Bound Together: Two Competing Visions Thomas J. Sargent Covenant University May 5, / 34

Two Visions Planning versus unfettered markets The Tyranny of Experts, William Easterly 2 / 34

Substance and implications of the debate Intellectual foundations of planning and free markets Computational methods Ironies abound I I I 3 / 34

An Economy People of various ages, talents, preferences Non-human resources like land, air, water Technologies for producing goods of various kinds I I I 4 / 34

Economic questions Production Distribution I I 5 / 34

Economic questions How should resources (people, land, water, air) be combined to produce different goods? (“production”) How should goods be distributed among different people? (“distribution”) I I Karl Marx: “From each according to his ability, to each according to his need.” 6 / 34

Who is to decide Production (allocating inputs) and distribution (allocating outputs)? Competing classic answers: Government planners No one – an invisible hand I I 7 / 34

Scientific methods for answering ‘who should decide?’ Intuition and English language Math I I 8 / 34

Who should decide? The invisible hand Assertion of faith in good unintended consequences I I 9 / 34

Law of unintended consequences One of Milton Friedman’s favorites 10 / 34

Adam Smith Moral philosopher – Theory of Moral Sentiments Economist – Wealth of Nations Each book contains describes the activities of the invisible hand I I I 11 / 34

An invisible hand By directing that industry in such a manner as its produce may be of the greatest value, [the individual] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of society more effectively than when he really intends to promote it. 12 / 34

An invisible hand It is not from the benenovelence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages. 13 / 34

Adam Smith Prices send signals back and forth between producers and consumers Competition means that no one sets prices – an invisible hand I I 14 / 34

Competition Decentralization “production” and “distribution” are decided jointly Incentives and information I I I 15 / 34

Power No market power Spontaneous order I I 16 / 34

Smith’s list of enemies of invisible hand Monopolies (market power) Government impediments to competition and support of monopolies I I 17 / 34

Proof ? Smith’s argument was verbal and informal , economists sought to formalize a formal proof for Smith’s ‘invisible hand’ assertion An effort to understand more thoroughly the “ifs’ that imply Adam Smith’s “then” I I I 18 / 34

Proof ? The quest for a proof led to many discoveries along the way – roles of returns to scales, monopolies, monopolistic competitition, number of markets needed to be open, information available to traders, / 34

Proof – the welfare theorems Pareto, Hicks, Oskar Lange: Method of proof: formulate a grand optimal resource allocation optimization Under some ‘ifs’, then / 34

Victory: proof – the welfare theorems Just as Smith said, a competive equilbrium allocation is good (i.e., optimal), but... The same allocation can be obtained by a command economy run by a “benevolent planner” who issues orders to workers and consumers and who don’t see prices I I 21 / 34

Two interpretations Smith wins – free markets, unfettered competition Benevolent socialist wins – command economy I I 22 / 34

Ironic consequence The cases in favor of ‘planning’ and ‘free markets’ are tied together intellectually and not easily divorced 23 / 34

Caveats The ‘ifs’ are important Information available to people and the planner Nature of technologies – returns to scale Nature of the goods – private or public, ‘rival’ or ‘non-rival’ I I I 24 / 34

Followup – a great debate Planning versus complete trust in free markets and unfettered, unplanned competition An important but tenuous debate because of shared intellectual foundations 25 / 34

Examples Friedman and free banking Social security – government or private? I I 26 / 34

Hayek’s attack Hayek objected to the ‘welfare theorems’ because they ignored difficulties of private and disparate information, dynamic processes of learning, experimentation, trial and error. He doubted whether there could exist a benevolent, knowledgeable, and disinterested planner – a harmful fiction He said that existing mathematical formalisms did not capture what a free market economy accomplished, and doubted that mathematics ever would I I I 27 / 34

Accepting Hayek’s challenge After 1950, modern economic theory accepted Hayek’s challenge to add dynamics, disparate information, conflicting interests – many ‘incentive constraints’ – to social allocation problems. Mathematics a key tool. Irony: through modern versions of ‘mechanism design’ and post-Hayek ‘welfare theorems’, the intellectual cases for free markets and planning remain intricately linked. 28 / 34

Computation and another irony Relation to planning in WWII – linear programming Used to compute competitive equilibria in scientific models Computationally challenging I I I 29 / 34

Another irony Distributed computing – break one big problem into many smaller problems Starts to look like a decentralized competitive economy Curse of dimensionality I I I 30 / 34

Reallocation Creative destruction Exits and entries – firms in US Job creation and destruction I I I 31 / 34

Banks Time, savings, projects, ideas, matching savings to ideas and projects 32 / 34

Incentives 33 / 34

Adaptation versus design Return to Easterly book Tyranny of Experts 34 / 34