Public economics evolving

I started this week a three-month course on Public Economics. The course is taught in English, and I use mostly the textbooks by Jonathan Gruber and Hindriks & Myles. The first is more empirically and policy oriented (although too much centered on the US for my purposes), and the second is more theoretical, with relatively updated materials on the measurement of inequality, behavioral economics and political economy.

I’ve used the Rosen and Gayer and the Stiglitz textbooks, and I keep them as reference for specific topics. But all of them show the inertias of textbooks, and the difficulties they have in incorporating ideas and results that are now broadly accepted in the research community and even in the public debate.

There is paradoxically a tradition in Public Finance or Public Economics of portraying a skeptical and even cynical view of the public sector. It is a world of (Niskanen’s) bureaucrats, tragedies (of the commons) and (Arrow’s) impossibilities, which combined imply that we are relatively hopeless when it comes to trying to solve humanities’ problems.

Two relatively old-fashioned ideas are still promoted from the introductory chapters of these textbooks, even in books written by relatively progressive and innovative authors such as Gruber and Myles. One is the supposed existence of an inescapable trade-off between efficiency and equity, and the other is the idea that “most” of the time markets are efficient and market failures are exceptions to the rule.

The “Leaky bucket” that was necessary to transfer resources according to Arthur Okun is only a valid metaphor once a frontier has been achieved where all the simultaneous gains in efficiency and equity have been achieved. I asked my students to come up with examples where it is possible to improve both in efficiency and equity and they easily suggested policies like helping immigrants, reducing unemployment, promoting public education, and promoting women’s participation in the labor market. Once all these and many similar policies have been successfully enacted, only then, perhaps to improve on equity has a cost in terms of efficiency. Of course, it is also easy to come up with examples of stupid policies that are sold to reduce inequality but that bakfire (sometimes in terms of equity as well). But at a macro level, if we imperfectly equate efficiency with income per capita, there is empirically no correlation between this measure and measures of inequality such as the Gini coefficient. Equally developed countries with high sandards of living on average have different levels of inequality.

The notion that markets in general are efficient is today quite conventionally replaced by the view that the conditions for markets to be efficient are very demanding and quite unusual. Of course this does not translate into the notion that fixing widespread market failures is easy, as we know by the current experience of trying to fix pandemics, climate change and inequalities. And not only it is quite generally accepted that governments (and other institutions and mechanisms beyond markets) can help alleviate conventional market failures, but by expanding the notion of market failures, they can also help give a socially desirable direction to technological change or globalization. Some of the spirit of the materials of the CORE Project (or the forthcoming micro book by Bowles and Halliday) should permeate the public economics textbooks.