All Commentary
Tuesday, December 1, 1992

Welfare Economics and Externalities in an Open-Ended Universe: A Modern Austrian Perspective

The mainstream welfare economist should rethink his perfect competition-general equilibrium position.

If every drama has a villain, perfect competition-general equilibrium (PCGE) is Roy Cordato’s royal knave. PCGE is the welfare economist’s paradigm of political correctness, complete with a recommended list of allegedly remedial public policies.

Armed with this PCGE paradigm and fortified with advanced mathematics (as a glance at any professional economics journal will reveal), the mainstream welfare economist assumes a world of perfect competition and perfect knowledge. He blithely imagines an ideal economic system in general equilibrium in which there is a broad balance of forces facilitating the simultaneous fulfillment of plans by sellers and buyers. He holds that markets are efficient only when market price and marginal cost are equal; he says that in the absence of such equality markets “fail”; he claims that “market failures” further proliferate when market “side” or “spillover” effects lead to “negative externalities” with less than optimal results in terms of prices, production, and pollution.

Not to worry. Father Washington knows best. Market failures are corrected, proclaims the modern exponent of welfare economics, by taxes, subsidies, import quotas, antitrust laws, pollution controls, public utility regulations, and other government weapons, all of which magically do away with the problems that arise in the mainstream welfare economist’s imaginary model.

But these problems and solutions are presented to policy makers, says economist Roy Cordato of the Washington-based Institute for Research on the Economics of Taxation (IRET) “without any recognition of the fact that they were developed within a context that bears very little resemblance to the real world.”

Why so little resemblance? Dr. Cordato argues persuasively in this scholarly work that the mainstream welfare economist should rethink his PCGE position and see market activity as a dynamic and open-ended process creating demand and supply disequilibrium situations that veer toward but never quite reach equilibrium. He should also see that private property rights are sacrosanct, that value and utility are strictly subjective and therefore unobservable and unmeasurable, that knowledge of market phenomena such as demand curves and unit costs is always imperfect to both market participants and policy makers, that market competition is an entrepreneurially driven information discovery process upsetting some previously coordinated plans as fresh information comes to the fore and the price system adjusts to ever new situations.

It follows that the main answer to dealing with pollution damage is stricter stipulation and enforcement of private property rights so as to allow affronted property holders to claim tort liability and seek redress in the judicial system.

In light of this analysis, it is little wonder that government interventions on behalf of environmental concerns backfire. The concepts of general equilibrium and perfect competition are inherently false guides, says the author, inasmuch as market participants are not robots but real men and women who must ever cope with scarce time, with their own individual responsibilities and resources, with their particularly unique private property rights—i.e., with the world as it actually exists.

In introducing this book, economist Dominic Armentano of the University of Hartford and author of Antitrust and Monopoly: Anatomy of a Policy Failure, hails the Cordato logic for filling a gap in Austrian economics and for obviating, among other things, such dubious antitrust tools as market share, concentration, and entry barriers. He writes: “Roy Cordato’s new book is both timely and important. Questions of liability and efficiency with respect to negative spillovers are current, cutting-edge public policy issues. In the area of industrial pollution especially, significant private and taxpayer resources have been committed to schemes to redress the ‘social costs’ of alleged environmental degradation. In addition, government agencies and the courts are increasingly regulating private behavior in this area. Thus it is important to re-examine the economic rationale for regulating externalities and whether existent public policy is appropriate.”

Dr. Cordato has made an important contribution to our understanding of welfare economics. 

Dr. Peterson, adjunct scholar at the Heritage Foundation and Mises Institute, holds the Lundy Chair of Busi ness Philosophy at Campbell University, Buies Creek, North Carolina

  • William H. Peterson (1921-2012) was an economist, businessman and author who wrote extensively on Austrian Economics. He completed his PhD at New York University in 1952 under the supervision of Ludwig von Mises.