Sunday, March 27, 2011

Entrepreneurs vs. Regulators and the "Alchian Thesis"

An interesting discussion has started in the comments section to a post I wrote in response to Paul Davidson. Jeffrey Friedman is again seen leading the charge, and this time the problem concerns the relative superiority of entrepreneurs vis-a-vis regulators. This passage by Mr. Friedman is central to the discussion:

"With epistemic uncertainty, *if* there's an empirical, credible argument for market participants doing better, overall, than regulators, then generally libertarian conclusions do follow ... when coupled with a view of entrepreneurs and investors that sees them as not wise, relative to regulators, because of the profit motive; but as being weeded out by losing money if they are relatively unwise, compared to other entrepreneurs and investors."

The point here is that entrepreneurs are not performing optimally relatively to regulators, but only that comparatively they are more efficient. Now TGGP was correct in noting that this discussion is similar to Armen Alchian's 1950 paper and the now famous "Alchian Thesis." However, there is a difference here between Alchian's 1950 paper and the "Alchian Thesis" --- the latter being put forward by Milton Friedman in his 1953 essay. The Alchian Thesis does hold that, as TGGP says, "Armen Alchian relied on the elimination of inefficient firms to explain why businesses will tend to maximize profits." But in fact this is not what Alchian argued. Alchian said that firms realizing any "positive" profits will succeed, and those who fail to make positive profits will disappear. This is true, Alchian believed, because in an uncertain world there is no way to know what conditions are required for maximizing profits. I also think this is what Jeffrey Friedman was getting at. Markets are not more efficient than regulation because they maximize profits, but only that they are more successful at realizing positive profits.

Next we come to Professor Steve Miller's interesting comment. My argument here is that Professor Miller is mistaken in believing that knowledge and incentives are responsible for the market's success relatively to that of government regulation. Even if everyone was ignorant of the relevant knowledge and completely lacking in incentives, there would still be competition in the realization of positive profits. As Alchian said "Even in a world of stupid men there would still be profits." He also argued that the greater the uncertainty, the more likely it is that the "lucky" ones will be those that succeed, and not the logical and prudent ones. Also his comment here:

"Only with experience do entrepreneurs develop heuristics that give them a fighting chance over the long term. Does Warren Buffet really know nothing? He may have biases, but the most dangerous of those biases have been shed... or at least diminished, no?"

indicates that through trial and error one can learn from his mistakes and survive "over the long term." Again, the conscious elimination of bias is immaterial. Intentions do not matter in competition; only those who behave in accordance with the requisite conditions for success will succeed --- not because they "wanted to," but because their behavior was favorable to survival. Also, trial and error procedures do not work because, as Alchian noted, it is (1) difficult to specify a success and a failure; and (2) trial and error does not work in a changing environment.

Alchian's 1950 paper is very important because, in my reading, it takes "knowledge" and "incentives" off the table. One can "try" to succeed all one wants, in the same way that plants can "try" to grow. But if they are not positioned in such a way as to receive the necessary sunlight, then they simply will not survive, no matter how much they "try" to. Could a defense of libertarianism and free markets be made from this analysis? Why or why not?

No comments:

Post a Comment