Thursday, April 2, 2009

Are the economic rationalists in Canberra losing their marbles?

When Jim asked me whether I was an economic rationalist I thought he was just stirring. The term “economic rationalist” has been used mainly in Australia and doesn’t seem to be used much anywhere these days. I don’t think there were ever many people in Canberra who called themselves economic rationalists. Those of us advocating economically rational policies just thought of ourselves as economists doing what economists should be doing. We knew that when people referred to us as economic rationalists they were probably intending to be offensive, just as most of those who refer to classical liberals as neo-liberals are intending to be offensive. But I don’t think the label worried us much. When people referred to me as an economic rationalist I knew that I was among good company.

I admitted to Jim that people had sometimes referred to me as an economic rationalist. Jim then asked me if I thought John Smith (name changed to protect Jim) would be an economic rationalist. I don’t know that I have ever met Smith but he has the reputation of being a good economist, having held senior positions in the Treasury as well as other government departments at a time when major economic reforms were being undertaken. I told Jim that I thought that Smith could be relied on to provide good public policy advice.

Jim then seemed to change the topic of conversation. He asked: “Do you think economic considerations should be taken into account in quarantine policy?” I replied that economic considerations were obviously relevant. For example, it doesn’t make economic sense to implement policies that will raise consumer prices by a huge amount in order to protect a tiny domestic industry, even if scientific evidence suggests a high probability that diseased imports will damage this industry.

Jim said: “So, are you suggesting that quarantine decisions should all be subject to a full blown 100-page cost benefit analysis?” I acknowledged that a full-blown analysis would be too expensive to do every time and is not necessary in most cases because the answer that such a study would come up with was usually obvious. I suggested that the legislation should incorporate a national interest test and require that the economic advice used to apply that test should be made public when decisions are made.

Jim replied: “But wouldn’t that make it difficult for politicians to take account of things like impacts that are concentrated in particular electorates, their concerns that voters might attribute damage to industries from highly improbable events to their mismanagement - and other irrationality that people exhibit on risk.” I said: “So what! If you are designing public policy rules in the interests of the whole community then you want the rules to make life difficult for populist politicians who pander to such concerns”.

Jim said: “I thought you might say that. But John Smith tried to sell me a very different line when I spoke to him in Canberra recently. He said that it would be important for the analysis of quarantine matters by the advisory economist to place higher weights on extreme events and on things with concentrated impacts and to make other adjustments to account for the irrationality that people exhibit on risk.”

I was stunned. All I could say at the time was that I could now understand why Jim had asked me whether John Smith was an economic rationalist.

Jim’s story makes me wonder how many other Canberra people who once advocated economically rational policies have lost their marbles by getting too close to politicians.

A friend and former work colleague has responded by suggesting that it is normal for people providing economic advice within the bureaucracy to advise Ministers on the distributional effects of policy initiatives. I think my friend has missed the point.
As I understand it, John Smith is considering what rules should apply in assessing future quarantine cases. The issues involved take this outside of normal bureaucratic policy advice. There are interest groups who will see quarantine as a way to obtain protection from import competition by the back door i.e. through a non-transparent process. Ideally, the issues involved should be subject to some kind of public inquiry to assess national economic benefits and costs through a transparent process. The fact that this is not practicable in every case doesn't mean that we have to resort to normal processes for bureacratic advice to Ministers. As I understand it what is proposed is legislation that would require an assessment to be made of the relative economic costs and benefits of proposed quarantine action. John Smith seems to be proposing to muddy the waters.

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