Assume Anarchy
Rajan's call for doing better economics
In yesterday’s post, I wrote about the X-ray vision of economics. One reading of the “X-ray” vision is to think in terms of demand and supply. This means primarily looking at exchange relationships.
Exchanges are prevalent in markets, but exchanges might happen outside the marketplace as well. For instance, we can model our friendships as exchange relationships, and even marriages.
In September 2004, Raghuram Rajan wrote an essay, Assume Anarchy. The point can be summarized in the following sentence from the essay:
“Our [economic] analysis would be better informed by assuming anarchy as a starting point rather than a pristine world of complete contracts.”
— Raghuram Rajan. (2004). Assume Anarchy
The complete markets model which Rajan is directing his critique towards, and also known as the Arrow-Debreu model named after Kenneth Arrow and Gerard Debreu, assumes negligible transaction costs and perfect information. Effectively, this means
“everyone is fully informed; every eventuality is anticipated in contracts; all contracts are enforced by omniscient, incorruptible courts; and governments automatically take care of all the public goods and interfere in none of the private ones.”
— Raghuram Rajan. (2004). Assume Anarchy
The study of institutions, which are humanly devised constraints on human action, greatly improves our understanding of the real world. Institutions address the problems of contract enforcement, knowledge creation, knowledge use, and define the role of the government. Institutions set constraints and shape the cost-benefit calculus of consumers.
Peter Boettke, in conversation with Scott Cunningham, spoke about the UCLA school of economics, which emphasized on studying property rights. Boettke says:
“But [Armen] Alchian had to rediscover property rights economics because in the Samuelsonian synthesis, the institutional bedrock of exchange relations got dismissed. It was treated as given. And when it's treated as given, it can be forgotten because it gets pushed back into the background.”
— S3E15: Peter Boettke, Austrian Economics, George Mason University. The Mixtape with Scott.
Answering “What Should Economists Do?” Buchanan (1964) says:
Economists “should” concentrate their attention on a particular form of human activity, and upon the various institutional arrangements that arise as a result of this activity. Man's behavior in the market relationship, reflecting the propensity to truck and to barter, and the manifold variations in structure that this relationship can take; these are the proper subjects for the economist's study.
— James M. Buchanan. (1964). What Should Economists Do?
From Buchanan to Rajan, economists have emphasized the need to focus on studying institutions.
Assume anarchy. Study institutions. Apply price theory. Study outcomes.
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