Economic Policy and Market Regulation Part 1

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1 1

Economic Policy and Market Regulation

Part 1

Dr. Stefan KoothsBiTS Berlin

(winter term 2013/2014)www.kooths.de/bits-ep


Outline

1. Introduction and Overview2. Market Mechanisms and Government

Interventions3. Externalities and Public Goods4. Competition Policy and Regulation5. Ordoliberalism and the Social Market Economy6. Summary: The Key Lessons Learnt


Outline

1. Introduction and Overview Motivation and key aspects Methodology and general approach Course scheme

2. Market Mechanisms and Government Interventions

3. Externalities and Public Goods4. Competition Policy and Regulation5. Ordoliberalism and the Social Market Economy6. Summary: The Key Lessons Learnt


Economics and the key allocation problem


Alternative allocation mechanisms

Violence (military campaigns, robber barons) Discrimination (Sex, Nationality, Age, …) Greyhound racing („First come, first served“) Communism („Each according to his/her need”) Egalitarianism („Each the same“)

Market (competitive exchange mechanism)» Property rights» Voluntary exchange„Each according to his/her preferences and performance“

(ability-to-pay resulting from market income = valuation by others)


Property rights and the role of government

Property rights» Usus» Abusus» Usus fructus (includes: accountability!)


The fundamental policy question: Markets vs. hierarchies


Fields of economic policy:Allocation, redistribution and stabilization

Allocation» Improving economic efficiency

Redistribution» Changing the distribution of disposable income

(primary vs. secondary income distribtuion)

Stabilization» Growth, employment, price stability, external equilibrium

(macroeconomic approach)» Fiscal policy» Monetary policy (and choice of currency system)


The extended Tinbergen rule

One policy target One specific tool (policy instrument) One independent authority (in case of target conflicts)


Levels of economic policy: Constitutional vs. interventionist approaches

Constitutional level» Designing the general institutional framework (economic order)

Interventional level» Modifying/interfering with market processes


Incentives and government interventions:Intention vs. outcome (The Cobra effect)


The big picture: From Feudalism to Neoliberalism (1/3)

Subjects

Feudal power

Economy

Feudalism

(Democratic) State

Constitution

Capitalist economy

Competition

liberalrevolution

Free market system(classic liberalism)


The big picture: From Feudalism to Neoliberalism (2/3)„Invisible Hand“/Laissez-faire: Self-interest and public welfare

Adam Smith (1723 – 1790)„It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” (Wealth of Nations, 1776)

Vincent de Gournay (1712 – 1759)„Laissez faire, laissez passer,

le monde va de lui-même.”

Bernard de Mondeville (1670 – 1733)The Fable of the Bees:or, Private Vices, Public Benefits (1714)


The big picture: From Feudalism to Neoliberalism (3/3)

(Democratic) State

Constitution

Capitalistic economy

Competition

Inte

rven

tions

Influ

ence

Degenerate„unfree“ market system

Demokratischer Staat

Constitution

Social economy

Competition

Neoliberal system

Protec-tion

Regu-lation


Regulation vs. deregulation: An ongoing debate

Regulatory design is technology-dependent Competing paradigms for economic policy making


Outline





Methodological individualism

General method» Individuals as point of departure for economic analysis» Explaining social processes via actions of involved persons

Individuals …» … are diverse» … have exogenous preferences» … are capable of acting on their own

(Mises: Humans as universal entrepreneurs)

Subjectivism» Individual preferences» No scientific inter-subjective comparisons of utility


Human Action: Humans as universal entrepreneurs(decision makers and explorers)

Ludwig von Mises (1881 – 1973)

http://mises.org/document/3250


“Collective” action and average “behavior” of groups:Pitfalls of collectivist analysis and the Arrow paradox

Person Ranking of alternatives A, B, C1 A > B > C2 B > C > A3 C > A > B

Voting ResultsA vs. BB vs. CC vs. A


Voluntary exchange and the gains from trade: Markets as reference and default system (free-market prejudice)


Pareto efficiency and Kaldor-Hicks criterion


Workable economic coordination: Static and dynamic functions(“What are markets expected to do?”)

Static functions» Consumer sovereignty» Efficient factor allocation» Performance-based income distribution

Dynamic functions» Flexible adjustment to changing conditions» Technological progress/innovations

Coordination efficiency


Positive vs. normative analysis

Positive economics» Economist as observer» Explanation of cause and effect

Normative economics» Economist as advisor to a “social planner”» Judgmental knowledge (explicit or implicit assumptions)» Second-best problems

Political economics» Analysis of politicians/bureaucrats/pressure groups» Public Choice/New Institutional Economics


Markets vs. politics/morals

Market system: Coordination mechanism (instrument)» Usefulness basically open to scientific analysis» But: Links between personal freedom and market system

Politics/morals: Definition of targets (normative)» Legitimation cannot be established by economic science» Economics: Looking for best means to reach specific targets and

determining opportunity costs/trade-offs


Transaction costs

Ex-ante transaction costs» Search» Negotiation» Contracting

Ex-post transaction costs» Implementation» Monitoring» Adjustment

Using the market is not for free (BUT: so is hierarchical/central planning)


Categories of market failures

Technological externalities

Natural monopolies (subadditivity of cost functions)

Information deficiencies

Instability (deficient adjustment processes)

[Non-rationality]


Potential room for improving social coordination:The two-stage burden of proof

Intervention analysis: Market vs. hierarchy (central planning)(1) Significant market failure?(2) Market failure > government failure?

(comparing relevant alternatives)- Information problem

(getting/distributing data, value problem)- Incentive/bureaucracy problem

(individual utility vs. realization of the plan)- Financing/spillovers to other fields

(distortions on other markets)

Intervene only, if (1) and (2)» Default: Market-based coordination (free-market prejudice)» Minimally invasive operations (market-compatible solutions)


Dubai: Is the desert a market failure?

Ruler of Dubai: „Market failed to put Dubai on the global map!“


Outline





Literature and web

Literature» Fritsch, M. (2011): „Marktversagen und Wirtschaftspolitik –

Mikroökonomische Grundlagen des staatlichen Handelns“, 8. Aufl., Verlag Vahlen: München.

» Grossekettler, H., A. Hadamitzky and C. Lorenz (2008): „Volkswirtschaftslehre“; UVK Verlagsgemeinschaft: Konstanz.

» Groll, D. and S. Kooths. (2013): „Vor der Bundestagswahl: Argumente für Mindestlöhne überzeugen nicht“; Wirtschaftsdienst – Zeitschrift für Wirtschaftspolitik, 93. Jg., Heft 8, p. 545–551.

» Mankiw, N. G. (2011): „Principles of Economics“, 6th Edition, South-Western.

Web: www.kooths.de/bits-ep

http://www.kooths.de/bits-ep

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Economic Policy and Market Regulation Part 1