At Least Take off Your Nobel Prize When You Say That

Joseph Stiglitz makes an interesting claim in his review of Benjamin Friedman's The Moral Consequences of Economic Growth:

[Friedman] goes on to point out the importance of investment, both in physical and human capital, and to note that huge government deficits ("dissaving" on the part of government) are hurting those investments. A perfect market economist would dismiss this claim as nonsense: private savings will eventually increase to offset negative government savings, and if citizens want to consume more and save less now, that is their prerogative -- just because Friedman wants to consume less today does not mean that he should be allowed to impose his preferences on the rest of us.

This is remarkable primarily for the fact that it's coming from the pen of a Nobel laureate. And not just any Nobel laureate---if you see someone walking around with a Nobel Peace Prize around his neck, you kind of expect this sort of thing---but a real, live winner of the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel.

I've recently begun to suspect that this "perfect market economist" is just a strawman that advocates of government intervention pull out to avoid dealing with the real arguments for free markets. In fact, the following is an actual conversation I had with a famous left-wing economist after we were both dropped stark naked into the middle of a Nebraskan cornfield following an alien abduction.

ME: Wow.
HIM: Wow indeed. By the way, I'm [name redacted].
ME: It's nice to meet you. I'm Brandon Berg. I don't suppose you brought an extra pair of pants with you?
HIM: If I had, I assure you I'd be wearing them by now.
ME: Fair enough.
HIM: So...you like free markets, do you? You know who else likes free markets? That guy!
ME: You mean...that scarecrow?
HIM: Yes. I mean...no! He's a perfect market economist. I think he has a PhD from GMU.
ME: How can you tell? I don't think he even has a mouth. Isn't that just a bunch of buttons sewn on his face?
HIM: Well...yes. But I can understand him. He talks to me!
ME: Well...if you insi---
HIM: And do you know what he says? He says that the government should refrain from intervening in the economy because markets are perfect. And look! His head is full of straw! Are you going to listen to someone whose head is full of straw?
ME: I guess that depends on the specifics of his---
HIM: Exactly! And neither would I. Now help me nationalize the health care system. We'll start with that hospital over there.
ME: Isn't that a corn silo?
HIM: What am I, an architect? Now let's get nationalizing!

But let's suppose that these perfect market economists really do exist. If so, they certainly wouldn't take the positions which Dr. Stiglitz attributes to them. By definition, a perfect market would, if left on its own, produce optimal results. Any intervention which interfered with the workings of a perfect market would create distortions that alter the outcome. If the government started consuming investment capital, yes, this would raise the interest rates and cause people to save more than they would otherwise. But the net change in the national savings rate would still be negative, because the people wouldn't save enough to make up for the extra government consumption.

More importantly, any change in private savings would come at the expense of private consumption, which is hardly insignificant. Granted, government consumption could substitute for private consumption to some extent, but a perfect market economist would say that this would lead to deadweight loss, because people prefer to consume their money in ways they choose rather than in ways the government chooses for them.

With the second claim, Stiglitz is right to some extent. A perfect market economist would say that it's just fine if people choose to consume more and save less. The choice of whether to consume now or in the future is a value judgment, not an objective law. But we're not talking about people choosing to consume more of their own resources; we're talking about government taking money they've decided to save and then consuming it instead, and consuming it on things other than those which the people would themselves choose if given the choice.

What Dr. Stiglitz is describing is not a hypothetical perfect market economist, but a government shill trying to explain why it's okay for Congress to spend vast quantities of money it doesn't have. To suggest that a perfect market economist would ever take such an absurd position is unfair, and an insult to strawmen everywhere.


Update: It seems that I misinterpreted Dr. Stiglitz's claim. Details here.

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Stiglitz and the

Stiglitz and the Strawman.
Over at Catallarchy: This is remarkable primarily for the fact that it’s coming from the pen of a Nobel laureate. And not just any Nobel laureate—if you see someone walking around with a Nobel Peace Prize around his neck, you

And you thought it was

And you thought it was impossible to write enterta
Finally, Brandon Berg complained in Catallarchy that Stiglitz should have at least taken off his Nobel before saying something that is (and I paraphrase) so incredibly stupid.

"By definition, a perfect

"By definition, a perfect market would, if left on its own, produce optimal results."

What does "if left on its own" mean in this context? What exactly is being excluded, just government actions? What about actions by institutions which have some of the features of governments, instances of private regulation, coercive actions by non-governments, theft, natural disasters, etc.?

It seems to me Stiglitz is taking government as part of the natural background environment in which market forces (and individuals) operate--like a natural disaster.

A perfect market is much

A perfect market is much like the perfect city that New Orleans was before Katrina, at least as voiced by those in love with everything that New Orleans was.

Links and Minifeatures 11 07

Links and Minifeatures 11 07 Monday
Activity other than financial and real estate type articles may be light for a while. I'm facing a couple of crunches.

Carnival of Personal Finance is up.

Stiglitz is referring to the

Stiglitz is referring to the Ricardo theorem. Ricardo's basic argument was that if individuals are rational and well informed, the size of government spending matters but whether it is funded by taxes today or by borrowing today paid back by taxes tomorrow doesn't. Individuals adjust their consumption over time, by borrowing and saving, to the pattern that maximizes their welfare. Since in either case individuals have the same options available (proof left as an exercise for the reader--the important assumptions are that individuals face the same interest rate as the government and that taxes are allocated to individuals in the same way tomorrow as today), they end up with the same consumption pattern.

If you want to trash a famous economist for making the argument, it should be Ricardo, not Stiglitz--but it would be worth understanding the argument first.

Dr. Friedman, stop

Dr. Friedman, stop trol---actually, I guess you're right.

I thought that Dr. Stiglitz meant deficits as opposed to spending less, rather than deficits as opposed to increasing taxes. But your interpretation is probably the correct one, and Stiglitz's contentions make much more sense in that light.

Ricardo's argument, then, is that taxpayers will increase savings in order to help pay for future tax increases, right? This seems intuitively correct. After I work out the math, I'll post a follow-up and correction. Thanks for pointing that out.

Stiglitz's second contention still seems a bit odd, though. If we assume perfect rationality, taxpayers will adjust their savings to compensate for deficit spending. If they want to consume more now and less later, that's because of their time preferences, and has nothing to do with deficit spending, right?

Am I at least correct about (modern-day) perfect market economists being a strawman?

"Stiglitz’s second

"Stiglitz’s second contention still seems a bit odd, though. If we assume perfect rationality, taxpayers will adjust their savings to compensate for deficit spending. If they want to consume more now and less later, that’s because of their time preferences, and has nothing to do with deficit spending, right?"

I don't know the full context of Stiglitz's comment, but my guess is that his point was that saving and investment aren't automatically good things. People often write as though "increases investment" means "is desirable." But, from the standpoint of standard economic arguments, there is some optimal allocation between present and future consumption, and shifting too much to the future is a bad thing just as shifting too little is.

The point has nothing to do with deficit financing, at least if you accept the Ricardo Theorem. But it has to do with the argument "deficit financing results in less investment, and is bad for that reason" since that argument takes it for granted that "less investment" implies "worse outcome," which is a mistake.

I don’t know the full

I don’t know the full context of Stiglitz’s comment, but my guess is that his point was that saving and investment aren’t automatically good things.

I might be wrong, but I'm almost certain that that was a position which he was attributing to perfect market economists and implicitly rejecting.

Also, I did the math, and the Ricardo theorem doesn't seem to work when you factor in capital gains taxes. If taxes are low in the first period and higher in the second period (to pay off the debt), the capital gains are taxed under the higher rates, which reduces incentives to save. If I save all of my income from the first period and consume everything in the second period, my consumption is higher under the balanced-budget model than under the deficit/surplus model.

Am I doing something wrong, or is it just that this violates the "equal distribution of taxes" assumption?

There's still something

There's still something fishy about this from Stiglitz:

"...just because Friedman wants to consume less today does not mean that he should be allowed to impose his preferences on the rest of us."

Aren't we taking about a system where such preferences are imposed? Why single out Friedman without acknowledging that the system being addressed has no right to impose such preference either?

Stiglitz: There is, for

Stiglitz:

There is, for instance, a greater role for government in promoting science and technology than Friedman seems to suggest. A report by the Council of Economic Advisers (conducted when I was its chair) found that the returns on public investment in science and technology were far higher than for private investment in these areas and than for conventional investment in plant and equipment. So, too, with education, especially at a time of such concern with the quality of American schools, and particularly for low-income families.

Isn't he effectively saying that if can think of better ways to spend your money than he thinks you would he's pretty much entitled to do it, or the collective is?

Aren’t we taking about a

Aren’t we taking about a system where such preferences are imposed? Why single out Friedman without acknowledging that the system being addressed has no right to impose such preference either?

Yeah...I haven't quite figured that one out. Perhaps David Friedman is right, and he's going off on a tangent that has nothing to do with deficit spending. In which case he'd be rejecting in general the idea that the market should be left to determine the savings rate on its own.

Isn’t he effectively saying that if can think of better ways to spend your money than he thinks you would he’s pretty much entitled to do it, or the collective is?

Well, yes. That's pretty much the essence of statism. I don't know where he gets the idea that returns on public education spending are significantly better than returns on private education spending, though. Unless, perhaps, he's referring to diminishing returns for tuitions at elite institutions.

"In which case he’d be

"In which case he’d be rejecting in general the idea that the market should be left to determine the savings rate on its own."

Which means he favors imposing preferences on others, especially his own.

"Well, yes. That’s pretty much the essence of statism."

And implicit in utilitarianism/consequentialism.

You're suggesting that most

You're suggesting that most consequentialists think that government action helps maximize utility? Micha doesn't seem to think so, but maybe he's a rarity.