Economic Policy
and Market Regulation
Part 1
Dr. Stefan Kooths
BiTS Berlin
(winter term 2013/2014)
www.kooths.de/bits-ep
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Outline
1. Introduction and Overview
2. Market Mechanisms and Government Interventions
3. Externalities and Public Goods
4. Competition Policy and Regulation
5. Ordoliberalism and the Social Market Economy
6. Summary: The Key Lessons Learnt
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Outline
1. Introduction and Overview
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Motivation and key aspects
Methodology and general approach
Course scheme
2. Market Mechanisms and Government Interventions
3. Externalities and Public Goods
4. Competition Policy and Regulation
5. Ordoliberalism and the Social Market Economy
6. Summary: The Key Lessons Learnt
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Economics and the key allocation problem
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Alternative allocation mechanisms
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Violence (military campaigns, robber barons)
Discrimination (Sex, Nationality, Age, …)
Greyhound racing („First come, first served“)
Communism („Each according to his/her need”)
Egalitarianism („Each the same“)
 Market (competitive exchange mechanism)
» Property rights
» Voluntary exchange
 „Each according to his/her preferences and performance“
(ability-to-pay resulting from market income = valuation by others)
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Property rights and the role of government
 Property rights
» Usus
» Abusus
» Usus fructus (includes: accountability!)
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The fundamental policy question: Markets vs. hierarchies
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Fields of economic policy:
Allocation, redistribution and stabilization
 Allocation
» Improving economic efficiency
 Redistribution
» Changing the distribution of disposable income
(primary vs. secondary income distribtuion)
 Stabilization
» Growth, employment, price stability, external equilibrium
(macroeconomic approach)
» Fiscal policy
» Monetary policy (and choice of currency system)
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The extended Tinbergen rule
 One policy target
 One specific tool (policy instrument)
 One independent authority (in case of target conflicts)
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Levels of economic policy:
Constitutional vs. interventionist approaches
 Constitutional level
» Designing the general institutional framework (economic order)
 Interventional level
» Modifying/interfering with market processes
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Incentives and government interventions:
Intention vs. outcome (The Cobra effect)
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The big picture: From Feudalism to Neoliberalism (1/3)
Free market system
(classic liberalism)
Feudalism
liberal
revolution
Feudal power
Constitution
(Democratic) State
Subjects
Economy
Competition
Capitalist economy
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The big picture: From Feudalism to Neoliberalism (2/3)
„Invisible Hand“/Laissez-faire: Self-interest and public welfare
Adam Smith (1723 – 1790)
„It is not from the benevolence of the butcher, the
brewer, or the baker that we expect our dinner, but
from their regard to their own interest.”
(Wealth of Nations, 1776)
Vincent de Gournay (1712 – 1759)
„Laissez faire, laissez passer,
le monde va de lui-même.”
Bernard de Mondeville (1670 – 1733)
The Fable of the Bees:
or, Private Vices, Public Benefits (1714)
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The big picture: From Feudalism to Neoliberalism (3/3)
Degenerate
„unfree“ market system
Neoliberal system
Constitution
Constitution
Demokratischer Staat
Influence
Competition
Interventions
(Democratic) State
Protection
Regulation
Competition
Capitalistic economy
Social economy
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Regulation vs. deregulation: An ongoing debate
 Regulatory design is technology-dependent
 Competing paradigms for economic policy making
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Outline
1. Introduction and Overview



Motivation and key aspects
Methodology and general approach
Course scheme
2. Market Mechanisms and Government Interventions
3. Externalities and Public Goods
4. Competition Policy and Regulation
5. Ordoliberalism and the Social Market Economy
6. Summary: The Key Lessons Learnt
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Methodological individualism
 General method
» Individuals as point of departure for economic analysis
» Explaining social processes via actions of involved persons
 Individuals …
» … are diverse
» … have exogenous preferences
» … are capable of acting on their own
(Mises: Humans as universal entrepreneurs)
 Subjectivism
» Individual preferences
» No scientific inter-subjective comparisons of utility
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Human Action: Humans as universal entrepreneurs
(decision makers and explorers)
Ludwig von Mises (1881 – 1973)
http://mises.org/document/3250
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“Collective” action and average “behavior” of groups:
Pitfalls of collectivist analysis and the Arrow paradox
Person
Ranking of alternatives A, B, C
1
2
3
A>B>C
B>C>A
C>A>B
Voting
Results
A vs. B
B vs. C
C vs. A
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Voluntary exchange and the gains from trade: Markets as
reference and default system (free-market prejudice)
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Pareto efficiency and Kaldor-Hicks criterion
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Workable economic coordination: Static and dynamic functions
(“What are markets expected to do?”)
 Static functions
» Consumer sovereignty
» Efficient factor allocation
» Performance-based income distribution
 Dynamic functions
» Flexible adjustment to changing conditions
» Technological progress/innovations
 Coordination efficiency
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Positive vs. normative analysis
 Positive economics
» Economist as observer
» Explanation of cause and effect
 Normative economics
» Economist as advisor to a “social planner”
» Judgmental knowledge (explicit or implicit assumptions)
» Second-best problems
 Political economics
» Analysis of politicians/bureaucrats/pressure groups
» Public Choice/New Institutional Economics
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Markets vs. politics/morals
 Market system: Coordination mechanism (instrument)
» Usefulness basically open to scientific analysis
» But: Links between personal freedom and market system
 Politics/morals: Definition of targets (normative)
» Legitimation cannot be established by economic science
» Economics: Looking for best means to reach specific targets and
determining opportunity costs/trade-offs
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Transaction costs
 Ex-ante transaction costs
» Search
» Negotiation
» Contracting
 Ex-post transaction costs
» Implementation
» Monitoring
» Adjustment
 Using the market is not for free
(BUT: so is hierarchical/central planning)
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Categories of market failures
 Technological externalities
 Natural monopolies (subadditivity of cost functions)
 Information deficiencies
 Instability (deficient adjustment processes)
 [Non-rationality]
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Potential room for improving social coordination:
The two-stage burden of proof
 Intervention analysis: Market vs. hierarchy (central planning)
(1) Significant market failure?
(2) Market failure > government failure?
(comparing relevant alternatives)
 Information problem
(getting/distributing data, value problem)
 Incentive/bureaucracy problem
(individual utility vs. realization of the plan)
 Financing/spillovers to other fields
(distortions on other markets)
 Intervene only, if (1) and (2)
» Default: Market-based coordination (free-market prejudice)
» Minimally invasive operations (market-compatible solutions)
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Dubai: Is the desert a market failure?
 Ruler of Dubai:
„Market failed to put Dubai on the global map!“
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Outline
1. Introduction and Overview



Motivation and key aspects
Methodology and general approach
Course scheme
2. Market Mechanisms and Government Interventions
3. Externalities and Public Goods
4. Competition Policy and Regulation
5. Ordoliberalism and the Social Market Economy
6. Summary: The Key Lessons Learnt
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 1
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Literature and web
 Literature
» Fritsch, M. (2011): „Marktversagen und Wirtschaftspolitik –
Mikroökonomische Grundlagen des staatlichen Handelns“, 8. Aufl.,
Verlag Vahlen: München.
» Grossekettler, H., A. Hadamitzky and C. Lorenz (2008):
„Volkswirtschaftslehre“; UVK Verlagsgemeinschaft: Konstanz.
» Groll, D. and S. Kooths. (2013): „Vor der Bundestagswahl: Argumente
für Mindestlöhne überzeugen nicht“; Wirtschaftsdienst – Zeitschrift
für Wirtschaftspolitik, 93. Jg., Heft 8, p. 545–551.
» Mankiw, N. G. (2011): „Principles of Economics“, 6th Edition, SouthWestern.
 Web: www.kooths.de/bits-ep
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