Parecon Finland’s fourth publication is a debate about markets and economics between professor emeritus of economics Robin Hahnel, and professor of economics Hannu Vartiainen.

The debate has its roots in 2012, when Parecon Finland organized Robin Hahnel’s visit to Finland. The events were held in cooperation with University of Helsinki, Aalto University and Kela (Finnish Social Insurance Institution). Videos of all these talks are available from Parecon Finland’s YouTube-channel. At University of Helsinki Hahnel gave a lecture titled “Case Against Markets”, addressing structural problems inherent in markets.

This lecture ignited a heated response from some mainstream economists in Finland in 2012. The debate resurfaced in April 2018 when professor of world politics Heikki Patomäki referenced it in an article concerning the situation, and consequential debates between Parecon Finland’s Joona-Hermanni Mäkinen and the Academic Deputy Director of Helsinki Graduate School of Economics, professor Hannu Vartiainen. Mäkinen suggested that Vartiainen should debate professor Hahnel directly, to which Vartiainen responded feeling unease about “keelhauling a 72 year old professor emeritus” but ultimately agreeing to take part in the debate.

Finally, a formal debate was arranged during the summer of 2018 between Hahnel and Vartiainen.

HANNU VARTIAINEN: A LETTER TO PROFESSOR HAHNEL

My comments concern your 2012 lecture in Helsinki, titled “Case Against the Market”. First, let me say that I have nothing against what you said about the shortcomings about markets –all standard and accurately presented material from a public economics course. In fact, I found your talk entertaining. What I disagree about is a side point of the presentation, what you alluded about economics as a profession.

In the beginning of the lecture (at 3min), you claim that there has been a dramatic trend in mainstream economics to “sing the praises of the markets” and worry less on market failures than any time in the history. You further claim that the last 30 years has witnessed “free-market jubilee” both in the economics profession and in the society. You then associate this to the more general neoliberal movement that, according to you, caused the great recession and the fact that the government did not react on in adequately.

At later point (at 24min), you claim that economics has not paid attention on externalities. In particular, you state that there is practically no literature on the magnitude of (negative) externalities. The audience gets an impression that the economics as a profession deliberately avoids talking about externalities, to save the Welfare Theorems.

Later still (at 57min) you claim that minimum wage is against the free-market dogma, displayed by the fact that every micro textbook tells it is harmful. More generally, you seem to allude that economics is against income equality as a profession since texts often represent market regulation as a bad policy.

In discussion part, if my memory serves (unfortunately, the video does not contain the discussion section), you also described economics as a religion, not willing to change the corpus of the ideas even when new contradicting evidence emerges. The idea you put forward is that economics is an ideological project and should not be regarded as serious academic discipline.

Respectfully, I disagree on all these claims. In the last 40 years, the focus of economics research has, without slightest doubt, moved away from the analysis of markets. In fact, general equilibrium theory, once dominant theme of research, is largely regarded as a dead field. A quick look at what has been published in, e.g. top 5 journals or presented in important conferences surely confirms this claim.

Similarly, Welfare Theorems are not regarded as a research objective nor a dogma but rather as a benchmark, explaining under which conditions market work well (as you nicely explained). But that’s all there is with these theorems. The fact that the conditions are typically violated is precisely what has inspired most of the current research in economics. It is safe to say that externalities, incomplete information, strategic issues related to competition are present in most of economics research in the past 40 years. For example, if Nobel prizes display what is regarded important in economics, dominant themes in the past 25 years have been behavioral economics, game theory, institutions, regulation, taxation, social choice, mechanism design, market imperfections, etc.. Externalities, information, lack of competition, and market failures have indeed been the main story of economics since the 80s.

True, introductory texts typically lay down the basic market model and explain its welfare properties. But this is for didactic reasons only, to form a ground for and language to study more demanding, interesting and relevant topics. That they often provide minimum wage as an example of a harmful regulation is only to demonstrate the working of price mechanism.

In research, the classic Card-Krueger 1994 paper on minimum wage is among the most cited articles in AER. Since then, minimum wage has been an intensively studied, with arguments to both directions. It is a gross exaggeration to say that economists have a dogmatic view on minimum wage. And it is simply not true that economists are against regulation.

The most disturbing part of your talk, however, was the claim that economics is a religion, with assumptions and methods serving ideological objectives. You further seemed to insinuate that economics should be interpreted as part of the neoliberal political movement. In this line of thinking, motives of people who engage in economics are opportunistic.

In academia, this is a serious claim and eliminates any possibility to have a reasonable, constructive debate on the subject matter. I am confident that any of my colleagues would fiercely disagree on the claim. And find it insulting.

ROBIN HAHNEL: RESPONSE TO PROFESSOR VARTIAINEN

On September 11, 2012, I gave a public lecture at the University of Helsinki titled “The Case Against Markets” sponsored by the departments of economics and political science. Professor Hannu Vartiainen wrote a letter taking exception to my remarks which has been posted, to which I respond here.

Professor Vartiainen begins by saying: “I have nothing against what you said about the shortcomings of markets – all standard and accurately presented…. What I disagree about is a side point of the presentation, what you alluded to about economics as a profession.”

I believe this means that Professor Vartiainen (a) does not dispute any of my substantive criticisms about various shortcomings of the market system, but concedes that the different market “failures” I described at some length are, indeed, unfortunate liabilities, and (b) testifies that the problems I raised are generally acknowledged by the profession. To be honest, that is more than enough agreement for me!

So what do we disagree about? As best I can tell we disagree about (a) how much damage different market failures cause, and (b) the extent to which the economics profession owns-up-to, or instead down-plays the damage caused by various market failures. I talked about damage done when markets fail to equilibrate quickly, when markets ignore external effects, when markets are not competitive, and when income distribution is left to be determined by capital and labor markets. If we agree that absent intervention, there is good reason to expect outcomes will be inefficient and/or inequitable, the remaining question is how great the damage is, and whether the economics profession helps us assess the magnitude of the damage. In the interest of brevity I will comment regarding only macro disequilibria and externalities.

I agree with Professor Vartiainen that there was a time when the economics profession emphasized how much wellbeing is lost due to recessions and depressions – the “GDP gap” -- and recommended fiscal and monetary stimulus to mitigate damage. Unfortunately, today I see the profession emphasizing reliance on self-correcting markets, and warning about negative side effects of government intervention. I hope Professor Vartiainen is correct that “Keynesian wisdom” regarding the magnitude of lost wellbeing due to macroeconomic disequilibrium, and the usefulness of stabilization policy is still alive and well within the profession, but I fear it has been largely expunged.

As I said in my lecture, the profession has known that externalities generate inaccurate price signals leading to the misallocation of resources since A.C. Pigou first explained the problem in the 1920s. Professor Vartiainen is correct that there are studies estimating how much some particular market price deviates from the true social cost of production. As an environmental economist I am well aware of all the contingent valuation surveys and hedonic regressions we environmental economists are paid to carry out!  But to my knowledge, there has been very little, if any empirical work done to assess the overall damage done by externalities. What percentage of all the tens of thousands of markets are plagued by significant inefficiencies due to ignored external effects? In what percentage of markets do prices deviate by, let’s say, 10% or more from true social costs? What is the overall annual loss of economic wellbeing due to external effects that go ignored in a market economy?

After the Keynesian revolution the economics profession did prioritize empirical work to calculate the size of annual GDP gaps, but the problem Pigou raised decades earlier never generated a similar response. K. William Kapp published The Social Costs of Private Enterprise in 1950. But what is remarkable about Kapp’s admirable, although primitive attempt to answer this important question for the American economy of his day, was that it went entirely ignored by the mainstream of the profession. Instead of igniting work to collect necessary data and forge a better methodology for estimating how much annual damage externalities cause, Kapp’s work was met with silence. Again, I would be happy to be informed that I am wrong, and that a body of empirical work estimating the magnitude of lost wellbeing per year due to externalities for national economies around the world is available.

HANNU VARTIAINEN: A RESPONSE

Thanks for your response. I think there is not much to disagree on. As you allude, I do not dispute any of your points about shortcomings of the market system. And I doubt not many of my colleagues would either. Market failures of various kind have been probably the most important research agenda in economics in the past 40 years.  

But I do not think we disagree on the degree of damage market failures cause, either. In fact, I do not have an opinion on grandiose questions like this. My sense – and I believe many of my colleagues feel the same way - is that the question is too broad to be answered meaningfully. There are at least two major problems (I am focusing on the question from the micro angle).

1. To evaluate the welfare losses associated to market system one needs to have a meaningful benchmark and a meaningful welfare criterion. What would be a system wide contrafactual? Planning or regulated economy? How should one evaluate wellbeing associated to such a system, without prices adequately reflecting marginal utilities?

2. It is well known that externalities are, by default, awfully difficult to measure. Since externalities are not due to one’s own action (but by action of someone else), one cannot appeal to revealed preferences or similar criterion to evaluate the size the utility impact, as is the case in direct market interaction. Hence, by definition, estimating size of externalities always requires rather heroic assumptions. This is gigantically more so in the context of economy wide externalities.

True, economists tend to advocate market mechanism a viable option to solve resource allocation problems. But my feeling is that this not because of their conviction concerning the non-existence of market failures. Rather, it is because we understand rather well how the price mechanism works and what are its virtues. Alternative mechanisms are typically too complex to be implementable, vulnerable to exploitation and manipulation, or have poor (theoretical) welfare properties, as has been extensively studied in the literature on mechanism design.

However nothing above means that economists tend to ignore market failures or do not consider them important. On the contrary, as I said above, seeking remedies to them via, e.g., regulation, contractual arrangements, or organization of the markets, has been probably the most significant research agenda in economics in the past several decades.

ROBIN HAHNEL: SECOND RESPONSE

I’m happy that Professor Vartiainen and I agree that markets suffer from a number of “failures” -- when they fail to equilibrate quickly, when they ignore “external effects,” and when they are not competitive. In all these cases it is, indeed, conceded by most mainstream economists that, if left alone, there will predictably be welfare losses, i.e. the economy will not be as efficient as it might be. I also believe that if left to their own devices labor and capital markets will distribute income unfairly, i.e. many who make greater sacrifices for the common good will be compensated far less than others who make fewer sacrifices -- although this has not been part of our exchange to date so I am unsure if Professor Vartiainen believes that capitalist economies distribute the burdens and benefits of economic activity fairly or unfairly.

In his latest contribution Professor Vartiainen argues: “To evaluate the welfare losses caused by a market system one needs to have a meaningful benchmark and a meaningful welfare criterion. What would be a system wide contra factual? Planning or a regulated economy? How should one evaluate wellbeing associated with such a system without prices adequately reflecting marginal utilities?” I must say I am baffled because the contra factual is well known: In welfare economics we compare outcomes to Pareto optimal outcomes -- a procedure I have never objected to when discussing efficiency. This is the accepted procedure whether we are examining a free market economy, a regulated market economy, or some particular version of a planned economy, and “yes” does mean taking consumers’ preferences, or utilities as our best estimate of their wellbeing. Indeed, regarding efficiency my criticism of laissez faire market economies is precisely that because of disequilibria, externalities, and non-competitive structures I believe they generate outcomes that deviate farther from Pareto optimality than both regulated market systems and the system of participatory planning which I advocate.

Professor Vartiainen’s second point is that it is often difficult to estimate the magnitude of welfare losses from a “failure” in even a single market, much less in a system of literally millions of markets. I do not claim it is easy, nor pretend that we can hope to come up with a precise estimate of overall welfare losses. However, any serious attempt to evaluate how well a market system is performing requires doing as best we can. Macroeconomists attempt to estimate welfare losses from financial crises and recessions when they calculate how much actual GDP falls short of potential GDP. And environmental economists attempt to estimate the magnitude of welfare losses due to the fact that damage from carbon emissions have not historically been included in the market price of coal, oil, and natural gas. The fact that there are wide disparities between different estimates of the “social price of carbon” is testament to the fact that Professor Vartiainen is correct that this is not easy! On the other hand, I hope Professor Vartiainen will agree with me that working to improve estimates of the social price of carbon so we can correct for this negative externality to the right extent, and thereby prevent humanity from unwisely triggering cataclysmic climate change is a better option than throwing up our hands in despair. In sum, an important area of research for economist should be to improve upon estimates of the magnitude of welfare losses from various market failures, not to claim the task is too difficult.

Finally, Professor Vartiainen refers to an extensive literature demonstrating that “alternative mechanisms are typically too complex to be implementable, vulnerable to manipulation, or have poor (theoretical) welfare properties.” Because I do most of my research in the field of “mechanism design,” I have spent much time studying proposals by others as well proposing some of my own. For example, in my view a number of “demand revealing mechanisms” for public goods proposed by Groves, Clark, Loeb, Ledyard, Dreze, and de la Vallee Poussin  have much to offer precisely because they are “incentive compatible,” i.e. they have excellent theoretical welfare properties. The fact that they are not yet on politicians’ political radar – i.e. are deemed “too complex” -- is a problem with the political system not the mechanisms. I have also yet to read a compelling critique of my own “pollution damage revealing mechanism” (Review of Radical Political Economics (49, 2), 2017: 233-246) which I believe is far more promising than the pipe dream of establishing accurate Pigovian taxes and subsidies for all goods in a market system. In short, I believe any consensus that alternative mechanisms are unworthy of consideration is largely a matter of prejudice against anything that deviates from a market system, rather than a reasoned critique of alternative proposals, some of which have great merit.