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Information Matters?

from Peter Radford

Sorry I have been absent here lately: I am in the middle of several projects that take priority.

Nonetheless in the course of one of those projects I have found myself immersed in the many faces of economic theory with respect to the role of government in an economy. That role appears to lurch from one extreme to the other, which leaves the impressionable outsider having to resort to their political predisposition in order to seek an answer. Economics, you see, has many answers. Some of which flatly contradict others.

So much for science. 

The problem begins at the beginning. The beginning, that is, of economics itself. The early pioneers of the discipline were captivated by the apparent order they saw around them, and especially by the seeming ability of goods and services to turn up and satisfy demand without being ‘planned’ into being. This led them, naturally, to build into the subject a bias towards a market-centric explanation of everything. For it was the mystery of the market that they attributed this seeming order to.

Well one thing led to another and we ended up with an almost comical attachment to ‘the market’, very often with no real description of what that actually was. The market is shrouded in its own mystery, with its super-human powers flowing very much from that mystery. Strip the mystery away and the market becomes a whole lot more prosaic. Plus the elegant math used to describe its machinations begins to look very contrived.

It is one thing to marvel at what you think of as a great mystery needing explication, it is another entirely to become so fanatical that you tolerate not a single hint that the mystery might be slightly less than magical.

Yet that’s where we are.

In order to protect the object of their desire from the rude realities of its earthly manifestation, economists made a series of transitions in thought, with each adding layers of complicated theory in order to cover up or atone for what were perceived as prior weaknesses.

Towards the end of the 1800’s one such transition was so radical that it implied that all previous theory was not about economics at all. In  an effort to put economics on a more ‘scientific’ standing its subject matter was progressively narrowed. No longer were the big issues of where wealth and growth came from of any concern, what mattered now was exploring and describing the logic of the magic. Note that there was no doubt about the existence of the magic, that was presumed, all that economics was now to be concerned with was its inner workings.

In the 1930’s this led to an explosion of economic enquiry and argument.

At one extreme Oskar Lange could argue, quite plausibly, that if all the conditions of the magic obtain in a real economy, then socialist organization is not just a possibility, it is guaranteed to work. This set capitalist-leaning economists aflutter. They had to counter attack. One result was that Friedrich Hayek, whose libertarian politics could brook no morsel of socialism entering contemporary political reality, began to argue that the economy was actually a learning device and that, since knowledge was so unevenly distributed in any economy, and was thus well beyond the ken of any government, a decentralized marketplace was the best possible solution to the problem of coordination.

Note that the big problem of economics was now firmly coordination and not those older issues of wealth and growth. Although people like Hayek conflated the two traditions: the libertarians argued that market coordination was also the best longer term guarantor of ‘sustainable’ growth. By sustainable they did not – and still do not – mean sustainable in an ecological sense. What they mean is that growth can be sustained on a robust long term path, albeit with periodic interruptions due to the ups and downs of the business cycle.

Also notice that Hayek, in order to fend off Lange and his evil socialism, had to introduce a decidedly uneven vision of knowledge. In the Hayekian world knowledge was a very local and lumpy affair. Individuals were therefore likely to be much more attuned to it, whilst the government would inevitably be defeated in any attempts it made at gathering, assembling, and analyzing for policy purposes that self-same knowledge base. Such local knowledge is forever inscrutable to the central planner.

The problem with this vision is not its lack of reality. Indeed the Hayekian view on knowledge is a very realistic one. It’s that it seems to fly flat in the face of the parallel efforts being made at the same time to establish the concept of ‘general equilibrium’ as a central fact in economics. Since the days of Walras, economists obsessed with the apparent order of the economy had made attempts to describe the coordination problem in terms of all markets simultaneously. That is to say they sought to describe a world in which all markets, however diverse and seemingly disparate, would magically fall into place together at the same time. This requires prodigious calculation, but market magic was assumed to be up to the task. It was only after making a series of ever increasingly absurd assumptions that economists were able to arrive at a suitable description of such a general equilibrium. Only the very honest amongst them then stepped back and admitted the effort was worthless since those assumptions were so heroically other-worldly as to render the entire effort barren of practical use.

Amidst all those assumptions are one or two that imply information is both freely and widely available to all the players in the economy.

On the face of it this isn’t exactly what Hayek had in mind when he argued knowledge was fragmented and local. After all, how can knowledge be freely and widely available and yet fragmented and local at the same time?

On the one hand we have a theory that, in order to describe market magic as being, well, magical, has to allow us all to have equal access to all the relevant information we need in order to undertake our transacting calculations. And on the other we have a theory that depends upon that same information being impossibly divided and split apart such that no one can assemble it, least of all to undertake transacting calculations.

You might think this dichotomy would be an issue.

On one side the libertarians argue that the government has no role in the economy because it could never gather enough relevant information. The economy, they argue, is just too complicated for anyone to understand, so we ought leave it be. And others argue that the government has no role in the economy because everyone knows exactly what’s going on and can therefore both predict and defeat even the most well intentioned actions of the government. The economy they argue is perfectly understandable as long as everyone thinks and acts like economists theorize they do.

Either way the government doesn’t have a role to play.

If this sounds a tad ideological to you so be it. We are told this is all science.

Meanwhile it sounds to me as if information matters. It really matters. But as of now economists cannot quite agree on how.

  1. macroambiente
    June 18, 2015 at 1:34 pm

    I would prefer to be wrong, but it seems that “Government” may be seen as the way through which the political power commands society to obtain its private economic and financial ends. The political power is that capacity of some families to agree with each other on imposing to society “governmental” decisions that satisfy common interests, but this does not mean that there is always friendship; these families also compete always some opportunity appears. This principle applies to any political system, be it more or less “social”. For instance, there is no democracy as the manual describes it; actually its three theoretically independent powers are interconnect, interdependent, and prone to that private ends for their leaders are representatives of the political power and not the society. Besides government the political power also controls the media and the big multinational businesses. As ever, to identify where the main economic decisions come from look after the money.
    So, governments make decisions apparently difficult to understand if one expect they follow some consistent economic theory that generate economically positive values to society.
    Anyway, the connection between government’s economic decisions and its consequences is made by never equilibrating “markets”, i. e., Supply and Demand is Not a Neoclassical Concern (http://mpra.ub.uni-muenchen.de/63135/).
    The prevailing political power in democratic countries rejects the real world supply and demand theory and any other realistic economic theory for anyone of them contradicts its target of dominance. Instead, they adopted a convenient doctrine that the bulk of economists preach in schools, textbooks, central banks, journals, conferences, and so on. It will be very difficult to change this reality.

  2. Jeff Z
    June 18, 2015 at 3:59 pm

    Peter,

    I am struck by another irony as I read your entry. Hayek has a better conception of the distribution than many of his neoclassical counterparts. But most businesses need and use the statistics regularly compiled by governments in order to make decisions. Think about the monthly unemployment numbers and the releases of the Federal Reserve Open Market committee for a start. Whether these are accurate enough . . .?

    The tie in with the idea of externalities seems to be a close one. The idea of perfect information that many neoclassical economists use directly contradicts the idea of perfect information. Drop one of these as an assumption and you need to drop the other – that is, if externalities exist, then perfect information can’t. Some economists have posited the idea that institutions arise to deal with these kinds of externalities in the absence of perfect information – hence the rise of unions, and large banks, alongside large industrial firms. In any event, the lumpy conception of knowledge that Hayek employed might call forth a reaction where people build an institution to deal with this. It could be a government agency; it could be another market.

    Hayek identifies a source of friction and proceeds to tell us that nothing can, (or nothing should!) be done about this. Neoclassicals? Depends on the faction – Lucas/Sargent or Akerlof/Stiglitz. The latter won “Nobel” prizes for their work on imperfect information, which aligns them more with Hayek on a foundations level, but then you have completely opposite policy conclusions. Lucas/Sargent seem to build rational expectations based on perfect information, contradicting Hayek at the foundational level. But the policy proposals of Hayek and Lucas/Sargent are aligned. No wonder the economics profession is in such disarray.

  3. June 19, 2015 at 3:55 pm

    There seem to be a conflation here – not in your article, in people’s minds. There are two very different things called markets. Because they’re different things let’s use different words: “exchange” and “bazaar”.

    Exchanges are closed and highly artificial places where sellers and buyers meet to clear a commodity. Ideally, exchanges are about adjusting prices to maximise the quantity cleared and minimise profits. In practice they’re about exploiting deviations from equilibrium (speculation, market power).

    Because exchanges are such artificial and idealised constructs, they’re amenable to classical maths like calculus. So-called “free market” people want government (or an authority) to set up the exchange and then let it run mechanically so they can get on with creating or exploiting deviations from its ideal state.

    Bazaars are open places where producers meet to discover what people want and consumers go to discover what’s available. The point of bazaars are to make new connections in the economic graph. Previously a vendor of electric motors was selling them to an appliance manufacturer, but now a car maker wants them to make electric cars. The electric car maker shops around and asks a battery maker to make bigger batteries.

    Bazaars are not about equilibrium, they’re about connection. Adam Smiths invisible hand is not that impressive as a price setter – a bureaucrat with calculus could do that. The innovation of Capitalism is using the bazaar to discover new uses for things, and new needs that can be fulfilled. Bazaars are graphs, and they’re amenable to graph theory.

    Most natural markets and the economy as a whole are bazaars. Perversely, government actors are very useful participants in bazaars because they can set up long links around which other links form. Governments do this by motivating, I don’t know, jet propulsion, microchips, the internet, GPS…

  4. June 20, 2015 at 11:07 am

    Information and ignorance
    Comment on ‘Information Matters?’

    Information is a good thing because if people have the right information they make the right decisions. This is the idea of the market system as gigantic information processor that helps to achieve the overall best outcome.

    Interestingly, Adam Smith said exactly the opposite, i.e., that it is self-deception that keeps the system running.

    “Smith turns from these self-deceptions to the role that the striving in pursuit of such mirages means for society. For society’s sake, he assures us, it is well that these ‘deceptions’ are widespread because ‘this deception rouses and keeps in continual motion the industry of mankind’: …” (Kennedy, 2009, p. 247)

    In any case this easily explains how bubbles are kept in motion. Note well that Smith solves also a moral dilemma because the self-deception of the myopic egoistic individuals assures that they unintentionally work for the best of all. Ignorance is exactly what puts the Invisible Hand to work.

    “… the social sciences are largely concerned with the unintended consequences, or repercussions, of human actions. And ‘unintended’ in this context does not perhaps mean ‘not consciously intended’; rather it characterizes repercussions which may violate all interests of the social agent.” (Popper, 1960, p. 158)

    The real problem, however, is this. Information is not enough. In order to arrive at the right decision the agents need the correct model of the market system. Now, we know for sure that neither the Walrasian nor the Keynesian theory is correct and this makes the whole concept of rational expectation/decision self-contradictory.

    It far surpasses the economist’s capabilities to realize that economic theory cannot be built upon behavioral assumptions and that economics is quite different from, psychology, sociology, moral philosophy, anthropology, information theory, etcetera. Economists show up in every domain — except economics.

    When it is the Invisible Hand that actually runs the show then it is consequential to change the very definition of the subject matter to: economics studies how the economic system works.

    Egmont Kakarot-Handtke

    References
    Kennedy, G. (2009). Adam Smith and the Invisible Hand: From Metaphor to Myth. Econ Journal Watch, 6(2): 239–263. URL http://econjwatch.org/articles/
    adam-smith-and-the-invisible-hand-from-metaphor-to-myth.
    Popper, K. R. (1960). The Poverty of Historicism. London, Henley: Routledge and Kegan Paul.

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