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Friday, March 21, 2014

The Economist Who Said Maybe

The answer to most economic questions begins with “I don’t know”

Is microfinance in the developing world a beneficial strategy? Is bitcoin a good idea? Will 3-D printing substantially change our way of living? Imagine a panel of economists being asked questions like these. What kind of answer do you expect from them? Plenty of economic and techy jargon will get thrown around by those who have done their homework. Many of their answers will contain substantial merit, but I think the best answer is a simple “I don’t know.”

It’s not a complete reply and should be followed by some reasoned response. But “I don’t know” should be a prelude to more responses to economic questions, even pivotal ones about the future of our currency or the development of impoverished nations.

It might not look like a good answer for a trained economist to give. But humility is the most important lesson that training in economics yields. From Adam Smith to F. A. Hayek and many in between, a sound approach to economics involves understanding our limited capacity to answer such questions.

The essence of this humility is the respect for spontaneous order; market-based institutions answer questions like the ones above in ways no individual could. This yields phenomena, as Adam Ferguson puts it, of “human action, but not of human design.” The deep appreciation of the phenomenon of spontaneous order leads one to humility; we never know exactly what the market solutions will be.

The Evolution of Music

Consider a blunt history of music as entertainment. The trend of big bands was replaced in 1948 by LP vinyl records and moved individuals out of the dance halls and into their own homes. After vinyl came the 8-track in the late 1960s, the cassette tape in the late 1970s, and then the CD started to gain popularity in the late 1980s. The big band, vinyl, 8-track, cassette, CD progression is a bit of a simplification because radio had come into play as a separate market and multiple platforms had alternate sizes and models. However, the general popular-use trend was quite clear: About every decade, a better platform was developed.

It was not weird for people in the early 1990s to think that their CD collections were only temporary; most people thought something better would come along. More than a few thought they knew exactly what it was. The common thought was that popular music would be widely used on a disc similar to a CD, but the disc would be much smaller. If you watch the 1997 film Men in Black, the two characters have a discussion about the future of technology. One complains that he’s going to have to buy the Beatles’ White Album again soon to replace his CD with the mini-CD.

But just about everyone was wrong. Mini-CDs never supplanted the original CD. But a new market did emerge as the format of choice right around the year 2000. When answering the question, “What will be the next thing to hold our popular music?” the actual answer was, “Well, nothing!” What followed the CD was a digital file that could be transported via the internet. Imagine an individual trying to convince you in 1992 that the next step beyond a CD is in fact nothing. You wouldn’t have anything physical on you. You’d have nothing to search for underneath the passenger seat of your car, nothing to put into binders or towers for storage, and no worries about anything getting scratched, mangled, or tangled. You’d have this file called an MP3. You would essentially have nothing physical to replace the CD. Convincing someone of this invention before its existence would seem fairly absurd.

So What?

In a market society the answers to questions like “Is X a good idea?” are often conclusions that exceed what most people originally considered possible. The market system often moves beyond what we were capable of seeing. How is the market so effective at progress? It is the same reason I think the answer “I don’t know” is often a great response for an economist.

The true benefit of freedom is that the institution or the market system (not any one individual or expert) bears the cognitive burden of figuring out what is a good idea. The profit and loss system, where consumers voice their opinions, quickly guides entrepreneurs. What serves consumers' needs best? Do we value using titanium for the current design of a tennis racquet or would it be better used in a new design of a toaster oven? With so many consumers having so many preferences for so many products, it is no easy task to figure out what the best use of a resource is—that is, unless you have the profit and loss system.

Many entrepreneurs play their role in helping us to figure out little parts of what works and, perhaps even more importantly, what doesn’t work. Entrepreneurial actions bring disjointed, disparate, and detailed local knowledge to the forefront. When filtered through the market mechanism of profit and loss, the gathering of knowledge from the many will exceed the foresight of most, if not all, experts. Markets bring together the best from many and help us discover together instead of in isolation. When determining what works and what doesn’t, it is the market setting that allows a spontaneous order to do the heavy lifting that individual planners and experts simply cannot manage.

So is bitcoin a good idea? Is microfinance a path to prosperity for the impoverished? We have some grasp of the beneficial aspects of those ideas, and we can try to push forward some lines of argumentation to help the process. But it is a large part of our responsibility to remember our humility when it comes to questions of economics. F. A. Hayek put the context of discussing economics best when he stated, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

Michael Clark will be speaking at the FEE seminar “Econ in Unexpected Places” this summer.

Find a Portuguese translation of this article here.

  • Michael J. Clark is an associate professor at Hillsdale College where he holds the Wallace and Marion Reemelin Chair in Free Market Education.