In the Appendix of his dystopian novel 1984, George Orwell explained:
The purpose of Newspeak was not only to provide a medium of expression for the world-view and mental habits proper to the devotees of Ingsoc [“English Socialism” in Newspeak], but to make all other modes of thought impossible.
We are not there yet, but in The Fatal Conceit (University of Chicago Press, 1988), Friedrich Hayek wrote expressed a related idea:
The inadequacy of the terms we use to refer to different forms of human interaction is just one more symptom, one more manifestation, of the prevailing, highly inadequate grasp of the processes by which human efforts are coordinated.
A story in the Financial Times illustrates how approaches that are not informed by economics and methodological individualism produce faulty interpretations of reality and policy proposals. The story reports on the fear that, responding to the reduced gas supply caused by Vladimir Putin’s government, the German government, by supporting its businesses and consumers, will harm poorer countries (“EU Leaders Fail to Reach Deal to Cut Energy Prices,” Financial Times, October 7, 2022):
Italy and several other countries squared off against Germany at a summit in Prague on Friday, in a spat that mirrors clashes from past crises. Heavily indebted countries fear that their wealthier neighbors will gain an unfair edge by supporting their businesses and consumers.
Although this paragraph may not look like Newspeak, nearly everything there is strange. It is not “countries” that subsidize and clash, but their governments. Someone insisting that a country is the same as its government should be puzzled by a statement such as “this country has nice mountains.” If the “country” is viewed instead as composed of all businesses and consumers, that is everybody, we cannot properly speak of “its” businesses and consumers without a self-referential nonsense: businesses and consumers support their businesses and consumers. Finally, a state s that subsidizes “its” businesses and consumers in country S does not harm the individuals in country P, except in the very indirect sense that making individuals poorer anywhere reduces other individuals’ opportunities for exchange.
On this last point, consider the following. If the German government subsidizes some German energy consumers with the money (the resources) of some German taxpayers, this is merely a transfer: it makes some Germans richer and other Germans poorer (plus some deadweight loss caused by taxation). But if German taxpayers are obliged to subsidize some German energy businesses, the increased production of the latter and the resulting lower price of energy can only benefit energy consumers including those in other countries.
So why would an Italian worry about German taxpayers subsidizing German energy producers and thus, indirectly, Italian energy buyers? Don’t Italians and Frenchmen and many other individuals usually love to be subsidized by somebody else? The only rational reason for Italian wrath would be if the German government also forbade German energy producers from exporting their products to Italy, that is, established actual trade barriers around Germany.
If, as Eurocrats do, we extend the concept of “protectionism” to whenever a state in the world internally redistributes money or makes its own subjects poorer (say, through deadweight losses), we have to find another word for what used to be called “protectionism,” that is, your own government forbidding you to import or export or do it at terms it does not like. (See my EconLog post “Taking Comparative Advantage Seriously,” November 17, 2017.)
Non-sensical ideas often don’t come alone. From the first FT story cited, we learn more about Eurocrats’ and politicians’ thinking:
One area of convergence appeared to be a growing interest from member countries in working together to negotiate better prices for gas, some officials said, an approach the EU has previously suggested as a way to boost its collective bargaining power and avoid having countries bid against each other.
This project is actually being pushed by the European Commission (“EU Looks to Enforce Mandatory Co-Operation on Gas Purchases,” Financial Times, October 11, 2022). But what could it mean for “countries” to bid against each other? If it means anything, it is that rulers of each country do the bidding over and above the heads of their individual subjects. On a free market, on the contrary, a German person bids as much against other Germans as against Italians. He can stop his implicit bidding if he wants to, and he will simply not get the stuff, which goes to individuals who pay the bid-up market price. A free market is a continuous auction where every individual is equally free to bid. If the countries’ rulers create a cartel of states to do the bidding, it will still be over and above the head of their respective individual subjects. Moreover, since all European utilities and businesses (including those outside the European Union) consume only 14% of the world production of gas, it is not sure that the cartel would have enough market power to push down prices significantly.
Going back to the first quote, we may add that if the politicians of poor countries had not pushed their governments into debt in order to bribe their voters with apparently-free goodies, other countries could not now “gain an unfair edge”—even assuming that shuttling money inside Germany or subsidizing some German producers gave Germans any edge over non-Germans. And I haven’t talked about the price controls that the German government will impose, like other European governments already do and like the EU government is pushing at its level (I mentioned this problem in a recent post).
All that suggests that a different way of thinking is sorely needed.
(Featured Image: Wikipedia Commons, https://en.wikipedia.org/wiki/File:Le_penseur_de_la_Porte_de_lEnfer_(mus%C3%A9e_Rodin)_(4528252054).jpg)
READER COMMENTS
nobody.really
Oct 18 2022 at 1:27am
Once again, I have difficulty following this. Yes, taxes increase prices (effectively shifting the supply curve), resulting in some foregone transactions (“deadweight losses”). But don’t the transfers also generate additional demand (effectively shifting the demand curve)? And doesn’t this additional demand generate additional transactions (“deadweight gains”)?
Pierre Lemieux
Oct 18 2022 at 2:58pm
Nobody: I think the answer to your deep question is the following. A pure transfer (say a lump-sum tax or a theft that would be random and impossible to do again) does not cause a deadweight loss because, even if it does change behavior (the demand curves), it does not cause the total losses to be higher than the total gains; that is, it does not impose a portion of the cost that has no corresponding benefit. A deadweight loss is more than just “foregone transactions”; it it were, the whole universe would be a deadweight loss. (There are more babies that have never been born than the number who have had this chance.) As for a “deadweight gain” compensating a deadweight loss, it does not exist because the whole gain is already accounted for in the transfer (think of the Harberger triangles in the analysis of a tariff). The difficulty with this sort of construction along with your objection comes, I think, from its partial-equilibrium nature. It is better to model this with an Edgeworth-Bowley contract curve: you see the losses on both sides following a move away from the contract curve.
This suggests that it is better to follow Buchanan (who would anyway reach the same conclusion as mine about price controls):
nobody.really
Oct 18 2022 at 5:24pm
This seems like such an obvious question, I’d expect someone would have generated parallel graphs to illustrate the point. The first graph would illustrate a tax wherein government used the revenues to buy up grain, and then distributes it among the poor. In the second, government uses the tax revenues to buy grain, and then burns it, generating no benefit for anyone.
If Lemieux is right and “the whole gain is already accounted for in the transfer,” then I’d expect the graphs to differ. Yet as far as I can tell, the graphs measure the consequence of the tax without any regard to the uses of the resulting tax revenues. This strikes me as a pretty big bias in the analysis.
According to this webpage, we measure deadweight losses relative to the “ideal,” which is where the supply curve and demand curve cross. But, of course, no specific supply or demand curve is an immutable fact of nature. Today’s supply of and demand for goods and services differ from the supply and demand of a generation ago. Is that because humans have changed so much over a single generation? Or is it because humans live in a different context than a generation ago, and supply and demand are functions of that context?
So if we change that context–whether than means building an interstate highway system, or engaging in wealth transfers–we can change the supply and demand, thereby creating a new “ideal.” And relative to this new ideal, any change to the context–ripping up the highways, or eliminating the wealth transfers–would be regarded, by definition, as a sub-optimal deviation. But ultimately the analysis reflects (that is, incorporates as an exogenous factor, beyond the scope of the analysis) the social choices that create the context in which people “freely” transact their business.
Or so it seems to me.
Pierre Lemieux
Oct 18 2022 at 10:23pm
Nobody: We are speaking ceteris paribus. On the graph you referred to, the only thing that has changed is the tax–and, consequently to the tax being imposed, the price and the quantity demanded and supplied. The area B+C goes to the government that redistributes it; consequently, this area represents the gains to the receivers of the government’s largesse (from your original question, on the other graph you wanted to draw). The area E+F gives the deadweight loss, that is, the difference between the benefits and the higher total cost (reduction in consumer surplus and producer surplus).
nobody.really
Oct 19 2022 at 9:54am
Would the receivers of this largesse then become richer? And would richer people then have higher aggregate demand, ceteris paribus? I don’t see where that is reflected in the graph.
nobody.really
Oct 19 2022 at 1:29pm
Upon reflection, perhaps I failed to appreciate Lemieux’s caution that the graph depicts partial equilibrium.
The standard deadweight loss analysis suggests (yes, ceterus peribus) that society become POORER following a tax. Thus, in aggregate, even assuming that government generates benefits equal to the value of the revenues collected, we would expect aggregate demand to DECLINE due to a wealth effect.
Yes, a straight transfer might cause SOME people to become wealthier, but would necessarily leave other people poorer. Parallel graphs might illustrate this point: In one graph, recipients would bear the burden of the deadweight loss, but get the benefit of a boost in demand resulting from receiving the transfer from the tax revenues collected. But a second graph would show people bearing the cost of a deadweight loss, plus the resulting loss of demand resulting from lost wealth. (And conceptually a transfer could leave everyone poorer because the magnitude of the transfer to any one person would fail to exceed the burden of the deadweight loss to that person.)
Then again, government might use the resources to generate benefits that exceed the value of the revenues collected in the tax (such as some public goods), which might make everyone wealthier. Or government might squander the resources. Unlike a hypothesis with a transfer, there’s no necessary relationship between the social value of the revenues collected and the social value of the government expenditures. The resulting graph wouldn’t illustrate any conclusion (other than the conclusion that we can’t draw any conclusions from the limited data in the hypothesis–which is not a worthless insight, but not an especially powerful one, either.)
Pierre Lemieux
Oct 20 2022 at 11:11am
Nobody: To try to answer your argument without discussing it point by point (which would be too long), let me just focus on a few broad considerations you should incorporate in your reasoning.
(1) “Aggregate demand,” is a macroeconomic concept that has nothing to do with what we have been discussing here–except if you just mean adding the demand curves of the transfer giver and the transfer receiver, but that is not possible except on one single market, where it is just called “market demand.”
(2) The transfer giver is poorer and the transfer receiver is richer in the context of the standard tax model we are using here. In the case of a voluntary transfer (a gift), they are presumably both richer. Both consumers and producers “support” the DWL because, by construction, the latter is the excess of the cost (to some) over the benefits (to others through the government).
(3) As you point out, we must take care not too draw too wide conclusions from a simple partial-equilibrium model with primitive welfare economics.
(4) If you want to argue that the DWL provides larger benefits, you would argue, in a standard public-finance perspective, that the government uses the tax to produce not pure redistribution but a public good that will benefit everybody more than the tax he had to pay for it plus any DWL. You could hitch a ride with Buchanan, and you would already be in a different way of thinking (advocated by my post). This would oblige you (it’s a rhetorical “you,” literally pointing to nobody in particular) to also ponder the point that follows–a different way of thinking:
(5) If public goods do not exist or Leviathan does not have and cannot have the proper incentives to produce them, then you are riding more with Anthony de Jasay:
David Seltzer
Oct 18 2022 at 7:25pm
Pierre: I read your answer several times. Again I’m enlightened. Question: It seems to me DWL results in diminished consumer surplus because of under-production and loss of producer surplus due to over-production. Am I missing something here?
Pierre Lemieux
Oct 18 2022 at 10:40pm
David: I don’t see how we can say this. It should be clear if you refer to the graph that Polyphemus (writing “Nobody” here would gravely interfere with the grammatical meaning of my sentence) linked to (see the first graph). The deadweight loss result, in this case, from less production and less consumption, by the same amount of course. Except if supply is perfectly elastic, both the consumer surplus and the producer surplus decrease, depending on the elasticities of demand and supply. There is a deadweight loss (E+F) because the reduction in both these surpluses are greater than the increase in the benefits of increased government expenditures (B+C). Or, viewed in another way, the reduced production means that some units are not produced whose cost (in terms of decreased production elsewhere) is less than what the consumers would value the foregone production. Did I understand correctly what you were saying?
David Seltzer
Oct 18 2022 at 11:43pm
Pierre: You did understand correctly. Your explanation helps me grasp the concept. Thanks.
nobody.really
Oct 19 2022 at 1:33pm
Oh, that’s clever.
And apologies for hijacking your thoughtful post for the purpose of exploring deadweight losses generally. If it’s any consolation, I can say with authority that nobody valued this discussion.
Pierre Lemieux
Oct 19 2022 at 10:03pm
Nobody’s ideas are welcome.
Jose Pablo
Oct 19 2022 at 9:20pm
Another example that supports your thesis about the production of “faulty interpretations of reality and policy proposals”
In the official webpage of the European Council, you can read:
“Member states commit to reducing gas demand by 15% next winter”
https://www.consilium.europa.eu/en/press/press-releases/2022/07/26/member-states-commit-to-reducing-gas-demand-by-15-next-winter/
At the bottom of the page there is a link
Energy prices and security of supply (background information)
that leads the reader to some of the measures adopted to that end. The first, more relevant one:
To this end, EU countries are working together on:
cutting energy costs for households and businesses
They should be kidding! right?
Idiocracy is finally ruling one of the biggest world economic blocks.
Pierre Lemieux
Oct 19 2022 at 9:59pm
Jose: I am working on an article on these European energy price controls. That most people don’t understand the role of prices better than before Hayek and the market-socialism debate is, to say the least, disappointing.
Jose Pablo
Oct 20 2022 at 1:08pm
Examples are plentiful,
https://www.economist.com/finance-and-economics/erdogans-zany-monetary-experiment-is-impoverishing-turkey/21806459
Governments seem to be forgetting the very little economics they ever learnt. Voters seem to like it, though.
Disappointing is, definitely, an understatement.
Comments are closed.