When to Rely on Coercion

In the revised edition of The Company of Strangers, Paul Seabright writes (p. 26),

One of the great intellectual achievements of modern economics has been to work out very precisely the circumstances under which decentralized systems of market exchange can produce results that are efficient, in the sense of improving the condition of every individual as far as possible whenever this can be done without harming someone else…as we shall see, all real-life systems of market exchange fail to live up to these demanding conditions

These sorts of statements are often the start of an intellectual swindle, which goes.

1. Markets are great, under some conditions (no externalities, perfect information, commodity-like products).

2. Those conditions often fail in practice.

3. Therefore, in practice we often need government.

The swindle is that (3) implicitly assumes that whenever markets fail, government is the solution. But no theory of government is used to back this assumption. On the one hand, it is a great achievement to have worked out the precise conditions under which decentralized, competitive markets are optimal. On the other hand, mainstream economists do not seem to care about working out the conditions under which government will succeed where markets fail.

Consider the following matrix:

I am not really interested in the bottom right quadrant, hence the question mark.

I am interested in the conditions that make it better to be in the top right quadrant than in the top left quadrant. That is, when do you need to move from central planning by private organizations, from which an individual may opt out, to central planning by a government?

For example, I have argued that the government is needed to ensure that disputes are resolved without resorting to violence. That does not mean that government must resolve every dispute. But people should know that the government will help enforce private dispute resolution mechanisms. For example, the U.S. government supports the ICANN mechanism for assigning domain names on the Internet. If you want to claim ownership of an Internet domain, and ICANN rules against you, then if you cannot fight the ruling without going up against the U.S. government.

One thing I have never understood about the “nudge” idea of libertarian paternalism is why the nudges should come from government. There are private organizations that nudge–think of Weight Watchers.

Nor do I understand how “happiness research” became an excuse for government policy. To me, it is at best an excuse for economists to write self-help books.

I do not understand why consumer protection requires coercion. Why is it not enough for me to be informed about the research about a particular drug? Why do drugs have to be banned?

I think I can come up with an argument for why pharmaceutical companies would have to be forced to put drugs through clinical trials. A lot of consumers might want drugs to go through clinical trials, but it is difficult for us to solve the free-rider problem and other organizational difficulties in putting together a coalition that creates incentives for pharma companies to test drugs properly.

Environmental issues represent another area in which assembling the coalition necessary to bring to bear people’s preferences may involve free-rider problems that are difficult to solve.

In short, I think there are conditions under which one can argue for moving from the top left quadrant to the top right quadrant. However, those conditions are likely to be very stringent. And it is quite striking that the level of interest among mainstream economists for working out those conditions is much lower than their level of interest in working out the conditions under which the bottom left quadrant is perfect.