Mankiw’s Principles of Economics Part 7: Governments Can Sometimes Improve Market Outcomes

The introduction to this series is here.
Part 1 is here.
Part 2 is here.
Part 3 is here.
Part 4 is here.
Part 5 is here.
Part 6 is here.

Mankiw’s Seventh Principle of Economics is: Governments Can Sometimes Improve Market Outcomes. Mankiw says economics will refine the view of the student on the role of government. In Mankiw’s book, government has several acceptable roles:

1. Enforcement of property rights. It is imperative that scarce resources are owned by individuals and firms. Government enforces the rules and protects the institutions that support these property rights. If the rights of creators of products are not protected, people won’t make things. “The invisible hand counts on our ability to enforce our rights.”

2. Government intervention is allowed to achieve greater efficiency or greater equality.

The first point fits squarely with Mirowski’s commandments of neoliberalism. The Fourth Commandment is: Thou Shalt Retask the State to Thy Needs. The function of the strong state is to make sure that the neoliberal program can come into existence; it must, as we learn from the First Commandment, be constructed, it will not happen without force and socially acceptable forms of violence. This is accomplished by using the state to marketize everything, and by ensuring that scarce resources are put into the hands of the wealthy and secured to them. The rest of us become forced customers of private entities, health insurance companies, policing, and education. Can water be far behind? Care to buy your water from Comcast?

As an aside, privatized education really bothers me. We’ve learned that the Educational Testing Service has rewritten the guidelines for AP History to cut back on what wingnuts call negativity and the rest of us call reality, and to focus on US exceptionalism. The ETS is a private corporation. Its Chairman is Robert Murley, who is also the CEO of Apollo Education Group, Inc., which operates Phoenix University. His only interest is making money. The idea that he is a scholar is preposterous. But he sets the standards for many of our smart kids, the lucky ones in schools that have AP classes.

The second allowable activity of government is to achieve greater efficiency. This entails dealing with market failures or with externalities. Neither of these is an allowable function of government in a truly neoliberal society. Markets cannot fail in neoliberalism, as Mirowski explains in Commandment 3, Thou Shalt Worship “Spontaneous Order”. More important, market power is not a problem for neoliberals, as we learn in Commandment 10, Thou Shalt Not Blame Monopolies and Corporations. The idea that a government might intervene to reduce inequality is anathema to neoliberals. Mirowski explains this in his Ninth Commandment: Thou Shalt Know That Inequality is Natural.

For Mankiw, at least theoretically, government is allowed to legislate on externalities and market power. Sadly, all externalities can be litigated indefinitely. Between the courts and flaccid enforcement, antitrust law has been ignored for years. As to inequality, Mankiw tells us that markets reward those who produce things other people want to buy, which is closely related to his Principle Number 8. Markets, he admits, won’t make sure everyone has food, clothing, health care, shelter, or anything else. “This inequality may, depending on one’s political philosophy, call for government intervention.” That might mean welfare, progressive income taxation or other programs. Then we get a full paragraph explaining the problems of using government for these purposes, including this gem: “Sometimes policies are designed simply to reward the politically powerful.”

In my discussion of Principle 6 (markets are usually a good way to organize economic activity) I pointed out that Mankiw ignores the enormous amount of buying done by governments at every level, which in Mankiw’s language probably confuses the Invisible Hand. Similarly, in his discussion of Principle 7, Mankiw ignores the role of government in establishing the rules related to markets, and in enforcing a minimal level of anti-fraud rules. This role of government obviously improves market outcomes, unless the rules are “designed to reward the politically powerful.” I assume he doesn’t mention this crucial role of government in the economy because it would show that markets are a construction, not a given and that would be one too many deviations from neoliberal dogma.

That markets are constructed is most obvious in the area of “intellectual property”, a term that probably came into wide use in the late 1940s. Essentially, the people behind this term want to marketize intellectual activity, making it an article of commerce rather than a commons.

Mankiw assigns to government the obligation to “maintain the institutions that are key to a market economy.” I suspect this is more than the courts and US Marshals, but Mankiw leaves us hanging. Perhaps he means private groups like ETS, or the World Intellectual Property Organization. Or perhaps he means groups like the Uniform Law Commission. Who knows? Here’s a story about the Uniform Law Commission.

Several years ago, the group decided to rewrite the section of the Uniform Commercial Code governing security interests, which is the technical term for liens on personal property. The purported problem was that compliance with the requirements of Article 9 was so complex that bank paperwork occasionally didn’t comply. In Chapter 7 cases, the Bankruptcy Trustee is allowed to set aside a defective security interest, and sell the property for the benefit of unsecured creditors. Trustees are paid a small percentage of the funds raised, which encourages them to inspect the paperwork carefully. The idea was to amend the rules so that close enough was good enough. One of the participants in the revision process told a CLE session I attended that in drafting sessions, the members would joke that these provisions would really screw the Trustee. That was silly. Trustees have plenty of work, and only got a tiny payment for setting aside invalid security interests. The actual people getting screwed were unsecured creditors. Of course, none of the participants represented unsecured creditors, so the changes were made, and with the imprimatur of a supposedly neutral group, they were adopted in all of the states. I know for a fact that this resulted in more wins for the banks at the expense of common creditors. A decent government would have insisted on participation by all relevant groups in the drafting of these changes, which violently upset the original balance between secured and unsecured creditors that once was the hallmark of the UCC.

That’s the kind of institution Mankiw wants the government to protect. Oh, and ALEC.

Notre Dame undergrad (math); JD, Indiana University at Bloomington; 1st Lieutenant, US Army.; private practice in corporate and securities law; Assistant AG in Tennessee for consumer protection and securities; Blue Sky Securities Commissioner, Tennessee; private practice, bankruptcy and corporate law.

I have had a lifelong interest in economics. For most of my career, that interest was practical, focused on the problems in front of me. Lately I have been more interested in economics as a theory, especially its impact on the lives of people like those I met in my bankruptcy practice, and on the politics of money in the US. I also enjoy reading philosophers, starting in college and steadily expanding my reading ever since. I wrote at FireDogLake for a number of years.

Generally, I think the problem facing the US is the dominance of neoliberal discourse. I think it clouds the vision, and limits the kinds of problems that can be identified and solved. For example, the existence and danger of climate change can easily be identified in a scientific discussion. However, the problem does not fit the neoliberal discourse because science insists that the pursuit of individual and corporate self-interest will lead to devastation. In neoliberal discourse, the pursuit of self-interest always leads to Eden.

The neoliberal project has two prongs. One is the police function of crushing dissent and alternative views. The police function is provided by government agencies and private and institutional actors. The counterpart is the economic system , which is operated by government and by private and institutional actors. Some of these actors operate in both spheres. I focus on the second prong.

18 replies
  1. bloopie2 says:

    “That markets are constructed is most obvious in the area of “intellectual property”, a term that probably came into wide use in the late 1940s. Essentially, the people behind this term want to marketize intellectual activity, making it an article of commerce rather than a commons.”
    .
    What does that sentence mean? Does it mean that if I invent something, or create an artistic work, you want to take it away from me and give it for free to everyone? That people who work with their brains should be slaves to people who aren’t smart enough to do that? Or does it means something else? Please explain. Because if that’s what it means, then that’s bullcrap. And what do you mean “the people behind this term”? The grant of exclusivity for both copyrights and patents is part of the original US Constitution, which is well over two hundred years old; it didn’t come along in the 1940s. Do you think we should throw it out because some people get rich off it?
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    It would also be nice if some day you would say something nice about the private sector; most people do work there and they are honest and hardworking and contribute a lot to society.

  2. bloopie2 says:

    “Enforcement of property rights. It is imperative that scarce resources are owned by individuals and firms. Government enforces the rules and protects the institutions that support these property rights. If the rights of creators of products are not protected, people won’t make things.”
    .
    So you believe, then, that there are no property rights that should be enforceable by government action? If I steal your car, or appropriate your good name, or steal your water (a ‘scarce resource’ in California these days), then you believe you should have no recourse to a governmental justice system? It’s gross generalizations and mischaracterizations like this one that make your work so frustrating to read at times. You have a lot of good points to make; don’t turn intelligent people off by making statements that are so bald as to be wrong on their face. Take a few extra sentences to say, “This is the system, it works well sometimes for xxx, but it can be perverted at other times for yyy, and that perversion often happens at the hands of the wealthy.” Then propose a solution, don’t just rant.
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    And if your solution is that the government/people should own all the water, well, I’d love to see that one play out! I sure don’t have an answer for that.

    • Ed Walker says:

      I don’t think you are following the series. Please read the introduction, and if necessary the materials on Kuhn. As to intellectual property, there is a link. Please read the link. If that is too obscure, then read this site thoroughly: http://www.pluginillinois.org/ and think about how how this market arose.

  3. orionATL says:

    what mankiw appears to be talking about here is not science, but a kind of worshipfulness characteristic of religion. anytime one sees a reference to a “hidden hand” or “spontaneous order” one is dealing with the same quasi-relgious mindset present in minds that hold that only suprahuman beings are fit to intervene in human affairs, e.g., only god can “authorize” an abortion, or only god can end a life.
    .
    calculated human intervention in matters affecting human lives is suspect, the “enemy”.
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    of course individual, god-like social-manipulating capabilities of very wealthy individuals and private institutions are not suspect and are subject to reverence.

  4. Alan says:

    The posts are coming fast so having trouble keeping up. So this comment relates to Principle 5 (somewhat), 6 and 7.
    *
    I want to take a stab at the “invisible hand”. Mankiw takes the invisible hand bit from Adam Smith’s Wealth of Nations. He states this explicitly in his book (Principles of Economics, 7th edition, pp.10-11). He calls it the most famous observation in economics:

    Households and firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes. One of our goals in this book is to understand how the invisible hand works its magic.

    If you read what Smith wrote, along with what neoclassical economists claim he wrote, much of what they claim  is deeply problematic or just plain wrong. As Mirowski writes, in Never let a Serious Crisis go to Waste, about what happens when history and philosophy is banished from economics:

    Economists would periodically be sounding off in the most illiterate registers concerning Karl Marx, Vilfredo Pareto, Hyman Minsky, Adam Smith or even John Maynard Keynes,  because they were confident no one would ever call them to task on their shallow pretenses.

    *
    With that in mind let’s take a look at Adam Smith and the so-called invisible hand. The first thing to note is that the phrase invisible hand appears only once in Wealth of Nations and well into the middle of the book. If it was such an important observation you think he might have mentioned it more often and earlier in the book.
    *
    Here’s the section IV.2.9 quoted in full but it’s worth reading the rest of the chapter for more context:

    IV.2.9.  But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he 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 the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

    *
    Some comments:
    1. The invisible hand is a metaphor. It was a metaphor in common use at the time. Smith uses it once in each of his three books and to different ends. It’s not a concept, theory, or what have you of ‘the market’.
    *
    2. The section says nothing about the general working of the market: It a statement about the preference of some individuals for investment in domestic over foreign industry.
    *
    3. He talks about individuals; not firms (as Mankiw does). Presumably by firms Mankiw would include large corporations (e.g. GM, Bank of America, Exxon, etc.). Smith is highly critical of large institutions (in his time, the ), because they involve centralized management and planning, not to mention much else, such as collusion with government in the creation of monopoly (monopoly regulations is a major topic of the chapter). There is a big emphasis in Smith on trust in local understanding and knowledge and individuals being in the best position to know and act on their own interests.
    *
    4. The invisible hand section has a rather unremarkable statement about actions and unintended consequences. Note that Smith does not claim this always happens. He says pursuit of self-interest frequently promotes that of society. The question is really under what conditions this occurs and what general laws make this possible. WoN has numerous examples where the pursuit of self-interest runs counter to the social good. See for example his discussion of banking at
    II.2.94.

    But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed.

    *
    5. The entire chapter (IV.2) is titled “Of Restraints upon the Importation from Foreign Countries of such Goods as can be Produced at Home”. It is an attack of Mercantile economic theory and monopoly laws, which he mocks in this famous passage in IV.2.15:

    By means of glasses, hotbeds, and hot walls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expence for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines merely to encourage the making of claret and burgundy in Scotland?

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    *
    6. If you just look at the first part of the chapter it is an argument against intervention in economic matters by government but later discusses kinds of government interventions that are reasonable. Smith is pragmatic; not ideological. As he states in IV.2.43 “To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain is as absurd as to expect that an Oceana or Utopia should ever be established in it.” He’s not a free market ideologue or a utopian.
    *
    7. The bit Ed quoted in the Part 5 post: “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy…” is also part of this chapter i.e. two sections after the invisible hand section. See IV.2.11. This refers back to the division of labour in I.2, see especially I.2.2. The latter is the section with the famous “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest” section. This is another part of Smith that is frequently selectively quoted and mischaracterized. (Mankiw also refers back to this in his discussion of Smith.) Sometimes this is said to be about the virtues of greed and selfishness, a conflation of self-interest with greed. (see also Smith on Mandeville in  Theory of Moral Sentiments). More moderately it is about the virtues of self-interest. But that’s not really true either. If you read the whole section rather than the bits that are usually ripped out of context, it’s about exchange and cooperation.

    In civilized society he stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons….But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only.

    Benevolence, note, is not an unimportant virtue, it is just not one that one can rely on for everything. And this is where the cooperation comes in. The section is about addressing oneself to the interests of others (also see Theory of Moral Sentiments):

    It is not from the benevolence 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.

    *
    And no nonsense notions of equilibrium, maximization or mathematical models here either.

    • orionATL says:

      this is an excellent, informative, because highly detailed, comment.

      what bothers me about mankiw’s using the invisible hand metaphor in 2015 is that he has 250 more years of mathematics and economic science on smith. mankiw should know, and most certainly does know, details of “market” operations and summation of individual data over groups unknown to smith. where smith was borrowing an appealing metaphor for summation, mankiw is repeating a homilitic from the rich man’s religion – neoliberal economics. **
      .
      the invisible hand is a metaphor of summation and outcome. it implies that when large numbers of individuals act toward a single purpose, e.g., enter and sell or purchase in the corn market, there can result socially useful consequences. in fact, what happens is just that the market reaches a price and clears. whether that outcome is socially useful or not is not predetermined in any manner or circumstance as mankiw surely knows.

      i would guess that except for some markets with millions of participants, classically agricultural markets, manipulation of the market in question is the rule rather than the exception. even the “milion-man-market”, e.g., the stock market, is manipulable, as are derivatives and housing markets as demonstrated in the libor scandal:
      .
      https://en.m.wikipedia.org/wiki/Libor_scandal
      .
      http://topics.nytimes.com/top/reference/timestopics/subjects/l/london_interbank_offered_rate_libor/index.html
      .
      .
      .
      ** l think it’s been done here previousy, but the meaning of “liberal” in this context is a historical one and bears no relation to the word “liberal” as currently employed in american political discourse.

    • orionATL says:

      “…Here’s the section IV.2.9…”

      by the way, smith seems to be clearly talking what we now call macroeconomics in the quote. mankiw’s textbook seems largely microeconomics with a macroeconomics tail.

    • Ed Walker says:

      The Meeropol paper is well-argued and easy to follow; recommended to all. I love the description of what Bill Black would call control fraud in the East India Company, .pdf page 8.

  5. Alan says:

    Also, as I understand it, a big part of Mankiw’s Principle 7 has to do with externalities. This just adds to the fun because not only do neoclassical economists get 18th C. thinkers like Adam Smith wrong, they get their own colleagues wrong as well. See Deirdre McCloskey Other Things Equal: The So-Called Coase Theorem. For discussion of externalities and the ‘Coase’ Theorem in textbooks such as Mankiw’s see Butler and Garnett’s Teaching the Coase Theorem: Are We Getting It Right?

    • Ed Walker says:

      Thanks for the Coase links, and in fact all the links. I’m planning to do something on that idea after the Mankiw series, three more principles, a conclusion, and some discussion of one or two chapters if I can make myself.
      *
      Smith is a classical thinker, broad-minded and well-informed compared with others of his day, making him a valuable source, not just of ideas, but of the way to deal with economics. He and Keynes have much more in common than Smith and any of the neoliberals, and most of the pseudo-Keynesians, with their unrelenting focus on mathematical models. There is no wisdom, there is no judgement in math. Wisdom and judgment lie in the mind of individuals, and is best communicated by simple language and story-telling.

  6. Alan says:

    OrionATL and Ed:
    *
    I’m been trying to work through and get a better grasp of Smith having read enough to come to the conclusion that most of what is written about him, to quote a utilitarian philosopher (they have their uses), is nonsense on stilts. My post above is a bit of a ramble. As I wrote, I was taking a stab. I think I would agree with your comment on Keynes and Smith. I haven’t read a lot about Keynes, but he strikes me as someone, like Smith, who smart, pragmatic, and genuinely interested in promoting the common good.

    *
    I’ve found the writings of Gavin Kenmedy’s writings useful and recently also Samuel Fleischacker’s book on Wealth. I think I am about to start reading one of , one just published. I haven’t read it but Warren Samuels’ book is supposed to be a good analysis of the abuse of the invisible hand in modern economics.

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