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The Real Knowledge Problem

Economists of a certain stripe are fond of insisting that the failure of markets to live up in reality to the perfection of markets as depicted in textbooks is reason enough to empower government to “correct” these “market failures.”

It’s been pointed out frequently (here at the Cafe and in many other places – and by many other scholars – far more important than this venue and its proprietors) that governments are also imperfect.  Therefore, tolerating imperfect markets might well be the better option than trying to correct these imperfections by using imperfect government ‘solutions.’

One standard complaint about real-world markets is that these are infected with asymmetric information – situations in which some parties to trades know more relevant information about the goods and services being traded, and about the relevant alternatives, than other parties know.  The too-quick conclusion, of course, is that markets don’t work well with asymmetric information and that government must ‘correct’ the source of this problem or ‘correct’ for its ill-consequences.

Careful students of history and reality know that real-world people operating in real-world markets are generally far more creative and entrepreneurial than are the drone-like automatons of much neoclassical economic theory.  The ability of real-world people operating in real-world markets both to increase access to relevant information and to dampen the incentives of people with greater information to exploit those with less information is quite impressive.  I invite those who doubt this claim to read the Journal of Law & Economics, circa 1958 through 1995.  Read also the works of Ronald Coase, Joel Mokyr, Deirdre McCloskey, Elinor Ostrom, Oliver Williamson, Stanley Lebergott, and my colleague Dan Klein.  You’ll learn from these (and many other scholars too numerous here to list) that individuals – as consumers, as entrepreneurs seeking inroads into existing markets, and as established firms seeking to maintain market share against the competition of rivals – are remarkably creative and successful at avoiding market failures.  (You’ll learn also that many ‘market failures’ are the direct result of government intrusions.)

But the above paragraph is not my main point here.  I want chiefly to say a quick word about the significance of asymmetric information.  It might well be – indeed, I’m sure that it is often very true – that party A knows something relevant about a trade with party B that party B does not know.  And I do not doubt that such asymmetric information has at least the potential to harm person B.

But in addition to the reasons alluded to above for why government might be an untrustworthy ‘solver’ of such problems of asymmetric information, there is yet a deeper reason for why the existence of asymmetric information is a poor justification for giving greater power to government – namely, no kind of economically relevant information is more difficult for people to learn than information about the actual subjective preferences of others.

Ponder the claim of the U.C.L.A. professor who asserts, near the end of this video, that people who complain about Obamacare forcing them to give up their current health-care insurance plans in order to buy instead different and more costly health-care plans really will value these more-elaborate (and more costly) plans once these people discover all the great coverage that the new plans offer.  How does this professor know this?  He cannot possibly.  At best, he mistakes his own preferences for those of others.  But a person’s preferences, being subjective, are inherently knowable (or knowable best) only to that individual.

Asymmetric information of the sort that many professional economists get worked up over might in principle be discovered and spread more widely by government regulators.  But information about people’s subjective preferences can never, not even in principle, be known by government regulators.  And yet much government regulation is proudly justified by politicians, regulators, and intellectuals on the grounds that people allegedly will value X by amount $Y once they actually encounter X.

In private markets such guesses are harmless.  A private, unsubsidized firm that guesses that enough consumers will value, say, its new-fangled jar of chocolate-covered pickles by at least $4.00 per jar will actually find out if its guess is accurate or not because each individual has the choice of actually forking over $4.00 per jar (and getting a jar) or not forking over that sum (and not getting a jar).  When government acts, in contrast, no such discovery procedure is available to test politicians’ guesses about people’s subjective preferences.  People must pay for what government foists on them.  And no process of knowledge discovery or information revelation is available to cure politicians’ and regulators’ inevitable ignorance of the subjective preferences of the very people that they pretend they are seeking to help.

The inability of government to learn the subjective preferences of its subjects is the deepest, most dangerous, and most incurable source of asymmetric information.  It’s a problem that overwhelms – both in its size and in its consequences – the kinds of asymmetric-information problems that too many economics professors and their ambitious graduate students point to in order to scratch their itch to engineer society into happier states.