Noah Smith, discussing Arnold Kling’s new approach to thinking about economic activity, writes:
In a typical microeconomic model, the market clears, because price adjusts to balance supply and demand. In a PSST world, this does not happen. The pattern of specialization and trade will not always be disturbed by small changes in prices, because the global pattern itself represents a stable equilibrium (i.e., is “sustainable”). How many computers I buy and sell will depend not only on the price of computers, my desire for computers, and my cost of producing computers; it will depend on the prices, desirabilities, and costs of a bunch of other goods throughout the whole economy. The economy will be riddled with network externalities, and the resultant weakening of the price mechanism means that any market may or may not tend toward efficiency on any given time scale. In other words, in a PSST world, there is no invisible hand.
This opens the door for a hugely expanded role for government (or other large, centralized actors) in the macroeconomy. If global patterns matter as much as local prices, then an actor large enough to perceive and affect the overall pattern might be capable of nudging the economy out of a bad equilibrium and into a better one.
And this is what drives me crazy about so many economists. After all that careful thought about the details of how markets function, they utterly fail to put any thought into how government functions. “An actor large enough to perceive and affect the overall pattern…” There’s little doubt that government’s size allows it to affect at least some economic patterns, but how does government’s size enable its capacity for accurate perception and, the necessary follow-up, accurate policy direction? The only economists who seem to make a serious effort to analyze government with the same tools and care they analyze markets–public choice theorists–are, notably–the ones who seem least likely to share this confidence in government. In the middle of the last century, economists like Samuelson believed that if government could just collect enough data it could make accurate calculations leading to wise economic policy decisions in real-time. I don’t think many economists take that idea very seriously anymore–Hayek, et. al, won the calculation debate, after all–but I don’t see how Noah Smith’s claim about an expanded role for government can rest on anything but an unexamined assumption in government’s ability to calculate.
To be fair, Smith explicitly says that he’s not arguing that government would be good at this. But he still ignores the implication of government’s inability to calculate, which is that market failures don’t necessarily open up a role for government. After all, if there were in fact no medical doctors in this world, our illnesses could not reasonably be said to open up a space for witchdoctors or faith healers.