Economics in disarray

Economics has problems. Because of Samuelson, it got a half-century case of physics envy. Then people read Schumpeter and McCloskey, and realized economics can’t predict a whit. Economics became useful (ex post) stories, a bit like archaeology or geology.

Then came The End of History (1989) and The Great Recession (2008), and weirdos still talk of evolving economics, but into what they can’t explain. Like Marx redux, they blame ‘capitalism’ or neoliberals, though they can’t go whole hog back to old-style apparatchik economics. Some think that the missing link is a co-equal infant science called psychology.

What to do? At one point, one way out was to study ‘institutions.’ But this seemed like hard work — too much scholarly pain for little gain. But gains there were if you read Coase or Ostrom, or (if you want Keynes to shudder) Hayek.

Perhaps that’s just the way it is. Economists are more like chickens with no heads but imaginarily pecking away at crumbs of intellectual progress. Some toil away at saving the world from falling over a cliff, much like Salinger’s Catcher in the Rye. That’s at least humanitarian if mostly unheralded.

Keynes did say that economists should be more like dentists. Dentists are good guys who help people prevent cavities and enable them to smile. The economist can then go home after a day’s work knowing the economy will still do its wayward thing but not die.

Pigou vs Coase, as refereed by Demsetz

This is a good summary of the Pigou vs. Coase debate on externalities. I have one comment: That the author should have brought Hayek into the picture. After all, the piece was published in 1996. What follows is a kind of executive summary.

Demsetz sees the debate on externality as one between two ideals: An ideal state (with perfect information) and an ideal market (also with perfect information and zero transaction cost). Taken to the limit, both models do not generally produce identical solutions. It is well known that the initial distribution of wealth and income affects market outcomes. Change that distribution and the economy rests somewhere else. With Pigovian state intervention, one also needs to factor in the initial distribution of wealth and income as a determinant of political process. Still, it is reasonable to imagine that both models arrive at the same end-point if they started with the same initial conditions.

Demsetz then concludes, based only on theoretical considerations, that the choice between the two models is one determined by preferences for freedom and the final (and/or initial) distribution of incomes and wealth.

Once we depart from the ideal to actual governments and markets, the choice between the two solutions would then have to take into account how much information there is (available) in the competing models, and how well they would reduce transaction cost. Here, Hayek would pronounce in favor of Coase, if only because Hayek believes that the market is more capable of ‘discovering’ such phenomena as efficient technologies and consumer preferences. Transaction cost can be seen as another form of externality, so we start to run the risk of arriving at a proverbial slippery slope.

Nonetheless, Demsetz is essentially right. Transaction cost is not at the kernel of Coase; and neither did Pigou ignore transaction cost. What was being debated was who should have the property rights to the externality, a question that economists usually avoid but one that Coase faced head on.

12 Articles Every Aspiring Economist Should Read | Steven Horwitz

Here are 12 important articles to help you understand sound economics, ideally before you head off to grad school in economics.

Note: Coase, Hayek, McCloskey, Alchian, Buchanan, Friedman, Lucas

Source: 12 Articles Every Aspiring Economist Should Read | Steven Horwitz

EC 12. Pointers No. 8

FAQs on Chs. 10-14, and Epilogue of Backhouse

Ch. 10:

  1. What is Keynesian economics?
  1. What is the role of ‘animal spirits’ in Keynesian economics? [Try to research what Robert Shiller has written about animal spirits.]
  1. Who put forward the idea that would later be called the Keynesian multiplier? Explain this idea.
  2. Before Keynes came along, what were the most prominent theories of the business cycle?
  1. How did Irving Fisher think of the interest rate?

Ch. 11:

  1. What are the most important ideas in general equilibrium theory? What’s wrong with it?
  1. What is game theory? Is it a good alternative to general equilibrium theory? Why or why not?
  1. How is equilibrium defined in game theory? What is a Nash equilibrium?

Ch. 12:

  1. What is “welfare economics”?
  1. What is Pareto optimality?
  1. What is Kenneth Arrow’s “Impossibility Theorem”?
  1. How did Backhouse assess the contribution of welfare economics to economic thought?
  1. What is “market failure”?
  1. Explain the Coase Theorem.

Ch. 13:

  1. What is the main difference between the ideas in Keynesian economics and the so-called New Classical Macroeconomics?

  2. What are the main theories of economic growth in ‘development economics’? What is the ‘Washington Consensus’? Would the Washington Consensus be applicable or relevant to the Philippines? Why or why not?
  1. What did Hyman Minsky contribute to economics? (extra credit: not in Backhouse)

Ch. 14:

What is Austrian economics? Summarize the ideas of Austrian economics. Who are the main figures of Austrian economics? Is Austrian economics useful for understanding the Philippine economy?

Other topics (not in Backhouse):

What is the Tragedy of the Commons? Explain.


  1. What is the so-called “neoclassical synthesis”?
  2. Discuss and compare the two different ideas of competition in economics? (The first is the competition as imagined and written about by Adam Smith and Friedrich Hayek; the other is competition in the sense of perfect competition in neoclassical economics.)

Wrap-up Lecture in History of Economic Thought

The ancient world

Serious thought began in the ancient world – roughly 400 BC – with ideas on how to deal with what we know today as the “economic problem” (scarcity, and how society decides what to produce/consume, how to produce, and who will consume).

The background then was a stage in history when man had progressed from hunting/gathering to agriculture. We can imagine that the economic problem for hunter/gatherers was then mostly that of survival, but agriculture later brought some element of abundance beyond the most basic necessities of food and water.

Continue reading “Wrap-up Lecture in History of Economic Thought”