Thursday, August 03, 2006

Markets Attack!


Abstract: Revisiting the markets vs planning debate, but this time from a position of moral and intellectual superiority.

First, this post would be better titled, "Planning vs. Markets (Or, Why Plan?)," but for now I am sticking with the more iconic Hollywood/military imagery. Second, kindly enjoy this typically pithy comment on planning thought, action, and scholarship by USC's Krieger (in which, among other things, I learned the word elide):

Date: Sun, 16 June 1998
Subject: Planning and Markets

I have just read an essay by Ann Markusen where the markets ideal is compared to the planning idea. Thirty years ago when I first got involved with this business, that is how planning theory was taught, as if planning received its legitimacy from market failure, and in any case markets could be set up to do planning work (Oskar Lange). It is sort of treating a woman as a non-man, Not very illuminating.

Of course, markets and "freedom" are no more natural than centrallized tyrannical regimes, both reflect peculiar political solutions. The deep questions were the ones that Adam Smith worried about, as did Marx, about how do your arrange things for both political stability and economic growth. And what is most interesting is the variety of solutions that are available for doing so. See Scale and Scope, by Alfred Chandler, comparing the industrial/commercial realsm in US/Britain/Japan/Germany.

When one is preaching, one has to elide over fine points to get the message home. Real scholarship is about the fine points. Hence what is most interesting is not whether cities ought be compact or not, or health care be private or not, but under what regimes does eachmake sense, and what are the costs of each, and what actually works. That is why Marx, Smith, and Chandler are so preoccupied by particular examples and cases, why historical material is vital for them.

In general, I never take academic ideologizing too seriously. It is the luxury of the tenured classes: tenured professors argue for free markets but do not expose themselves to it; other tenured professors argue for more planned regimes, but are quite willing to try to bid up their salaries by seeking competitive job offers. There is no reason to believe professors are especially good at such ideologizing, since they are selected for their narrow technical competence, and their capacity to get along and brown-nose.

Your job as scholars is to get at the nitty-gritty details, how things actually work, the ironies and the peculiar successes. Look at Hirschman, or at Smith et al, or Business Week. Or the front pages of The Wall Street Journal--no one wants to buy an ideologically desirable company that is in trouble. Historians have done a great deal on various planning regimes, in particular cases.

Markets are no more opposite to planning, than a fish needs a bicycle.

MK

I can't easily locate the Markusen essay, where she may defend planning against economics, fish against bicycles, or vice versa, or both or neither. But her baseline appears to be that government intervention is justified when markets fail (where failure is defined with respect to either the Pareto or a specific equity criterion).

Krieger suggests this is a false dichotomy, implying the dominance of substantive nuances in the debate. He is hardly alone in this view. My former neighbor Alex Alexander is particularly crisp on this theme in his 2004 JPER article, "Capturing the Public Interest: Promoting Planning in Conservative Times." The context is the so-called conservative attack on planning, discussed by Calavita and Krumholtz, Sanyal, and others. From page 103:

Associating planning with the state, and the juxtaposition of planning against the market, are long-standing prejudices both among planners and planning’s enemies. Conventional explanations of planning in welfare economic terms (Moore 1978; Klosterman 1985) explicitly or implicitly associate planning with government intervention and state action, juxtaposing the (planning and planned) public sector with the “free” market. Other discussions of planning and markets reveal the same dichotomy, contrasting “market-” and “plan-rationality” (Dahrendorff 1968), comparing “synoptic planning” to an incremental political market(Wildavsky 1979), or identifying planning with the public domain (Friedmann 1987, 38).

But more advanced theory and observation suggest that this dichotomy is no longer correct, and if it ever was, it has outlived its usefulness. Many definitions of planning (e.g., as rational choice, as anticipatory coordination, or as the attempt to control future actions) are so general as to transcend it. Increasing complexity has also blurred the boundary between the public sector and the market.

In its place, Alexander offers up transactions cost theory (TCT), which (1) emphasizes, Krieger-like, specific cases over general forms, (2) refutes the mutual exclusivity of state v. market, and (3):

TCT also offers a third way to argue for planning. Besides deflecting attacks on planning that are really critiques of public intervention, TCT provides an authoritative theoretical base and a set of conceptual tools for responding to attacks on public planning itself. It does this by moving the debate from the arena of broad generalizations to the locus of situational specifics.

Neoclassical economists’ attacks on public planning (Markusen 2000, 265-69) are the easiest to refute. TCT rebuts their unqualified advocacy of privatization; instead, it demands close institutional analysis of the specific case to determine the most appropriate form of governance. Such analysis can conclude that the public bureau is the most effective for a particular purpose, as Williamson (1999) did for the U.S. State Department, or that public planning and regulation may often be the best way of ensuring an efficient market, as Alexander (2001a) did for land-use planning and development control.

TCT also demands abandoning neoclassical economics’ narrow focus on the goal of economic efficiency. It recognizes a broader goal of effectiveness in its criterion of minimizing parties’ and stakeholders’ transaction costs. In institutional analysis to review alternative modes of governance, this can replace the simplistic Pareto optimization on which neoclassical economists base their opposition to public investments and their case for privatization and deregulation.

Alternatively, USC's Gordon and Richardson have long argued that market failure is often exaggerated, with the cure worse than the disease. From their 1993 JAPA article, "Market Planning: Oxymoron or Common Sense?":

One argument in support of planning is based on the concept of market failure. This position states that since monopolies are rampant and restrictive, externalities are ubiquitous, and some goods are consumed in common, the allocative efficiency of the market system is rarely achieved. Hence, planners must intervene to put things right. An alternative, slightly more promarket argument posits that markets achieve a high degree of economic efficiency but often at the expense of equity. This view holds that since most allocative choices involve a tradeoff between efficiency and equity, planners must intervene to achieve an appropriate degree of redistribution. In this view, the market attends to efficiency, while planners look after equity.

Neither of these arguments is fully sound. Both greatly exaggerate the prevalence of market failure. Both fail to recognize that the abstractions of perfect competition and pure monopoly rarely exist.

Their position is usually to argue in favor of (a) market-based allocation schemes over top down planning but, where they agree that planning can improve markets, in favor of (b) incentive-based planning strategies over regulatory strategies.

These are only a sample of views on these issue but, hey, life is too short for too long blog posts and these set the stage for my points just fine.


My main points

My main main point is that I somewhat disagree with everybody quoted here. Making neoclassical economists out to be bad guys because their story of (a) how the world goes round includes (b) an awkward normative assessment, is almost entirely missing the point. Let's break this down into these two parts.

1. Neoclassical microeconomics is largely a positive story of rather rational individual behavior. Parts of the story may be disputed, especially the rather rational part, but you'd better have a better tale to take its place. It says that when costs rise at the margin, people back off. Put another way, people evaluate their alternatives by comparing what they like versus what they don't like.

In the simple version we explain in class, there are a number of assumptions in play. Most of these can be dropped without challenging the underlying story, which then gets more complicated. Leaf through any recent game theory text. Again, the value of this framework is in anticipating behavior, not in judging it.*

2. On the other hand, the "invisible hand" theorem is an explicitly normative take on competitive market equilibrium. It says that markets of independent individuals, looking out for their individual interests only, (a) are much more orderly than you might expect, tending toward relative stability and, more to the point, (b) "succeed" in the weak sense of the Pareto efficiency criterion; namely, if a long list of critical assumptions hold, no mutually beneficial transactions remain.

If any one of these assumptions are violated, markets are said to "fail." In principle, this means that to restore Pareto efficiency (i.e., given public goods, externalities and equity problems), individuals will need to coordinate their actions instead of exclusively operating atomistically. This is the primary rationale for planning in the economics literature -- to restore market efficiency -- and the standard answer to the question, "Why plan?"

However, market failure is hard to correct under the most favorable circumstances. Here is the crux of the debate: Market success is easy if all goes perfectly, but correcting market failure requires information, agreement and coordination, all of which are challenging at best.

The reality, therefore, is that we live in a world of market failure, which is in turn really hard to fix. And there is no obvious criterion for what we mean by fix anyway. Hence planning tasks, generally speaking, tend toward the troublesome and onerous.

So any comparison of private vs. public sector efficiency should, first, recognize that the public sector has the more arduous job. (Again, this is a quite general characterization. Addressing market failure is by definition a more complex undertaking, fraught with informational and coordination challenges, than participating in a well-functioning market as a competitor. That indeed is why markets fail in the first place.) Second, as Gordon and Richardson emphasize, just because there is an argument for public solutions doesn't mean they will improve things in practice. Which everyone knows.


Planning can be good but hard

To summarize, there are many ways to address the why plan issue. Economists rely on the market failure story, which says in some cases the market works better with collective decision making. But collective decision making is hard, making planning hard. Which we knew.

In particular, there is no mainstream neoclassical argument than there is no role for planning in a market economy, except in hypothetical situations that planners are rarely concerned with. Rather, the more typical complaint is that planners have overstepped their bounds or made mistakes. To repeat, this is substantively different from saying there should be no planning or that planning is generally bad.

The logic that a given market would do better if subject to less planning takes 3 main forms: One, how respect for or a reassignment of property rights can correct many market failures; two, how hard it is for planners to get all the information they need to make the right decisions; and three, a complaint about the resulting redistribution of resources or property rights. These can be extremely valid points, especially in any specific situation. However, they do not in general imply that less planning is better.

Krieger and Alexander say the details matter most. Well, we all agree they matter more than we'd like. Alex also says that economists overstate the general problems of government provision and the advantages of private provision. No doubt some do, but that is painting the whole school of thought with a fairly broad brush. As a planner, I find that the tools of economics can sometimes clarify the applied problems of cities and their hinterlands tremendously. It makes no claim to comprehensiveness.

The only time the normative content of economics comes up in my work is when justifying why planners do what they do, where I think it makes a compelling argument. The rest of the time, the normative has to come from somewhere else; economics has little to say on that point. As to how we do what we do, and how to do it well, a good understanding of how markets tend to work is mighty handy.

So when markets attack, or go bad, we should roll up our sleeves and fix them without doing more harm than good. If critics on the right have a problem with that basic principle, they do not understand basic microeconomics. If critics on the left have a problem with the normative implications, they mistake a story about behavioral determinants for a statement of values.

Debates over the details of any specific implementation should be expected, however. These are always challenging tasks, not least because they require lots of good information, coordination, and at least some agreement, over which there almost always will be some disagreement.

If correcting market failure was easy, anyone could do it.
____________________
* Someone smart recently asked me if this didn't amount to environmental determinism. I said no, by which I meant to stress the rival point that planners might think we know how people will behave in specific situations, but are often wrong because the underlying behavior is more complicated than we realize. That is, we underestimate the complexity of how people will respond to denser cities, straighter streets, or more expensive gasoline, and anyway people are diverse in their responses, etc.

In hindsight (I was thinking on my feet, always a handicap), a better answer is no and yes. Microeconomics does posit that behavior is partly explained by one's circumstances, along with all the other things (preferences, culture, etc.) that might matter. Partly for that reason empirical studies focus on average individual behavior, where we try to identify the systematic determinants, rather than on uniquely individual behavior.

8 comments:

Peter Gordon said...

Back in the late 1960s, Harold Desmetz wrote that market failure theory is a failure. Since then, some have referred to the game of spotting shortfalls in the "Nirvana economics" model nothing but shooting fish in a barrel.

I am ambivalent about the neo-classical model and find that Austrian economics (some prefer to call it "spontaneous order" economics) is a more useful theory. The finest expression of spontaneous order economics and how it relates to planning is (in my view) the recent book by Chris Webster and Lawrence Lai. I think that their discussion is much more useful than many of the ones that Randy has cited. Peter Gordon

David Renkert said...

We're working to resolve the markets v. planning issue in exurban areas. Landpooling, much like McHarg's syndication theory, makes property owners shareholders in a regional vision; one that they create and form a real estate business to implement. Planners benefit from a reduction in the competing interests of property owners, consumers benefit from increased certainty, the environment benefits from large-scale conservation, and the participating landowners have more control over their area and make more money. In the end, we're bridging the divide between the enviro's and the private property advocates to create and implement real regional plans.

randall crane said...

To follow on Peter's comment, without requiring you physically step into a library or shell out cash, here is an online paper by one of his recommended authors, Chris Webster, that appears to lay out much of his thesis, followed by a succinct and favorable deconstruction of the book by Lew Hopkins in a JPL review:

Webster, Chris (2001) "Contractual agreements and neighborhood evolution," Planning & Markets 4 (1).

Hopkins, Lewis (2004) "Review of Webster, Chris and Lawrence Wai-chung Lai. 2003. Property Rights, Planning and Markets: Managing Spontaneous Cities," Journal of Planning Literature 19.

Ernest Alexander said...

Dear Randy,

I read your Market Attack posting and related comments with interest, and with some satisfaction in being quoted at such length. Nevertheless, in your summing up you more-or-less disagree with everyone (which is o.k. in my book) but respond to my basic thesis in two ways to which I object.

The first is in attributing to me an anti-market bias - this is simply incorrect and unfounded. The "Integrated Transaction Cost Theory" I advocate (i.e. economic transaction cost theory extended into the non-economic realm) is totally neutral between "market" and "public/planning", and in fact its main insight is that these categories are often operationally meaningless: e.g. is the system providing U.S. defense public/planned or private/market?
It's possible that the source for your impression that I have an anti-market bias is my efforts to "balance" the problematic bias in traditional institutional economics and economic transaction cost theory, which is (often implicitly) based on an assumption that the market is/should be the default option. I pointed this out to Oliver Williamson in correspondence we had over his (draft - at that stage) 1999 article on the U.S.State Dept., and he agreed with me!

My other objection is to your (relative) dismissal of my main conclusion (which you quote at length) about the irrelevance of arguments about planning vs markets. You sum up my thesis (and agree with it) as "the devil is in the details", but go on to blithely ignore the main implication of my conclusion to (once more) return to the old "planning vs markets" argument and supposedly resolve it in your own terms. I don't see your final normative conclusion (based on some questionable generalizations about the respective robustness of "planning" and "markets" as adding much to our appreciation of our institutional environments and how to deal with them - for that, I recommend a look at the emerging discussion of institutional design.

randall crane said...

There is a Texas expression, "when you find yourself in a hole, stop digging," but ...

1st, I can't find where I said Alexander had an anti-market bias. I didn't mean to.

2nd, I wrote this informal essay mainly to consider the rejection by some of neoclassical economics on normative grounds, which is easy and fair but misses the point of its utility, and then secondarily to revisit the market failure rationale for planning -- in part to defend a paper by Markusen I still haven't actually seen, which I suppose could be considered risky behavior. Krieger and Alexander were convenient examples of clear, incisive thinkers who rejected the markets/planning dichotomy.

I believe Alexander, who knows more about planning than I ever will, first argues that actual markets are made of firms made of groups of individuals who plan all the time, just as in government. So he concludes the markets/planning dichotomy is false. What, then, is his rationale for "public planning"? Alexander's unit of analysis is the transaction and his focus -- to the best of my understanding -- is on how the details of different institutional settings and kinds of transaction costs suggest different planning strategies, regimes, and rules by different arrangements of principals and agents.

Whether I understand Alexander properly or not, I accept that any substantially more realistic case of varied and pivotal transactions costs may well argue for additional planning rationales, and their forms. That said, I do not see how it negates the private market failure motive advanced by economists. (I never said it was anyone else's rationale for public planning.) The basic logic of public goods and externalities holds without transaction costs, and I do not follow how adding them repudiates it. It may, I just don't see it.

Rather than markets vs. planning, I might have been clearer by saying private vs. public. As stated, I was examining the idealized case only, where private market failure provides a compelling normative motive for public planning intervention. I did mention that more realism would complicate the argument without undermining it, but this isn't the place to explore those details.

These may be "questionable generalizations" but the idea certainly was not to add anything, let alone much, "to our appreciation of our institutional environments and how to deal with them." It was to riff, for idle sport, on the market failure rationale for planning and what that directly implies about the intrinsic difficulty of planning. I agree it is wordy and any unplanned mischaracterization of anyone's research is regrettable. The feedback is very welcome.

Eran Kaplinsky said...

Webster also developed some of these themes in "The Nature of the Neighbourhood" (40:13 Urb. Stud. 2591), where he defined the neighbourhood as "a nexus of contracts".

Lew Hopkins said...

Is it at least ironic that a discussion of planning versus markets makes no mention of plans? The discussion is actually about firm size (generalize firm to include organization). It is about the scope of command and control. It is also about a particular kind of organization--a government with legitimate monopoly on use of force--in contrast to organizations without.

Ironically, we already know a tremendous amount about these phenomena, and so do the fields of economics and political science.

But any of these organizations of any size, whether government or not, sometimes makes and uses plans, and other times does not. They make and use these plans, or don't, without necessarily changing their scope of command and control and without changing their status as governments or non-governments.

We know surprisingly little about when, why, and how organizations affecting urban development make and use plans. And the discussion of "planning versus markets" is not helping because it focuses on a different question.

Is the current proposed mix of plans being created for Katrina Rita recovery useful? Why or why not? Not should there be new regulations? Not will new property rights patterns emerge in any case? But why, when, about what, and who will make plans? Should we expect these plans to be useful?

Shih-Kung Lai said...

The Taipei urban renewal plan failed because the officially delineated urban renewal areas did not get rebuilt over years simply by ignoring market forces, I think. Lessons should be learned that plans must take into account market forces, or natural processes as Lew Hopkins's book tries to argue, and that centralized, top-down plans tend to fail because the market does not work as planned.

 

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