Friday, April 05, 2013

Agreeing to Be Ruled By Others, or: Taking Comparative Advantage Seriously

-- Posted by Neil H. Buchanan

In the last few weeks, my posts here on Dorf on Law have been largely devoted to critiques of orthodox economic theory and the economists who promote it.  My major theme has been that the field of economics has affirmatively closed itself to outside influences, making it remarkably resistant to cross-disciplinary insights.   Then, when called upon to understand and explain a world that can only be understood by applying a combination of skill sets, the practitioners of "the queen of the social sciences" end up floundering.  Sometimes they look merely silly, while far too often they give terrible advice.  To make it all worse, the norms of the field create and reinforce an overweening arrogance among its membership, so that it becomes impossible for them even to admit that they are out of their depth.

Even if I am wrong about any of that (or merely overstating the case), a deeper problem is the frequent failure of orthodox economists to remain consistent to their own professed principles.  Given that these guys think of themselves as Scientists with a capital S, who are credible because they are "rigorous" (and not at all sociological), failure to be consistent is a rather important sin.  If we are really Scientists, then we should follow the logic and evidence wherever it leads, refusing to reject implications of our models merely because they are unpleasant or "politically unrealistic."  That, in any case, is the claim that I have heard literally hundreds of economists make over the years, in remarkably similar words.

In a post last month, I mentioned a prominent Swedish economist who had reportedly lamented that his fellow Swedes do not have the "tastes" that he believes they should have.  In particular, he accuses them of liking government too much.  To a non-economist, this might not sound like a big deal, because this is merely a familiar case of someone saying that people should think differently.  Frankly, that is what expert opinion frequently involves.  For an economist to say that people's preferences are wrong, however, is a rather major gaffe.  People's preferences are our building blocks -- taken as prior to our models.  Milton Friedman famously likened racism to a preference for vanilla over chocolate ice cream.  He claimed merely to be making the unremarkable point that people should be allowed to express their preferences through the market (and that the market itself would make it unprofitable to be a racist).  He was wrong, of course, but not within the strict confines of orthodox economic reasoning.

Another interesting version of this question arose recently during a conversation that I had with a former U.S. securities regulator.  He was talking about the limitations that international competition place on the ability of American policymakers and regulators to police financial markets.  His argument was a familiar one: If the U.S. goes too far in trying to impose higher standards on financial actors, those actors will vote with their feet, and move their operations to Singapore or London.  We need to tread lightly, he argued, to keep the U.S. financial markets "competitive," or we will lose all those great jobs on Wall Street to other countries.

This is, of course, yet another version of the "race to the bottom," in which proposals to live by higher standards are regularly shouted down by the claim that doing so will harm the economy.  There is a large literature on the subject, which I will set aside here.  One aspect of this logic, however, is seldom discussed.  If one takes seriously the idea that foreign competition will prevent us from doing things differently than the rest of the world, why would we care about preserving jobs in finance at all (on Wall Street, or anywhere else)?

After all, the financial industry is almost entirely engaged in "intermediation," which simply means that the products that they sell are not services that people desire for their own sake, but merely as a means to an end -- easier ways to pay bills, to save for future consumption, etc.  If people in other countries are setting the standards by which those financial services can be bought and sold, and those services are highly mobile across borders, why is that not an industry that we should be happy to turn over to those other countries to run (or, at least, to regulate)?  In the 1990's, we reached the point where televisions were no longer built in the U.S.  Why is it presumptively necessary that financial work be done here?

This brought to mind a comment from one of my professors in graduate school.  (Because she was a wonderfully unorthodox economist, she quickly moved out of the economics department, into a multi-disciplinary program in social science.)  This was in the 1980's, when one of the main points of concern among U.S. policymakers was how to compete with the highly efficient Japanese industrial conglomerates.  U.S. business schools were busily trying to catch up with the new wave of management, and American companies were sending their managers to Japan to learn from the best.  (What a difference a "lost decade" or two can make!)

My former professor was unimpressed.  Why, she asked, are we not taking seriously the brutal logic by which her orthodox colleagues told everyone else that they must live?  They told us, for example, that it is "simply not competitive" to have an active labor movement, because the rest of the world could undercut our wages.  Why were we bothering to be competitive in management?  Would it not make sense to say that foreign managers are simply better than U.S. managers, and that U.S. managers should find something else to do?  The market had spoken, and it said that U.S. managers were the losers.  Live with it!  Under the logic of "the theory of comparative advantage," we should have learned that we lack a comparative advantage in business management.

What would happen to American workers?  That same theory says that productive workers will be hired to work in foreign-owned enterprises in the U.S., and paid a wage commensurate with their level of productivity.  It does not matter where the managers are located.  And, as my former professor pointed out, whether the management team running the asbestos plant in southern Ohio is made up of Japanese nationals or U.S.-born MBA's should not matter at all, from the standpoint of orthodox economics.

In the current discussion about post-crisis financial regulation, the argument seems to be even more basic.  Whether or not we have "won" or "lost" is not the point, and we do not even need to admit that someone else does things better than we can.  It is not, therefore, a matter of trying harder, so that we can ultimately win.  What matters is simply that we are already playing by someone else's rules.  If we delude ourselves into thinking that we have any power to do what we really want, then we are wasting our time -- and, more to the point, being inefficient.

I am not aware of any orthodox economist who takes this logical step.  Certainly, the assumption among the people who claim to believe strongly in the logic of orthodox economics is that we should try harder to remain competitive in financial services, even while other people have to accept the lower standards that are imposed from outside.  The same people who were happy to allow passenger trains to wither in this country, and who blanch at the suggestion that we raise the minimum wage or spend money on worker training, are saying that we need to "keep financial jobs in America."  Why?  Because we need to keep financial jobs in America.  That's why.

Emerson wrote: "A foolish consistency is the hobgoblin of little minds."  One of the prime virtues of orthodox economics, however, is supposedly that its logic is consistent and inexorable.  Any attempt to avoid the implications of the two examples above -- to argue that there should be American-run businesses, and that financial services should be produced in the U.S. -- inevitably requires one to be inconsistent with the supposedly iron logic of laissez-faire economics.  The conversation advances when we admit that the supposed consistency of market idolators is conveniently abandoned when necessary.  When everyone admits that they are trying to advance something that is not captured by what orthodox economics is peddling, then the policy choices will expand, and policy discussions will become a lot more honest.

5 comments:

Michael C. Dorf said...

A tiny caveat on a tangential point: I think that in the 1980s American companies did learn a lot from Japanese PRODUCTION techniques: e.g., low-inventory just-in-time systems; flexible teams; etc. The Japanese lost decade(s) was/were mostly the product of bad macro policy, too much savings relative to consumption, over-reliance on exports, and the rise of China and other low-wage competitors.

Paul.K said...

If people in other countries are setting the standards by which those financial services can be bought and sold, and those services are highly mobile across borders, why is that not an industry that we should be happy to turn over to those other countries to run (or, at least, to regulate)? In the 1990's, we reached the point where televisions were no longer built in the U.S. Why is it presumptively necessary that financial work be done here?Cheap Runescape Gold | WOW Gold Kaufen

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