Wednesday, March 21, 2018

The Father Of "Market Failure" Analysis Dies

That would be Francis M. Bator. Born in 1925 in Budapest (moving to US in 1939 with family), Francis M. Bator died at age 92 a few days ago after being hit by a human-driven car while crossing the street. The funny thing is that when I read of it, I  was surprised he was still alive, thinking he had died some time ago.

It turns out that for the public he is best known as an economic and national security adviser to LBJ in the 1960s, being for awhile the Deputy National Security Adviser to McGeorge Bundy and thus partly responsible for the war in Vietnam policies.  I did not know about that and am uninterested in commenting on that, although supposedly he left the administration in 1967 mostly because of his lack of enthusiasm for that war, after encouraging friendlier relations with both the USSR and western Europe.  He also seems to have been one of the founders of what is now the Kennedy School of Government at Harvard,  where he went after being in the LBJ administration, retiring in 1994.  In later years he wrote much about interaction between fiscal and monetary policy, but little of it is of much longer term interest.

Why Bator interests me and why I am posting this is because of his intellectual role dating from 1957 and 1958, soon after here got his PhD from MIT under Robert Solow, with a pair of highly influential articles that essentially set textbook discussions of the matters they discussed (and as I basically had not heard of him since the 1960s is why I thought he was dead, not being aware of how young he was when he wrote those papers).  The second one is the more important and gave the label to his now widely accepted formulation, "The Anatomy of Market Failure." It was Bator who coined that term and who also laid down the standard list of reasons for  "market failure," the syndrome of a free market possibly failing to be Pareto optimal, essentially a large caveat on Pareto's First Welfare Theorem that says that general equilibrium is Pareto optimal.  The textbook four reasons for such possible market failure according to  Bator are monopoly power, collective consumption (or "public") goods, externalities, and imperfect information.

Probably the most important part of his formulating this widely accepted list is that he was the first to clearly distinguish between the second two of these: collective consumption (public) goods and externalities.  It is easy to forget that both of these involve collective aspects in one way or another, but in slightly different ways.  But in our accepting his distinction we have come to forget that some of our most important problems involve both simultaneously being involved, with global climate change being perhaps the most important current example.  Pollution leading to climate change involves externalities while the condition of the global climate is clearly a collective consumption good of the highest order.

As it was, externalities were first rigorously analyzed by Pigou in 1922 in his Economics of Welfare, with the "Pigovian" view becoming the standard textbook view, and still is with some caveats.  Thus the 1960 critique by Ronald Coase in his "Theory of Social Cost" made it clear that under the right conditions, well-defined property rights and low transactions costs, markets might succeed in internalizing externalities, and much environmental policy since, including cap and trade, have been inspired by trying to bring about an internalization of externalities using markets.  It must be noted that Bator's paper appeared two years prior to Coase's.

The part that had not been clarified until shortly before Bator's papers involved collective consumption goods, with this being done in 1954 in a famous paper by Paul Samuelson, who would have been teaching Bator when he was a grad student at MIT.  Samuelson's famous formulation is that such good involve non-depletion and non-excludability due to  their collective nature, which implies that to find true market demand one must vertically sum individual demand curves in the form of "willingnesses to pay" in contrast to the horizontal summation of demand curves we see in markets for purely private goods.  Super individualists sometimes argue that there are no pure collective consumption goods, and it is true that some classic examples such as lighthouses have been shown not to be such, but some certainly do exist, with global climate a pretty clear case.

In any case, presumably influenced by the recent publication of Samuelson's clarifying paper on collective consumption goods (where Samuelson did not comment on the matter of externalities), Bator proceeded to produce his list and analysis, which indeed went into the textbooks a long time ago, much  to the annoyance of some free market Coasian types, such as the late James Buchanan, who regularly publicly debated Richard Musgrave, who played a key role in putting Bator's analysis into the public finance and public economics textbooks.  I am unaware of anybody ever suggesting that Bator should get a Nobel Prize for what he did, but serious rumor has it that when Buchanan got his for public choice, the person who  nearly shared it with him and did not was not Gordon Tullock but Buchanan's long-running debating partner, Musgrave, who is probably more widely identified with advocating the "market failure" analysis than is Bator.  But it was Bator who first formulated it.

Barkley Rosser


ProGrowthLiberal said...

Bator wrote so many incredibly precise and insightful papers. I still remember vividly his "Simple Analytics of Welfare Maximization":

His precise layout of the standard invisible hand theorem laid bare both its limitations as well as where the real world might undermine its underlying assumptions. It is no wonder that he also captured market failures and the role of public finance.

John Quiggin said...

Sad news. He wrote to me about early drafts of my "Economics in Two Lessons" book. I was looking forward to sending him the manuscript.

AXEC / E.K-H said...

Futile beatification and canonization of an economics Flat-Earther
Comment on Barkley Rosser on ‘The Father Of “Market Failure” Analysis Dies’

Science is about truth/knowledge, politics is about belief/opinion. Science appeals to logical/empirical proof, politics appeals to emotion and good guy/bad guy moralizing. Economics is a failed science on one level with the Flat Earth Theory, economists are fake/cargo cult scientists. Walrasianism, Keynesianism, Marxianism, Austrianism has NO truth value, only some political use value.

Standard economics is built upon this set of foundational propositions, aka neo-Walrasian axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

These premises contain three plain NONENTITIES (constrained optimization HC2, rational expectations HC4, equilibrium HC5) and therefore are forever unacceptable. Being incompetent scientists, though, economists swallowed this inane stuff hook, line and sinker from Jevons/Walras/Menger onward to DSGE.

In methodology it holds, when the axiomatic foundations are false the whole analytical superstructure is false. So, General Equilibrium, Pareto Optimality, the Welfare Theorems, the Coarse Theorem, the concept of Market Failure are all elements of what is an economic Flat Earth Theory.

Make no mistake, whoever accepts only one axiom of the set HC1/HC5 proves that he is a proto-scientific deadhead.

Since Newton made faux humility popular with his “If I have seen further it is by standing on the shoulders of Giants” all dwarfs desperately try to convince the general public, which simply cannot assess genuine scientific merit, that they are standing on the shoulders of geniuses.

This is where attention managers, cheerleaders, and claqueurs like Barkley Rosser have to bring in their talents. Being himself a Flat Earther he simply cannot resists to award the fake Nobel posthumous to a fellow fake scientist like Francis Bator whose claim to the title of useful political idiot rests on the fact that he is best known “as an economic and national security adviser to LBJ in the 1960s”.

To abuse an obituary for great-man myth creation is a tried and tested ― but nonetheless forever reprehensible ― PR stunt. Fact is that standard economics is a scientific failure and no orthodox/heterodox economist will ever be accepted to the pantheon of science.

Egmont Kakarot-Handtke

Peter Dorman said...

Thanks, Barkley -- we do owe this guy a debt. Clarity is one of the greatest gifts, no?

My view is that Bator's list of canonical market failures leaves out perhaps the most important of all, nonconvexities and multiple equilibria. (It also leaves out collective action problems, which sometimes generate multiple equilibria, sometimes not.) I suspect that at some future date we will recognize the Keynesian critique as a species of nonconvexity/multiple equilibria. Roger Farmer suspects this too, although his formulation goes after just one aspect of it.

(For clarity, by nonconvexity here I'm referring to "off-diagonal" interaction effects, not increasing returns.)

On a very minor note, it's not quite accurate to say that, for Coase, markets internalize externalities. RC's enormous contribution (clarity again!) is to identify externalities as missing markets. If there's a well-functioning market for an effect it's not an externality. If there isn't, and we manufacture one, the externality, being internalized, no longer exists.

(And incidentally, it can be shown that externalities in the Coasian sense are neither necessary nor sufficient for multiple equilibria. For years I was led astray by Baumol and Bradford until the light dawned.....)

Barkley Rosser said...


"Simple Analytics...." was the 1957 predecessor of the 1958 "market Failure..." paper, with some arguing with good reason that it is really the greater paper, even if the 1958 one gave us the textbook version, which I and Marina have used in our comparative systems textbook. It really is the standard, which does not mean it is without flaws or limits.


Sorry you got cut short in your communications with him.


I agree with your additions to the list, a bit esoteric for the late 1950s and only understood later, although the matter of Keynesian insufficient aggregate demand was well known then. However, I think the list was strictly micro oriented and just like trade theory assumes full employment implicitly, with, ironically a sort of Chicago Say's Law bias, which believes that insufficient demand arises from bad government policies, even though Keynes himself certainly did not think that.

Regarding Coase, it is well known that he never liked Stigler's formulation of his argument as a theorem or a law. For him, the father of new institutional economics, the point really was on understanding transactions costs, whose nature was a central focus, with him fully aware that rarely do they approach zero, as some free market environmentalists think. Of course the more "shocking" implication of his analysis was that it did not matter who bore the internalizing costs, who might be the pollute. But in fact we know that sometimes the pollute is a rich person and the polluter is a poor person (think of who owns polluting junker cars), so that indeed while we moralistically declare that "polluter must pay (!)" it is far from obvious that this is really a morally justifiable general principle. Coase argued that each case must considered distinctly to understand the details involved.

AXEC / E.K-H said...

Peter Dorman

You say: “My view is that Bator’s list of canonical market failures leaves out perhaps the most important of all, nonconvexities and multiple equilibria.”

Equilibrium is one of the neo-Walrasian axioms (see HC5 above). It is a lethal methodological blunder to put equilibrium into the premises. This idiocy/fraud is known since antiquity as petitio principii.#1

Joan Robinson put it thus: “Economic theorists should not make such a production about taking a rabbit out of a hat after having put the rabbit into the hat in full view of the audience.”

Equilibrium is not a feature of economic reality, it is the rabbit which has been put into the hat as an inadmissible axiom. Because equilibrium does not exist, general equilibrium does not exist, and multiple equilibria, too, do not exist.

Methodologically, multiple equilibria are analogous to the epicycles of Geo-centrism.

The fact of the matter is that the market system is inherently unstable. It either explodes or implodes, albeit in slow motion and overlaid by cycles, so that the underlying instability is normally imperceptible.

Because the idea of an underlying tendency towards general equilibrium is false, the concept of market failure, which makes only sense in relation to GE, makes no sense at all, it is a self-created pseudo-problem. The market system as a whole is structurally/functionally defective because it has some positive feedback loops built right into its core.#2

Standard economics is one of the worst cases of theory failure of all times and you are part of it.

Egmont Kakarot-Handtke

#1 Petitio principii — economists’ biggest methodological mistake

#2 Proof of the inherent instability of the market economy