On X, Oren Cass and, separately, James Broughel, carelessly misinterpret my views about externalities. I’ll answer in a later post Broughel’s mistaken accusation that I “have a history of denying externalities exist.” In that post I’ll explain what I – and what all careful economists – mean by “externality.” (It’s not the capacious meaning that Broughel gives it. I do have a history of denying that much of what Broughel calls “externalities” are externalities.) Here I offer the first of what I expect will be at least two posts responding to Oren.
The passage of mine that Oren misinterprets is this paragraph in my earlier post titled “Oren Cass Errs Again”:
Another error – one that’s ironic – is his [Cass’s] assertion that free trade creates a negative “externality” because corporations and consumers, when making production and consumption choices, “will probably not consider the broader importance of making things in America.” Not so. The value of producing particular outputs in the U.S. as opposed to abroad is captured in the prices, wages, and other market signals that guide corporations’, workers’, and consumers’ choices. Or at the very least, the information and incentives conveyed by the market signals that guide private-sector economic decisions are more accurate and reliable than are the information and incentives conveyed by the interest-group lobbying, electoral bargaining, and retail politicking that guide political decisions.
Here’s Oren’s interpretation: (Just fyi: @MasonEconomics isn’t my account; it’s GMU Econ’s; I have no X account.)
Here’s Prof. Donald Boudreaux @MasonEconomics claiming that there is no externality related to domestic production because market signals fully account for the value to a nation of its industrial base. “The value of producing particular outputs in the U.S. as opposed to abroad is captured in the prices, wages, and other market signals.”
I describe Oren’s interpretation as “careless” because, as you see, he actually quotes the key sentence of mine. His carelessness is his economically uninformed assumption that when I wrote “value of producing particular outputs in the U.S. as opposed to abroad” he takes me to be saying “the value to a nation of its industrial base.” More on this important point below.
I begin, though, with a relatively minor point: I do not, contra Oren’s suggestion, use the word “fully.” Use of that word is attributed to me by Oren. It’s a word that I would never, unless careless, use in such a context.
First, the meaning of to “fully account” for the value of something is economically ambiguous. Does the price at which Sarah buys apples fully account for the value that she expects to get from consuming those apples? Does it fully account for the value of the apple-seller’s efforts? (Perhaps the apple seller gets some non-price satisfaction from selling apples at the farmers’ market.)
Second, because the term “fully” is extreme – or suggests an extreme position – I would, to avoid implying that I think that reality is perfect, avoid using that term. Even if in theory a market price meaningfully captures some value “fully,” because real-world markets are imperfect, any real-world market price likely doesn’t. For this reason, I was careful to mention in my original post – as quoted above – that the relevant comparison is not one of real-world markets to god-like government; the relevant comparison is one of real-world markets to real-world government. However imperfect market prices might be at reflecting relevant costs and benefits, to establish a case for having the government override these market prices requires a credible demonstration that a real-world government is likely to improve matters. This latter demonstration is not done by Oren.
Third, because of the point just above, as a purely practical matter I would avoid, in such a post, use of the word “fully” simply in order to protect myself from being the victim of a “gotcha”! “See! Boudreaux made a utopian or extreme claim, that market prices fully capture this or that value! Well we know that in practice they don’t fully capture values!” Yet despite my care in avoiding the use of any such extreme term, Oren put it in my mouth nevertheless. But, again, I didn’t write “fully.”
Now to a more-substantive point: Being an economist of at least minimal competence, I would never have written that ‘market signals fully or even partially account for the value to a nation of its industrial base.’ Here’s why.
Market signals account for the value of property interests that can be exchanged. Goods and services – or, as I wrote in my original post, “particular outputs” – are concrete things that can be, and are, exchanged. The prices of these actual outputs are among the market signals that guide producers’ and consumers’ decisions. Other market signals that have direct effects on, or are directly affected by, the prices of outputs produced domestically are the prices of inputs, including labor, used to produce the outputs in question, and actual and expected profits and losses.
In contrast to concrete goods and services and inputs, a nation’s industrial base is an abstraction. It has no market value, for – at least in a market economy – no one does or can have a property interest in a nation’s industrial base. A nation’s industrial base doesn’t emerge as the result of a conscious production decision; in a market economy, what’s commonly called a nation’s “industrial base” emerges as a result of countless particular production and consumption decisions over time, some of which prove to be profitable and others of which don’t. Importantly, none of these decisions are made for the purpose of contributing to the nation’s “industrial base.” A nation’s industrial base belongs to no one. No one has a right in or to it. Again, it’s an abstraction, constructed mentally after the fact. What counts as “industry”? What counts as “base” as opposed to superstructure? Is a factory located in Mexico but owned by a U.S.-headquartered corporation part of America’s industrial base? These and other questions must be answered in order to define a nation’s “industrial base.” Reasonable people can and do disagree on the answers to each such question.
Establishing the fact that a nation’s “industrial base” is an abstraction and not a concrete phenomenon in which someone or some group can have a property interest is sufficient reason to dismiss as economic error any suggestion that when producers and consumers are guided in their economic decisions by market prices that an externality is afoot – that these decisions unleash a negative externality in the form of an inadequate accounting of the resulting effects on the nation’s “industrial base.”
Oren might read the above and accuse me of dealing with a side-issue, one merely ‘rhetorical’ – namely, the meaning of “externality” – whereas his substantive point is that market signals are insufficient to prompt producers and consumers to act in ways that take account of the full value ‘to the nation’ of having an industrial base sufficient to provide something close to the ‘best’ mix of the goods, services, and opportunities the people of the nation want.
I’d respond by saying that the meaning of “externality” is not a side issue, for if the term is misunderstood and misused it paves the way not only for intellectual misunderstanding but also for poor public policy.
But I also want to address – as I’ll do in a follow-up post – Oren’s argument that market signals are insufficient to prompt economic actors to choose in ways that ensure the creation, maintenance, and growth of factories, research labs, human capital, and other goods and services that are reasonably classified a part of a nation’s “industrial base.” He’s mistaken, and not merely because he doesn’t know the meaning of the word “externality.”
