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Quotation of the Day…

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… is from page 65 of Richard Epstein’s superb 2003 volume, Skepticism and Freedom [2]:

Given this assumption about the diffusion of knowledge in society, Hayek’s ultimate defense of markets does not rest on the Pollyannish view that perfect competition leads necessarily to the best outcome in the best of all possible worlds. Rather, it rests on the incremental ability of each individual to capitalize on his or her own partial knowledge through a system of voluntary exchange.

DBx: A common move of market skeptics is to express awe and wonder at the marvelous workings of a perfectly competitive market economy – as such an economy is described in economics textbooks – but then to point out the indisputable fact that almost none of the textbook conditions for such an economy hold in reality. The conclusion is then drawn, as if it is the final and inescapable step in a logical syllogism, that markets in reality work so poorly that government intervention is necessary to ‘correct’ and improve real-world economic outcomes.

Every step of this common train of reasoning is unjustified. The true case for free markets does not rest on assumptions such as perfect knowledge, absence of irrational behavior, and no externalities. Adam Smith made no such assumptions. Nor did Mises or Hayek. Nor did Jim Buchanan or Ronald Coase. Nor did Armen Alchian or Harold Demsetz. Nor did Julian Simon or Leland Yeager. Nor does Israel Kirzner or Thomas Sowell. Nor does Walter Williams or Deirdre McCloskey. Nor does Robert Higgs or Vernon Smith.

People on the political left have for decades made the illogical move described above. Distressingly, this same illogical jig is being done today by people on the political right – people such as Oren Cass and Daniel McCarthy. Even some scholars associated with the Niskanen Center appear to be performing this dance.

So let’s say it again, clearly and without qualification: no markets in reality ever have or ever will work as described in textbook models of perfectly competitive general equilibrium. Those models are worse than useless. People who build and use those models assume away far too much of what actually motivates and directs market competition in the real world.

Those mainstream economics models of perfectly competitive general equilibrium, therefore, explain almost nothing of what happens in real-world competitive markets. But because those models are taken to be descriptions of ideal markets – after all, it’s called “perfect competition” and “general competitive equilibrium“! – mainstream economists, and those individuals who pay attention to mainstream economists, naively assume that those models describe ideals against which real-world markets can and ought to be compared. Yet nothing could be further from the truth.

Just as no one would take a textbook description of human beings who could fly by flapping their arms as an ideal against which real-world humans can and should be compared, no one should take mainstream textbook descriptions of “perfectly competitive, general-equilibrium” markets as a meaningful ideal. Such textbook artworks describe nothing of any relevance.

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