Saturday, April 11, 2020

The Covid-19 Economic and Political Restructuring Narrative In The Light Of Preference Falsification

Thanks to Eric Weinstein, this year's curriculum kicked-off with an introduction to the concept of "preference falsification".  The ongoing and encompassing tsunami of current events make it exceedingly germaine for you to revisit this little-known - but nevertheless determinative concept.

voxeu |  We characterise the motivations central to the workings of civil society by a series of other regarding or ethical values including reciprocity, fairness, and sustainability. Also included is the term identity, by which we refer to a bias in favour of those who one calls “us” over “them.” We draw attention to this aspect of the civil society dimension to stress that in insisting on the importance of community in fashioning a response to the pandemic, we recognise the capacity of these community-based solutions to sustain xenophobic, parochial, and other repugnant actions.

Figure 2 illustrates the location in “institution-space” of different responses to the epidemic. At the top left is the government as the insurer of last resort. Neither market nor household risk-sharing can handle an economy-wide contraction of activity required by containment policies; and neither can compel the near-universal participation that makes risk pooling possible.

Closer to the civil society pole are social distancing policies implemented through consent. The triangle opens up space for modern-day analogues of the so-called Dunkirk strategy – small, privately owned boats took up where the British navy lacked the resources to evacuate those trapped on the beaches in 1940.  An example is the public-spirited mobilisation by universities and small private labs of efforts to undertake production and processing of tests and to develop new machines to substitute for scarce ventilators.

These examples underline an important truth about institutional and policy design: the poles of the institution space – at least ideally – are complements not substitutes. Well-designed government policies enhance the workings of markets and enhance the salience of cooperative and other socially valuable preferences.  Well-designed markets both empower governments and make them more accountable without crowding out ethical and other pro-social preferences.

Much of the content that we think is essential to a successful post-COVID-19 economic vernacular is present in two recent advances in the field.

The first is the insight – dating back to Hayek – that information is scarce and local. Neither government officials nor private owners and managers of firms know enough to write incentive-based enforceable contracts or governmental fiats to implement optimal social distancing, surveillance, or deployment of resources to the health sector, including to vaccine development.

The second big change in economics gives us hope that non-governmental and non-market solutions may actually contribute to mitigating problems that are poorly addressed by contract or fiat.  The behavioural economics revolution makes it clear that people – far from the individualistic and amoral representation in conventional economics – are capable of extraordinary levels of cooperation based on ethical values and other regarding preferences.  

As was the case with the Great Depression and WWII, we will not be the same after COVID-19. And neither, we also hope, will be the way people talk about the economy.

But there is a critical difference between the post-Great Depression period and today. The pandemic of that era – massive unemployment and economic insecurity – was beaten new rules of the game that delivered immediate benefits. Unemployment insurance, a larger role for government expenditures and, in many countries, trade union engagement in wage-setting and the introduction of new technology reflected both the analytics and the ethics of the new economic vernacular. The result was the decades of performance referred to as the golden age of capitalism, making both the new rules and the new vernacular difficult to dislodge. 

It is possible, but far from certain, that the mounting costs of climate change and recurrent pandemic threats will provide an environment that supports a similar symbiosis between a new economic vernacular and new rules of the game yielding immediate concrete benefits.