Alfred Marshall’s grand vision of economics was that you did the maths to check your logic. Then you translated all of that into English and burnt the maths. Steve Keen won’t do it that way for of course Marshall was a neoclassical and that’s just wrong, see?
Keen did once try to insist that I followed along with one of his papers – he was showing that there are no free markets, there are only oligopolies and therefore everything must be controlled by politics – and was most put out when I said well, yes, that’s mathematically true but useless.
For his contention was that as we’ve never got an infinite number of producers (nor consumers) therefore that model of free markets – which relies upon no individual producer or consumer having pricing power, which in itself implies an infinite number – therefore neoclassical economics was all wet. His maths was fine for that’s all true too. Except for the bit where if we analyse markets which we know are oligopolistic and then see how many producers we need for them not to be then the number seems to be about 5 or 6. True, true, 7 supermarkets doesn’t mean a wholly perfectly free market with profits no higher than the cost of capital but it’s pretty damn close. Close enough for either jazz or the economics of public policy.
The maths is for working through the logic not a replacement for it.
The truth is that perfect competition is nuts. See George Reisman’s Capitalism, a treaties on economics as excellent takedown.
Isn’t it true, though, that, even when there aren’t unlimited competitors, the free-market tendencies will remain so long as anyone is free to enter that competition whenever they see an advantage appearing?
@Stephen Houghton
The truth is that perfect competition is nuts. See George Reisman’s Capitalism, a treaties on economics as excellent takedown.
I don’t know George Reisman’s work, in fact I’m not an expert at all on economic theory. But what I will say is that the OP is based on a fundamental flaw in thinking — namely that the purpose of the economy is to minimize prices and/or eliminate pricing power. It is related to this thing I bang on about here occasionally about how I don’t like the word capitalism.
Free markets are about freedom, they aren’t about making prices low or allowing the accumulation and investment of capital. These are just additional powerful benefits of the freedom.
In this context it is much simpler: let’s say we have two supermarkets and, as Adam Smith predicted, they collude together to keep prices high. Well in a free market society there is an easy solution — if their profits are so high I can start my own supermarket and compete with them which will drive prices down. I don’t need some sort of perfect pricing model, what I need is the freedom to compete whenever I want to. And this doesn’t need to be some big replacement for Kroger or Safeway. I can sell vegetables grown in my small farm direct to the public, or set up a little fruit stand, or start a farmers market or start an online meat delivery service.
And that is why the government is so problematic, because ultimately when that cartel starts to include the government in their little operation then I am no longer allowed to compete. What drives the prices up is not a lack of supermarkets but a lack of freedom for someone else to start their own supermarket, or to find some other way to provide a similar service.
So again, it isn’t about fancy economic models, it isn’t about capitalism, it is about freedom, the freedom for anyone to make any trade with anyone else without a third party or the government interfering. That is what makes economies successful and prosperous.
The truth is that perfect competition is nuts. See George Reisman’s Capitalism, a treaties on economics as excellent takedown.
A brilliant book.
There is also the important insight from Austrian economics: the that competition is a discovery process that occurs through time. Humans aren’t omniscient with perfect knowledge of the future, let alone the present.
You don’t need hundreds of firms for there to be competition that is effective; what you do need is the threat that competition can arise. Consider how many large and seemingly arrogant businesses were felled, and fast, by upstart competitors (Kodak comes to mind). And where there are barriers to entry, nearly all of these are created or significantly increased by the actions of governments.
Mr. Worstall missed a good opportunity to insert one of the classic economics jokes.
“An economist is someone who says, when an idea works in practice, ‘let’s see if it works in theory.’”
— Walter W. Heller, former chairman of the Council of Economic Advisers.
The awful truth is that neo-classical economics (Samuelson, Solow et al) has always been flawed below the waterline, sunk by the Cambridge Capital Controversies in the 1950s=60s. Even Samuelson recognized eventually that the problem was real and insoluble, but, he said, look at all the interesting things we can show and build if we just ignore it. And indeed, what they built was interesting, and persuasive. But always wrong (take Samuelson’s word for it) and so eventually and inevitably damaging.
Steve Keen, and a Legion of others, assume if they prove that competition is not “perfect” that proves the case for state intervention.
Firstly – “perfect competition” is indeed a mathematical concept, it is NOT about how things work OR SHOULD WORK in the real world. The non mathematical reasoning of an economist such Ludwig Von Mises (or indeed of economists of some two centuries ago such as Richard Whately) is better than the mathematical approach of Alfred Marshall (although, yes, Marshall said that one should use mathematics – NOT be a slave to it, not be used by, trapped by, the mathematics) which leads some people to treat economics as if it was physics which it is not. Non mathematical logical reasoning very much exists – everything can not be reduced to mathematics.
But also – Steve Keen and the Legion of other interventionists, fundamentally misunderstand the nature, the effect, of state (violent) intervention.
A classic example is the 1887 Interstate Commerce Commission in the United States – it was created because railroad companies, in some places, were colluding to fix prices and conditions of service, allegedly this hurt customers in those areas of the United States where such activities occurred. Also it was pointed out that for some routes only one company (one railroad) existed – and that, therefore, there monopoly exploitation on those routes – as the only real alternative was wagon and horses.
Yet every study of the Interstate Commerce Commission has shown that it made everything WORSE – the actions of the government ICC hurt the customers, they did not help the customers.
This is not an isolated example – it is the normal course of affairs. The government sees a problem (either an imagined problem – or a real problem) and uses the threat of state violence, regulation, to intervene – and the interventions make things WORSE not better.
Sadly the response to this is to demand even more government intervention – for example the Democratic Party in the United States responded to the harm done by the Interstate Commerce Commission by demanding, in its (supposedly conservative) 1904 election platform that the ICC be give more power.
More power for the ICC would mean MORE HARM – but they did not see it.
The same is true for the other government regulatory agencies.
It is always the same story…..
“Perfection has not been achieved – so the government must intervene”, “for some reason things have got worse since the intervention – so there must be even more intervention, we must have wider powers”.
This is why, in the last section of his book on Socialism, Ludwig Von Mises called interventionism “Destructionism” – as the response to the harm done by regulations is to demand even more regulations, in an insane negative feedback loop, or vicious circle, till society is destroyed.
By the way for those who do not know.
If-taken-literally, the mathematics of perfect competition is insane – utterly insane.
For example average costs would equal average revenue – which would mean that there was no profit (inventing a concept called “normal profit” and trying to put it in the mathematics as part of costs – is silly, indeed daft).
The mathematical “Perfect Competition model” where the costs of all producers are the same and competition pushes prices down to costs, is not how the real world works (in the real world producers have different costs – indeed the point is to make better products less expensively, by finding new ways to do things), and that is not a flaw in the real world (and certainly not one that can be “fixed” by government intervention) – what it shows is that the mathematical model is not as useful as even Marshall claimed it was – indeed that the mathematical model is not the right way to do economics.
As for the cult like nature of interventionism – it is shown, for example, by the endless screaming against the Long Island Power and Light Company in New York State.
Supposedly this greedy-capitalist-corporation is responsible for various terrible things – and the government must take action against it, but, in reality, the government has owned this corporation for many years – it is part of the government.
In Britain it is much the same – with, for example, endless attacks on the “private” railway network – which, in reality, is GOVERNMENT OWNED. Network Rail owns the railways – and Network Rail is government owned. It is Japan (not Britain) that has private railways – but that is not what most British people believe, because they are presented with “operating companies” which they (the British public) think own the railways – but, in reality, are just puppets of the government (and the unions – given power by such measures as the 1875 and 1906 Acts – which led to structual UNEMPLOYMENT by encouraging “Collective Bargaining”) who do NOT own the railways.
It, these attacks on private companies that are are really government owned, is like people in a country blaming “the Jews” for XYZ, when there-are-no-Jews-there. And there are such countries.
Paul,
You have a very interesting take on a subject that fascinates me which is the relationship between maths and science. Your take is – I think – essentially correct and insightful. Basically there are two issues here. The first is you always have to be very careful with zero and infinity and treat both as ideals which are computationally useful but not physically “real”. The second is that you should never treat a mathematical model as reality.
Unfortunately, unless you really grok how The Calculus works you can get into a mess on the first point*. On the second, unfortunately, as computer models have got more powerful at an exponential rate a lot of people have increasingly failed on the second point. The latter is an extremely severe problem in the more complicated / “softer” sciences (by which I mean the sciences which are further from physics and more complicated than physics). Climate models, economics and sociology are all at the far end here.
*This is why in physics equations you can simplify things a lot by, in certain circumstances, allowing quantities to tend towards infinity or zero. It might seem a cute distinction from being infinite or zero but it does matter. And that is also why The Calculus uses “infinitesimals” and such jiggery-pokery.
“a fundamental flaw in thinking — namely that the purpose of the economy is to minimize prices and/or eliminate pricing power”
An economy does not have any purpose. An economy is an emergent behaviour of humans interacting with other humans. Emergent properties don’t have a function, they are emergent properties. It’s like saying “temperature’s function is…”. No, temperature is a property of the state and activities of the thing having a temperature.
NickM
If all producers have the same costs and competition pushes down price towards costs – then profits would end up as zero, and the economy would collapse.
It is not so much the mathematics that is wrong (although I do hold that mathematics is not the right way to do economics) it is the basic assumptions behind the perfect competition model that are wrong – for example the costs of producers are not the same, and they change – as people find less expensive ways to produce goods and services.
Alfred Marshall knew all this – he knew the mathematical model did not reflect the real world, but he still thought the mathematical model was useful.
I do not believe that it is useful.
Paul,
Sometimes cost of production works the opposite way. People will pay top-dollar for hand-crafted luxury goods. Casio and Timex dramatically reduced the costs of watch making but they didn’t put Rolex and Longines out of business.
For those interested, Reisman’s treatment of perfect competition is on page 430-431 of Capitalism a Treaties on Economics which is available for free online.
NickM – yes “luxury goods”.
But that does not help the “Perfect Competition” mathematical model – it helps sink it.
Producers are not making the same products – they are producing different products.
It (the model) is just not helpful – it is not a good way to do economics.
Yes, Rolex isn’t competing with Timex, they’re competing with Lamborghini and breast enhancement surgery.
“Mr. Worstall missed a good opportunity to insert one of the classic economics jokes.”
I use that joke repeatedly. For good jokes bear repetition of course. It’s just that I make it – more accurately – about French economists.
“so long as anyone is free to enter that competition”
Yes, it is potential competition that really matters, not actual.
Tim Worstall – only if it is competition in an honourable pursuit.
Competition between robbers, extortion rackets, Credit Bubble swindlers, and so on, is no good.