Friday, September 14, 2007

Kling on the Spontaneous Order of Markets

Another beautifully written piece, chock full of truths, such as:

When spontaneous order exists, we take it for granted and make little effort to understand it. If your body is healthy, you do not need to think about how your muscles work, how your heart and brain function, or how your metabolic processes operate. You only notice it when order breaks down, and you are sick or in pain.

Similarly, when the economy is functioning properly, we do not notice all the behaviors that are required to make it work. We go to the supermarket and find grapes available, and we do not wonder why or how.

Those of us who lived through the gasoline crisis of 1974-1975 will never forget the frustration, perverse incentives, and absurdity of the disorder caused by price controls. That is why very few experienced politicians argued for price controls after Hurricane Katrina shut down many oil refineries.

We saw an example of Soviet-style economics in the United States in the mid-1970's, when we maintained price controls on gasoline. This was in response to the Arab oil embargo.

In Oil Econ 101, I explained that because "oil is oil," it is not really possible to boycott Saudi oil. If we do not use Saudi oil, someone else will. The oil we use will come from country X, and Saudi oil replace the oil of country X somewhere else.

The same logic says that the Saudis cannot boycott us. If they stop selling to the United States, but they continue to supply their oil to the market, then we will get more oil from other countries instead.

If markets had been allowed to operate in 1974 and 1975, the effects of the oil embargo almost surely would have been minor and temporary. Instead, price controls created a massive disorder.

Because gasoline prices could not rise, there was no natural incentive to increase supply or to curtail demand. The result was a shortage.

The minimum wage is another example of a government policy that fosters disorder. Harvard economist Greg Mankiw aptly describes the minimum wage as:

  1. A wage subsidy for unskilled workers, paid for by
  2. A tax on employers who hire unskilled workers.
Other economists, including recent Nobel Laureate Edmund Phelps, prefer the idea of a pure wage subsidy for unskilled workers, paid for out of general income taxes. A minimum wage lowers the demand for unskilled workers. A pure wage subsidy does not.

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