David Warsh: On the failure of markets

Note Independence near the border with Kansas.

As especially interesting place to visit is Independence, Mo., 250 miles up the Missouri River from the Mississippi.  It was nothing more than a river bank in 1804, when the Lewis and Clark expedition stopped overnight to pick wild plums, apples and raspberries.  Mormons began to settle in the little frontier town in 1831, and by 1840, you could stand by the gate of the marshalling yard and contemplate the junction of all three main wagon routes to the west: the Oregon Trail, the California Trail and the Santa Fe Trail.

Something of the sort may have been in the back of the minds of the Nobel Committee when they designated William Nordhaus and Paul Romer recipients of the 2018 Swedish Central Bank Prize for Economic Sciences in Memory of Alfred Nobel. By unexpectedly linking the two, each of whom could have been cited separately, the Scandinavians got people thinking and writing about subjects not yet well-connected in the popular mind. Nordhaus is an environmental economist. Romer is a theorist of economic growth.

The link that the prize awarders emphasized was the researchers’ shared concern with the failure of markets to deliver desired results. These are known as externalities, the effect that certain kinds of transactions have on persons who were not involved in the deal. These so-called “market failures” may be negative, as with greenhouse-gas emissions that adversely affect the global climate, or they may be positive, as with the knowledge spillovers that occur when technological know-how is widely shared.

Nordhaus has built models with extensive links to physical science models to gauge the social costs of atmospheric pollution. Romer has deepened and broadened the argument for policies in support of education, for the sharing of intellectual property, and for thoughtful zoning. Much the best discussion of the ins and outs of the laureates’ work that I have seen is by Kevin Ryan, a professor at the University of Toronto’s Rotman School of Management.

I wrote about some part of this story many years ago in Knowledge and the Wealth of Nations: A Story of Economic Discovery (Norton, 2006). Over the next couple of months I thought I might scatter half a dozen weeklies updating the story as best I can in light of the 2018 prize. It will be a welcome alternative to hashing over the election news.

The single most important message of the shared work is to show how modern mixed-market economies can cope with the exigencies of continued economic growth without a lot of regulation.  Carbon taxes, on the one hand, government support for long-term research and development of green technologies on the other, can limit the damage to the Earth that is already in train, and, eventually, even roll back some of the enormous quantity of carbon dioxide that pell-mell growth over two centuries has dumped in the atmosphere.

True, the way ahead is more fraught with peril than were those trails to the Pacific Ocean. But humankind’s inventiveness has grown. What is lacking, so far, is cohesion.

David Warsh, an economic historian and veteran columnist, is proprietor of Somerville, Mass.-based economicprincipals.com, where this essay first ran.