05/13/2013 10:18 am ET Updated Jul 13, 2013

Markets, Power and Economic Policy

Here's an interesting piece worth slogging through on ways in which policy changes implied by traditional economic analysis can skew power in ways that make a lot of people a lot worse off. The prose is a bit dense and opaque, but the point and the many historical examples are interesting and convincing.

The authors -- Acemoglu and Robinson -- are the same duo behind "Why Nations Fail," a similar foray into the way policy choices can lead to starkly different outcomes, based on whether the political economy supports "inclusive" or "extractive" institutions.

The point of their new article comes down to this: When economic "rents" or market failures provide economic benefits to weaker groups -- those with less stature or power in society -- efforts to eradicate such "inefficiencies" may further empower dominant elites in ways that are counterproductive for the larger society.

For example, policy makers often argue that unions, minimum wages, or financial regulation create inefficiencies that reduce growth, jobs, investment, business formation, yada-yada, bark-bark-woof-woof. A&R cook up a simple "two-period" model where such "efficiency gains" now lead to power imbalances later that reduce aggregate social welfare (the best outcomes for the most people).

Take unions, for example. It's simple to show using Econ 101 concepts that unions distort the price of labor, by raising their members' wages above the market equilibrium. And there's little worse in the firmament of basic economic theory than distorting price signals. So when you "fix it" by whacking the union, equilibrium is restored.

Acemoglu and Robinson argue that by eradicating union "rents," you risk further skewing bargaining power away from the working class towards those who already have disproportionate power and income and influence. The outcome is a further disconnect between economic growth and the living standards of broad swaths of working families, aka income/wage/wealth/power inequality.

It's a resonant argument for sure, but it also has kind of an emperor-has-no-clothes-on feel in the following sense. A fair bit of this type of critique is engendered by the fundamental incompleteness of the basic economic model. That is, the classical model itself ignores issues of bargaining power, distribution, and multiple equilibria. Thus, when theorists introduce reality back into the model as in pieces like this -- they've even got same math in there! -- it can seem kind of strange to those who never bought the inherent limits of the model in the first place.

The insight that the basic model itself is woefully incomplete can thus free one up from a lot of work proving that -- guess what! -- raising the minimum wage or regulating financial markets can actually help (and getting rid of them can actually hurt)!

At the same time, we should be grateful that folks like Acemoglu and Robinson, well-placed academics, are engaged in that work (same with Joe Stiglitz, who has made a long career out of reintroducing reality back into economic models).

The classical economic model interacts with wealth concentration and money in politics in ways that block progressive policy. The model is constantly used by economists and think tanks funded by the disproportionately wealthy and powerful to protect their status and block the policy agenda that would threaten it. Any academic work that pushes back on that pernicious dynamic is welcomed.

This post originally appeared at Jared Bernstein's On The Economy blog.