Was Ayn Rand awake in Econ 1?

Great Debates
1

In the past 5 months, I have completed an economics 1 course at college, and I have read Atlas Shrugged by Ayn Rand. In reconciling what I learned from those two things, I have come across some contradictions that I cannot seem to resolve. I suspect they are flaws in Ayn Rand’s philosophy, but perhaps someone will clue me in on some aspects of it that I may be missing.

So to get down to it:

Even my highly conservative econ professor made it abundantly clear that government regulation was an absolute necessity in certain cases. For instance, no self-respecting economist would dispute the existence of the “inefficiency of monopoly” - namely, the fact that a monopolist who cannot perfectly price discriminate (i.e. charge different people different amounts of money for the same product) will create a condition where, say, a consumer wants to buy a widget for $100, the monopolst is willing to sell the widget for as little as $80, but the deal doesn’t get made because the optimal price point for the monopolist is $110. In perfect competition, the price of widgets would naturally settle to $80, and thus there would be no instance where a mutually beneficial deal would be passed up.

Furthermore, monopolists have the power to use uncompetitive practices such as dumping (temporarily selling a product for less than it costs to produce) in order to squeeze out any potential competitors, thus entrenching market inefficiency.

And finally, there is the existence of externalities - goods whose price is paid by others (e.g. pollution). Without government regulation, externalities would never be present in a socially optimal fashion (i.e. massive quantities of pollution, poor safety standards, etc)

In reading Atlas Shrugged, it seemed to me that Ayn Rand was naiveley ignoring these basic tenets of economics. If I’ve understood her stance correctly, it is that there should be no government regulation whatsoever, but you don’t have to be a socialist to see that a socially optimal result can never occur on its own - after all, even Adam Smith was wary of monopolies.

Finally, the central industry in Atlas Shrugged - railroads - is identified by economic theory as a “natural monopoly”. In other words, the enormous fixed costs at the outset (laying miles of track) and the relatively small variable costs (placing one additional person on a train costs the railroad very little), means that without government regulation, a monopolist will inevitably take over such an industry, raising rates and creating the inefficiency mentioned above.

Why did Ayn Rand miss such obvious economic facts? Am I understanding her ideas correctly?

2

First, my econ 101 book spells out that there are advantages and disadvantages to a monopoly or oligopoly. In many cases no government oversight is necessary. Micro-monopolies are very common as small local markets cannot bear competition (think corner grocery stores in small towns). Some large services cannot be properly scaled for “good” pricing without a monopoly.

Rand did not feel there was something inherently wrong with monopolies, and that their formation came about through natural market practices that people would otherwise condone. Obviously in an open market competitors will do whatever they can to beat out the competition. When a company is very successful at this, they become a monopoly. The question would then be (to Rand, and the government): has this company done something illegal to achieve this? If not, then no harm, no foul.

It is not illegal for everyone to choose to like a particular product to the extent that competition with this product becomes impossible.

Rand strongly felt that ethical business practices would not lend themselves to monopolies in the general case. But her assumption for this was based on the idea that man is a knowledgeable, rational consumer. This has not been borne out by empirical evidence, and market forces often act to conspire against this in addition to consumer’s own laziness.

Well, sure. A ban on slavery is of course impacting the market, though I don’t think Rand would agree that this was market regulation. Market regulation, for Rand, was interference in the behavior of businesses and consumers for no other reason than to shape the economy from a central viewpoint, to force an economy to behave in a way that it shouldn’t.

The basis for how an economy should behave was rooted in her philosophy.

Rand is not an economist, but I wouldn’t say that she was stupid. Certainly some economists do tend to agree with Rand on many issues, though not explicitly (except for Greenspan back in the day before he was such a big man on campus).

Oh?

3

—Without government regulation, externalities would never be present in a socially optimal fashion (i.e. massive quantities of pollution, poor safety standards, etc)—

You have to be very careful about how you “solve” these externalities though. Almost always, your best bet is either to give people ownership of things like public goods, and create another market. In a lot of cases, it is arguable that government regulation causes far more harm than it prevents, even in solving the problems it claims to address.

A favorite hobby of many economists is debunking claims of monopoly and externality.

4

I don’t see why this necessarily makes government regulation an “absolute necessity.” In fact, there are many such monopolies which the government will protect and enforce. For example, if I write a book – The Poetry of Lucwarm – I am free to charge $1,000,000 per copy. If somebody tries to undercut my monopoly by selling bootleg copies, the government gives me legal remedies against that person.

Now, it’s true that for certain types of monopolies, government regulation is appropriate. For example, public utilities. See my comments about railroads below.

**

As I recall, railroad rates in Atlas Shrugged were regulated by a public board. Rand didn’t seem to object to the existence of the board, just the use of political pressure to raise rates to unfair levels. But feel free to correct me, I haven’t read the book in a while.

By the way, I don’t buy Rand’s theories. I’m just taking exception to some of your criticisms.

5

Well, I just did a quick Google, and immediately found four or five sources that listed railroads as a natural monopoly.

Why is this surprising to you? From what I understand, virtually any industry with a high cost of infrastructure development (like the telephone and cable industries) is a natural monopoly.

Also, I really have to question Apos’ statement that “government regulation causes far more harm than it prevents”. Maybe in case of something like rent control this is true, but what about the example of how the government used voucher auctions to regulate SO2 emissions? Sure, that’s just an example of a government creating a market, but it seems like Rand wouldn’t have liked that at all since she felt that government should have no role in markets whatsoever. I would just like to know how she expected these problems to be solved with her ultra laissez-faire system.

lucwarm - Rand says that she wants separation of government and the economy in the same way that we have separation of church and state. The only role of government, in her opinion, is to a) defend the country against foreign invaders (army), b) protect citizens against violence (police) and to c) protect traders from breaches of contract (courts). I think you are getting mixed up - there was a board of directors in the novel that ran Taggart Transcontinental, but by the time the government got around to setting the rates for all railroads, it was pretty clear that Rand was vehemently opposed to it.

6

It’s possible that I’m mis-remembering, but I think it may be you who are confused. As I recall, there is a sequence where the heroine of the novel hauls ass and builds a super-duper rail link to Colorado to connect to the super-duper factories of one of the male characters. Eventually, one of the heroine’s family members lobbies for an obtains an (unfair) rate increase for the new rail link. This, along with other things, spoils the party.

7

It depends on how narrowly you define them. Railroads may have a monopoly on moving items in steel boxes by using rails. But in a larger sense, railroads are just transportation. And there’s no monopoly on transportation, especially when alternatives are similar in cost (trucking, for example).

This is an important point. Two of the most clear natural monopolies are DeBeers diamonds, and Canada Nickel. Now, Debeers apparently does benefit from their near-monopoly in diamonds, but most experts think that Canada Nickel sells their product at ‘competitive’ prices (i.e. the price that would exist if there were competition).

So how come? Well, because there are alternatives to nickel. If you define it as “A product used to create a material that has characteristics of x, y, and z”, then suddenly there are lots of alternatives.

Even when there are no alternatives directly, there are indirect alternatives. For example, if Railroads are the only way to get out of Dodge, and they are owned by a monopoly and therefore priced higher than the ‘competitive market’ price, then some people may choose not to travel at all.

Finally, a lot of free market economists would claim that the ‘problem’ of monopoly power arising out of free markets is greatly overblown. It is damned difficult to maintain even a decent fraction of market share. But it’s far, far easier to maintain a ‘monopoly’ by getting the government to pass a law that gives you exclusive rights. The railroads themselves are a good example of this - the early railroads were given land grants that gave them monopolies on rail routes.

How about naming some companies that grew to the point of wielding monopoly power, and without the power of government protecting them?

The problem of government squashing competitive markets is much, much greater than the risk of natural monopoly power arising out of the markets, in my opinion. Governments protect industries all the time from competition. They just did it with steel tariffs. Even things like milk distribution are non-competitive because of government intrusion into the marketplace.

So I guess a summation could be,

  1. Even natural monopolies are not necessary monopolies in a larger sense, in many cases.

  2. Non-natural monopolies generally only exist when one company offers products better and/or cheaper than the competitors can. The argument then is, “What’s wrong with that?”

  3. The ‘fix’ to monopoly power is to let the government insinuate itself into the economy in a particularly egregious way. A ‘fix’ that may be worse than the problem.

As for Ayn Rand, she actually wrote a lot about this in her non-fiction. Pick up “Capitalism: The Unknown Ideal” for more information. She was wrong about a lot of things, though. For instance, as I recall she was against government regulation of the airwaves, and instead favored ‘squatter’s rights’ or something like that. That wouldn’t work, but she didn’t have the technological background to understand that.

8

It depends on how narrowly you define them. Railroads may have a monopoly on moving items in steel boxes by using rails. But in a larger sense, railroads are just transportation. And there’s no monopoly on transportation, especially when alternatives are similar in cost (trucking, for example).

This is an important point. Two of the most clear natural monopolies are DeBeers diamonds, and Canada Nickel. Now, Debeers apparently does benefit from their near-monopoly in diamonds, but most experts think that Canada Nickel sells their product at ‘competitive’ prices (i.e. the price that would exist if there were competition).

So how come? Well, because there are alternatives to nickel. If you define it as “A product used to create a material that has characteristics of x, y, and z”, then suddenly there are lots of alternatives.

Even when there are no alternatives directly, there are indirect alternatives. For example, if Railroads are the only way to get out of Dodge, and they are owned by a monopoly and therefore priced higher than the ‘competitive market’ price, then some people may choose not to travel at all.

Finally, a lot of free market economists would claim that the ‘problem’ of monopoly power arising out of free markets is greatly overblown. It is damned difficult to maintain even a decent fraction of market share. But it’s far, far easier to maintain a ‘monopoly’ by getting the government to pass a law that gives you exclusive rights. The railroads themselves are a good example of this - the early railroads were given land grants that gave them monopolies on rail routes.

How about naming some companies that grew to the point of wielding monopoly power, and without the power of government protecting them?

The problem of government squashing competitive markets is much, much greater than the risk of natural monopoly power arising out of the markets, in my opinion. Governments protect industries all the time from competition. They just did it with steel tariffs. Even things like milk distribution are non-competitive because of government intrusion into the marketplace.

So I guess a summation could be,

  1. Even natural monopolies are not necessary monopolies in a larger sense, in many cases.

  2. Non-natural monopolies generally only exist when one company offers products better and/or cheaper than the competitors can. The argument then is, “What’s wrong with that?”

  3. The ‘fix’ to monopoly power is to let the government insinuate itself into the economy in a particularly egregious way. A ‘fix’ that may be worse than the problem.

As for Ayn Rand, she actually wrote a lot about this in her non-fiction. Pick up “Capitalism: The Unknown Ideal” for more information. She was wrong about a lot of things, though. For instance, as I recall she was against government regulation of the airwaves, and instead favored ‘squatter’s rights’ or something like that. That wouldn’t work, but she didn’t have the technological background to understand that.

9

—Also, I really have to question Apos’ statement that “government regulation causes far more harm than it prevents”.—

While technically true to say that Apos made such a statement, it’s highly misleading to say so. Apos made THIS statement: “In a lot of cases, it is arguable that government regulation causes far more harm than it prevents, even in solving the problems it claims to address.” And Apos also was essentially warning that government regulation, if ever necessary, needs to be very careful and well thought out: NEVER a knee jerk policy like “well, accidents are up, so we need to outlaw accidents.”

—Maybe in case of something like rent control this is true,—

Is it EVER!
And, to boot, it’s IMMORAL. (But not for the reasons Rand thinks it is).

—but what about the example of how the government used voucher auctions to regulate SO2 emissions?—

An excellent idea, agreed. Though then we still get into the nasty question of what level of prices should be set at. (since there is both such a thing as too high, and too low)

—Sure, that’s just an example of a government creating a market, but it seems like Rand wouldn’t have liked that at all since she felt that government should have no role in markets whatsoever.—

I don’t know enough about Rand to say. However, I’m not sure she would have disagreed: though she might have been in favor of simply selling the property rights off once and for all, instead of continual auctions. We need more detail on her attitude towards public goods.

However, we don’t need to dig up Rand to look for examples of people who think they are diehard advocates of free markets, and yet who don’t have the slightest clue of what free market theory even has to say. It’s called Congress.

10

Not nececelery. If people didn’t like pollution, they could enter into contractual arrangements – bargained for collectively, if need be – with the producers of said pollution, and agree to pay them to keep their pollution levels below some threshold amount.

11

I posted a quick run through of possible policy responses to natural monopoly in this sadly ignored thread.

As to whether railways are a natural monopoly - the network is, the rest isn’t. And the matter of whether there are alternative modes of transport is irrelevant - a market may be a natural monopoly without the firn running the market having any market power (either due to close substitutes or contestability).

Or the other way around. Pollutors could pay those potentially affected a bribe to accept the pollution. This would be the starting point under a system of amenity rights rather than pollutors’ rights. Under certain (fairly strong) informational assumptions the same result would obtain (This is the Coase “theorem”).

12

—This would be the starting point under a system of amenity rights rather than pollutors’ rights. Under certain (fairly strong) informational assumptions the same result would obtain (This is the Coase “theorem”).—

Coase’s theorem would suggest that, if all we are concerned with is efficiency (and not, for instance, penalizing one party or another for being at fault) we not start out from a position of giving more creedence to amenity rights vs. polluter’s rights. Rather, the key is simply to make the fullest range of possible negotiations available. The key insight is that, from the perspective of social efficiency, the costs of resolving the conflict should be borne by the party who can prevent the harm most efficiently, and the best way to do that is to make the affected parties negotiate a settlement directly, and help them enforce the contracts they make with each other.

13

Well I disagree - or at least remain to be convinced of that Apos. There is of course much disagreement about what the Coase “theorem” is as well as what it means.

The way I think of it is like this: in the absence of transactions costs all externalities will be internalised regardless of the initial distribution of property rights (arguably this applies to public goods and competition problems too). It’s probably also true that the actual outcome will be the same regardless of the initial distribution of property rights.

But of course there are transactions costs, and the “solutions” to the pollution externality problem mentioned by tracer and myself fail due to the free-rider and hold-out problem respectively.

Assuming this is not a formidable second-best proposition this is not a clear implication of the Coase theorem (much as many people including I’d guess Coase himself would dearly like it to be so). It’s very appealing and IMPO often good policy. But it is not clear that if the world differs from the free information neoclassical world in important ways that it would be a good idea to make the world more like the model in some but not all dimensions. There are circumstances where markets can be destructive.

14

Agree. I would add that free-rider problems, hold-out problems, and other problems related to transactions costs are freqently so serious and so intractable that free-market-style solutions to many problems are total fantasy.

With pollution, there might be millions of different parties involved. All of the parties will have slightly different interests and preferences. Many of the parties will be highly stubborn and uncompromising. There’s just no way you’ll be able to work out a deal that every last person can sign off on.

15

—But of course there are transactions costs, and the “solutions” to the pollution externality problem mentioned by tracer and myself fail due to the free-rider and hold-out problem respectively.—

I’m not sure I see your point. This is still no excuse for being ambivalent about who should bear the costs of something like pollution (or, rather, the costs of productive activity that causes pollution) and finding the way in which the largest range of options are open, whether “the people” are represented by a government stand-in or whatever other strategy we undertake to compensate for the various problems in representing the public side of things.
The goal remains finding the liability rule that leaves open the widest range of possible solutions. That’s why “pollution markets” are such a superior solution to industry wide pollution caps: in both cases pollution can be cut down to the same level, but with the first, we have the both the opportunity of whatever happened with the cap happening, but also the possibility (and even the strong likihood) that the costs of pollution cutbacks will be bourne by the right factories: the ones best able to bear them. But even that’s not really good enough, because it leaves out all the things that the public can do to deal with pollution (like moving away), which at some point may or may not be more efficient than cutting back on pollution one more increment. At some point the preferences of the public have to come into play if we are going to get any sort of truly efficient outcome, regardless of what tricks we have to employ to get around the problem the public has in bargaining collectively.

—It’s very appealing and IMPO often good policy. But it is not clear that if the world differs from the free information neoclassical world in important ways that it would be a good idea to make the world more like the model in some but not all dimensions.—

I think you are being entirely too glib about the “neoclassical world” where things like the Coase theorem live. The Coase theorem is precisely the sort of idea that is formulated in a model but explicitly made to be taken out of that model and approximated to reality. Coase’s original example involved just such a situation in which there were free-rider and holdout problems, and this does play directly into his solution.

16

Oh, I agree. But are permits superior to Pigovian taxes? It rather depends on the expectation of enforcement. In principle the proceeds from an auction of permits yields the same revenue as the discounted stream of Pigovian taxes. But once the permits are sold, will the government enforce them? If industry thinks not, all the nice properties of the permits (including that lovely excess-burden-free revenue) come into question. But yeah, I’m all for using appropriately designed markets.

One of Coase’s insights is that it is not at all clear that pollutors should pay or that they are in any sense the cause of the problem. Equity aside, it is a matter of complete ambivilence who pays the “costs of pollution” because externalities are inherently two sided. There is only a cost of pollution because other people want to use the resources - it’s not clear why we shouldn’t equally regard breathers of air as imposing a cost on pollutors.

This is why I called it the Coase “theorem”. There is no formal model in The Problem of Social Cost. It has been left for others to try to find the assumptions under which it works. The problem is that just because “the world approximates the model” does not mean that the results in the model approximate the results in the real world. What the past two decades of theory have taught us is that informational assumptions matter and matter a lot (see for example Akerlof’s The Market for Lemons piece in the QJE). But maybe it’s time I read The Problem of Social Cost again. My memory is that it’s better than that crap he wrote about lighthouses (which is the last thing of Coase’s I read).

17

Doesn’t this encourage people to pollute more? If such a system were in place, I would start burning sulfur in my backyard so people would pay me to stop. Viva Libertaria!

18

The reason this probably wouldn’t happen is because people are cheap and lazy.

Laws regulating things like that can be passed as long as not many people actively oppose the law – but those kinds of agreements would only be passed if many people cared a lot about it. As long as most people are pretty apathetic about the environment, we’ll have to regulate it by law.

(As an aside, if you wanted it to be regulated by the people without government intervention the simplest (and most libertarian/objectivist) way would be for people to buy their products from some other company that doesn’t pollute.)

19

—Equity aside, it is a matter of complete ambivilence who pays the “costs of pollution” because externalities are inherently two sided.—

I think you entirely missed my point. I know all about Coase’s insight into “who’s at fault.” I was talking about efficiency. If one is concerned about social welfare as a whole, then it is NOT a matter of indifference who pays the cost: because very often one side’s preventative action can be much less costly than the others’. Normally, the best way to figure this out is to let the parties bargain. Sometimes they can’t, whether it be because of ransom holdouts or unenforcable contracts. But EVEN if they can’t, that’s STILL no excuse for ignoring the possibility that one side might be able to fix the problem much more cheaply than the other. Coase argues that normally judges shouldn’t bother trying to figure this out, because it’s normally darn hard, and the parties have an incentive to inflate their claimed costs. But when direct bargaining is out of the question, some thought about who can bear the costs most cheaply is certainly better than no thought, or indifference.

20

Yep, I had entirely missed your point Apos. I was talking about indifference to the allocation of initial liability prior to bargaining. In the presence of barriers to bargaining it is indeed a touchstone of good policy to have those with greatest ability to control the costs bear the costs. When you talked about “bearing the costs” I guess I got confused thinking about the incidence of the costs of pollution (which remain two-sided) as opposed to efficient liability rules. Of course, in a zero transactions costs world, none of this matters.

By the way, an excellent article on the Coase “theorem” is this one from the Elgar Encyclopedia of Law and Economics. By “excellent”, of course, I mean that it backs up what I’ve said in this thread. :smiley:

This exchange has become a shocking hijack. But what it does show is that we lie to you in Economics 101. We tell you a good but oversimplified story about monopoly. It’s one that isn’t silly, but we don’t tell you the whole thing because it’s only when you get the basic story that you can go back and unpack some of what’s going on.