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Thursday, September 16, 2010

The Complexity of Simple Economics

Spontaneous order is key.

Last weekend I was fortunate enough to attend a ceremony honoring the 1986 Nobel Prize winner in economics, and my former professor, James Buchanan for his lifetime contributions to our understanding of the spontaneous order of the market and politics. The award was given by the Fund for the Study of Spontaneous Orders at the Atlas Economic Research Foundation.

Buchanan’s work was discussed in a public session by two other Nobel winners: Amartya Sen and Elinor Ostrom. In his brief remarks after receiving the award, Buchanan offered some thoughts about the fundamental task of economics and particularly the role of economists as educators. I want to share and expand on them here.

He first noted that the most basic insight of economics is fairly simple: the spontaneous order of the market. At the core of the economic way of thinking is the idea that economic coordination requires no coordinator and that an order which serves the interests of all can emerge from the interaction of self-interested choices. Although simple, it is also highly counterintuitive when first encountered.

Buchanan is aware of that counterintuitiveness, which is why he also has argued that economists must repeat this central insight over and over not just in the classroom, but also when we write and speak in public, whether in professional journals or in lay media like this column. Through an aphorism Buchanan took from his own teachers and passes on to his students, he reminds us that “it takes varied reiterations to force alien concepts on unwilling minds.” That is, we must take every opportunity to impart the simple lesson of spontaneous order, since only through multiple exposures in a variety of contexts will the resistance to the insight break down.

In his talk Buchanan made two additional points about the simple insight of spontaneous order. One was that despite the simplicity, it can take years to really build the insight into your intellectual DNA, that is, to fully understanding all the ways that markets guide our behavior and lead to adjustments that produce orderly and wealth-enhancing outcomes. It is often a complex process, he said. In turn, that simple insight offers the key to understanding a number of complex phenomena of the social world. The wisdom that spontaneous-order thinking produces sits atop a set of theoretical insights about the nature of the market, enabling us to make sense of its empirical complexities.

The Rules Matter

Buchanan’s final point, however, was one that is perhaps the most important in our own time and place. He reminded the audience that not all spontaneous orders are equally good. The quality of the outcomes depends crucially on the rules that frame the economic processes and behavior which produce that order. For self-interested action to produce socially beneficial consequences, the rules under which people choose must be ones which reward actions that benefit others and penalize actions which destroy wealth or value.

For example, in a world where firms believe that they will keep the profits of their productive activities but will be bailed out if they make losses, the connection between self-interest and the general welfare will be broken. Under that set of rules we would not expect the spontaneously produced order to be necessarily desirable, or as desirable as one in which losing firms pay the price themselves and face signals and incentives to correct their behavior. Thus what often looks like “market failure” is really a failure to frame markets with the appropriate rules, most likely because of political meddling.

The rules that frame markets determine the quality of the learning that takes place within them. It is that learning process which leads to the decentralized mutual adjustment and adaptation that is at the core of self-correcting processes. If the rules are not right, the actors will not get the right signals, incentives will be misaligned, and less orderly outcomes will be produced. Just saying “let the market work” isn’t enough in Buchanan’s world because what “the market” is also must include the rules that frame it. The real task for the political economist, according to Buchanan, is to figure out which sorts of rules will best frame markets such that they produce the best outcomes they can.

The interesting question, and one that was debated in the private two-day academic conference that followed the public presentation, is whether we are better off when such rules are consciously chosen through political processes or when they themselves emerge through other, complementary spontaneous ordering processes. The question whether markets can produce their own rules may well be the next frontier in research inspired by Buchanan’s lifelong work, for which this past weekend rightly honored him.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.