Prices as democratic?

By Matt Nolan 30/05/2013

Recently, a good friend of mine (who is a sneaky economist) was complaining about the policies of political parties on twitter.  In general, we were just doing our usual thing of being sad about Arrow’s Impossibility Theorem.

But it also reminded me of a little view economists hold, that many non-economists may not nowadays, the idea of prices being a type of voting – or a representation of preferences.  Now economists are right (surprised I think this?), but there are elements and issues to it that can sometimes be underplayed.

We vote on issues to illustrate our preference regarding the issue.  Given we use the idea of “one vote one person” we are only showing our preference in an “ordinal” (ranking) sense rather than the “cardinal” sense.  But that is where we are going with voting – showing our preferences.

When we pay for a good, we show a willingness to pay for it (as we are buying it, the person, group, or institution on the other end has a willingness to sell).  But just like with tax, in order interpret a price as value we need a much larger “general equilibrium” view of things, that includes the idea of “endowment” (there is a reason Arrow is also a big thinker here after all ;) ).  If someone is fundamentally endowed with more income, the fact they are willing to pay more for something doesn’t show they “value” it more.

This is why economists don’t just get big on prices, they get big on the idea of “equalising opportunity”.  Not equalising income or other outcomes, but equalising opportunity.  Why opportunity, well think of it this way, if someone genuinely works (relatively) harder in order to get more income to buy more goods and services they are showing that they fundamentally value these goods and services (relatively) more … or that work is inherently less costly for them as an individual.  The wage is part of that big web of prices, and when whatever we term “opportunity” is equalised in this way the wage provides one of the mechanisms through which people can inherently show the relative value they place on things, and then “vote” on the distribution, production, and allocation of goods by purchasing.

One of the key roles of government is “distributional”.  And the idea that they should work on distribution mainly through income transfers rather than randomly trying to fiddle with prices stems from this.  Making the price a type of “vote” in this sense makes economists view that it is endowment rather than price that should be looked at potentially clear (?).

Now you will no doubt say “what, we don’t think of it that way, what”.  That is cool.  But if this is our concern, I’d say take a step back, and lets list factors that determine prices.  We have the willingness to sell of those involved, but there are often “games” people play, or “monopolies”, or “information issues”.  This general principle helps to justify issues where we don’t think “prices are representing relative value fairly” GIVEN our view that equality of opportunity (in whatever normative way we mean this – the term is meant to be vague as its something we need to define subjectively to move forward.  Note:  After writing this I spotted Economist’s View talking on the issue) holds.  With a said market failure, we may intervene in pricing to help make the price represent the more democratic outcome – but once again, through this lens the ability to “vote” on your claim on resources depends on endowment – and we need a clear view about how we view endowments before we can conceptualise what we think is fair.

The fact we don’t walk up to something when we buy it and THINK it is like voting, doesn’t change the descriptive similarity!

Side track of GE

You may even say the view of GE is completely flawed as its unrealistic, and we shouldn’t talk this way at all.  To this I would have to say I don’t agree with your view – although you are in an interesting and fun area with your thoughts.  I could say some rubbish about “it is core assumption (required for the result) that need to be realistic, not our peripheral simplifying ones” – but we don’t have the ability to directly measure or even often model our core assumptions, and see if the result holds.  There are core assumptions that are inherently unrealistic.  One solution is to try and generalise, and then ask if a realistic assumption holds in a “hypothetical world” that exists within the space captured by our assumptions (this is a new Sugden paper from 2009, here is the original).  Another is to rely on certain non-testable assumptions due to their persuasive nature – which could be due to the belief of the community involved, or the fact they are captured in some inherent “common sense”. Both views assume there is some “objective reality”, and that our observation, intuition, and data only give us an unclear and partial window on that.

Both views are also broadly “scientific” if we are going all post-modern, and it is a bit hard to test the “hard core” if we are going down the Lakatos road – when we don’t have the required data (hence why Maki pushes us towards “scientific realism” in that second post) … which, given the push for logical consistency stemming from a hard core of assumptions makes economics consistent with the letter of the law on Lakatos … and since economics does predict “novel facts” (although not financial crises) it is progressive (scientific) rather than degenerate (pseudo-scientific).  I readily admit that my interpretation of the philosophy of science could be off here, no doubt I have biases ;)

Anyway the two views mentioned seem to be consistent as descriptions of GE, and much of economics more generally, IMO.   You would expect such generalisation to mean that, for each set of data there is more than one explanation.  Essentially, some of our core assumptions may be peripheral in this case, we just don’t know which ones – and don’t have the data available to help us narrow it down!  This is quite different to how I was taught at macro at university (although it is quite consistent with micro) – which was “we want a model that explains all the stylized facts, and don’t have it”.  However, what they weren’t telling me was that the models were all filled with ceteris paribus which could be loosened to explain the result … so in some sense we were flirting with the idea of hitting our ceteris paribus assumptions, but never doing it as students.

My preference is to say that economics is the study of tendencies, and that when it comes to description we are trying to isolate tendencies as a starting point and construct knowledge from there – I’d say this view is consistent with both of those explanations.  GE models help us to think about our tendencies in a way that challenges partial equilibrium logic.  It adds a layer of understanding, and in that way we can use it to check and challenge our intuition – as literary theorists, the very purpose of theory is to challenge our common sense intuitions!!!

However, I have a clearer point.  If you find my discussion of assumptions not useful and you are not persuaded by logic from GE models due to assumptions, that is cool.  But you don’t have  an additional model of prices (if you do, feel free to provide me a copy :) ).  Without any understanding of prices, there is no way to justify a role for intervening in them.  IMO, this is the main reason economics students eventually learn some level of respect for the idea of GE models – after looking at them with disdain at first.

Ok ok, what’s the point

The point here is, economists often view a price as a way that social desires, needs, wants, and preferences are aggregated – and as a mechanism for illustrating where scarcity is most apparent, and how relative production and investment should shift as a result.  In this sense, loosening price controls and pushing for competition was seen as more democratic – and this is true as long as we have our little conversation as a society about the “endowment/equality of opportunity” issue.

None of this is particularly enlightening I don’t think, but as a framework it is nice – it gives us a way to pool all the different fairness arguments we hear, and determine whether they are claims about specific market failures (coming in the price) or about endowment/equality of opportunity issues (coming in our philosophical framework and view on the drivers of wealth/income inequality).

The distinction is important, the tools and appropriate policies differ when the problem is different, and given the utter uncertainty involved in any case we want to be careful before we start trying to “improve things”.  Viewing prices and endowment in this way, with an appeal to democratic principles, gives us somewhere we can all start talking from.

We can go a step further and discuss Futarchy, but I’ll leave that up to Eric ;)