Welcome Robert H. Frank, (Robert-H-Frank.com) and Host Mark Thoma (Economist’sView.com).

[As a courtesy to our guests, please keep comments to the book and be respectful of dissenting opinions. Please take other conversations to a previous thread. – bev]

The Darwin Economy: Liberty, Competition, and the Common Good

The Aggregate Expression of Individual Behavior

The case for government intervention in the private economy is often based upon the need to correct market failures. When problems such as monopoly power, asymmetric information, or adverse selection cause significant departures from the purely competitive ideal markets found in textbooks – departures that cause these markets to deviate in important ways from the outcomes society would prefer – government intervention can correct the problems and improve social welfare. Thus, when consumers are vulnerable to exploitation because, say, they lack information on the value of medical treatments, the government can stop shady characters from selling them snake oil through regulations that require claims to be justified by reliable evidence.

Libertarians and market fundamentalists more generally do not accept this argument. In their view, it is almost always the case that government intervention creates more problems than it solves. And who needs the government in any case? According to this view, markets will fix these problems by themselves. People selling bogus products will quickly be revealed and driven out of business, some businesses will develop a reputation as trustworthy, information on effective treatments can be provided on the web, and so on. There’s no need for government. But what if the products cause permanent damage, should we leave it to the market then? Where should we draw the line?

The proper role of government in society hasn’t been settled after centuries of debate, and this particular facet of the debate – the role of the government in ensuring that markets produce outcomes that maximize the social good – won’t be settled anytime soon either. [cont’d.]

Robert Frank argues in his book The Darwin Economy that this is a false debate. It doesn’t matter which side is correct about the need for government to correct market failures, there’s still a strong case for government intervention into the economy – a case libertarians ought to support.

The argument is based upon an application of ideas from natural selection to economics. As Darwin explained, evolution favors changes that increase the chance that an individual organism’s genes will be passed on to the next generation. Most changes that give an individual an advantage over its rivals benefit the entire population – a mutation might make the individual faster, healthier, or stronger, and when that trait provides a reproductive advantage and it spreads throughout the population it benefits the entire group. But some things that give an individual an advantage – the book uses the example of larger and larger antlers to win battles for mates – are detrimental to the group as a whole. In this case larger antlers make it more likely the individual will win head to head battles and succeed in passing its genes along, but the larger antlers also restrict mobility and that makes the herd as a whole more vulnerable to predators. If someone – a government perhaps – could find a way to reduce antler sizes in proportion so that individual relationships were the same it would make the herd as a whole better off without changing the relative position of any individual.

Whenever the rewards for an action – profits, reproductive success, whatever – depend upon the relative performance of individuals within a group the problem of a divergence between the interests of individuals and the interest of the larger society is likely to be present. The book gives example after example of this “arms race” for positional goods, and details the waste of resources that this causes.

But the book doesn’t just identify the problem, it also points to a solution. The best way to overcome the arms race for positional goods and the associated wasted resources, it is argued, is to impose taxes that discourage this type of behavior. And the most efficient way to do that is through a progressive consumption tax.

As the book notes, it’s important to recognize that unlike the usual case where taxes result in too little consumption of desirable goods and services, taxes that discourage behaviors that are problematic improve societal outcomes. To the extent that we can fund government with taxes on wasteful, problematic behavior we will be better off. We, in effect, have the ability to control the size of our antlers.

The concepts in The Darwin Economy along with the many examples it provides explaining why people spend too much on clothes for interviews, buy houses that are bigger than they need, accept jobs with less safety than is optimal, and accept wages that are more equal than would be justified by individual productivity help us to understand how progressive taxes can make us all better off. And it also makes the important point that progressive taxation can be justified on efficiency grounds. When we use progressive taxes to redistribute income, it gives us more goods and services and greater societal satisfaction that we’d have otherwise. Thus, the case for a progressive tax structure does not have to rest solely upon consideration of equity and fairness.

When households engage in an arms race for positional goods, behavior that benefits individuals can be damaging to the group as a whole. Thus, the presence of positional goods gives markets a way to fail over and above the traditional sources of market failure discussed in textbooks. I do have a few questions and mild disagreements, we’ll get to those in the discussion, but the main idea in the book – understanding the relationship between individual maximizing behavior and aggregate outcomes – is essential in determining when and how governments ought to be involved in economic affairs. When individual behavior aggregates into what’s best for the community, there is no need for government to intervene. But when that’s not true – and this book adds to the list or reasons to suspect there are important cases when it’s not – there’s a role for government to play.