In a recent post, Dani Rodrik divides economists into first-best economists and second-best economists. Put simply, the former apply straightforward economic reasoning; the latter think more about market imperfections. To be precise:
You can tell what kind of an economist someone is by the nature of the response s/he offers when confronted with a policy issue. The gut instinct of the members of the first group is to apply a simple supply-demand framework to the question at hand. In this world, every tax has an economic deadweight loss, every restriction on individual behavior reduces the size of the economic pie, distribution and efficiency can be neatly separated, market failures are presumed non-existent unless proved otherwise (and to be addressed only by the appropriate Pigovian tax or subsidy), people are rational and forward-looking to the first order of approximation, demand curves always slope down (and supply curves up), and general-equilibrium interactions do not overturn partial-equilibrium logic.Â The First Fundamental Theorem of Welfare Economics is proof that unfettered markets work best.Â No matter how technical, complex, and full of surprises these economists’ own research might be, their take on the issues of the day are driven by a straightforward, almost knee-jerk logic.
Those in the second group are inclined to see all kinds of complications, which make the textbook answers inappropriate. In their world, the economy is full of market imperfections (going well beyond environmental spillovers), distribution and efficiency cannot be neatly separated, people do not always behave rationally and they over-discount the future, some otherwise undesirable policy interventions can generate positive outcomes, and general-equilibrium complications render partial-equilibrium reasoning suspect.
ReaderÂ Llewelyn Hughes emailed me, saying that he was pretty sure I’d be a second-best economist. Actually, I’m not so sure. In an academic seminar, that’s probably right. But in most Australian public policy debates, it seems to me that straightforward economic thinking often has a lot to offer. For example, thinking about water supply and skills shortages without considering prices has led our policymakers to some pretty silly places. There are certainly market imperfections here, but to get to them, you have to first pass through Econ 101. Or take the Baby Bonus. Simple economic theory suggests that unless you can identify credit constraints for parents or a positive externality of children, it’s hard to justify the policy.
In Australia, business economists are almost always in the ‘first best’ mould. In the ozeconblogosphere, I’d class Jason Soon, JoshuaÂ GansÂ and Harry Clarke as first-besters, and Nicholas Gruen, Fred ArgyÂ and Paul Frijters as examples of second-besters.Â IMHO, John Quiggin has played both roles. On economic reform in the 1990s, he was very much a second-best economist. On what to do about water policy today, he’s more of a first-best economist.
[See also Tyler Cowen's views.]
Update: Joshua Gans puts himself in the second-best camp.