.

Debates over the details of any specific implementation should be expected, however. These are always challenging tasks, not least because they require lots of good information, coordination, and at least some agreement, over which there almost always will be some disagreement.

If correcting market failure was easy, anyone could do it.
____________________
Someone smart recently asked me if this didn’t amount to environmental determinism. I said no, by which I meant to stress the rival point that planners might think we know how people will behave in specific situations, but are often wrong because the underlying behavior is more complicated than we realize. That is, we underestimate the complexity of how people will respond to denser cities, straighter streets, or more expensive gasoline, and anyway people are diverse in their responses, etc.

In hindsight (I was thinking on my feet, always a handicap), a better answer is no and yes. Microeconomics does posit that behavior is partly explained by one’s circumstances, along with all the other things (preferences, culture, etc.) that might matter. Partly for that reason empirical studies focus on average individual behavior, where we try to identify the systematic determinants, rather than on uniquely individual behavior.