Robert Solow on Market Advantages and Market Failures

Robert Solow (1924-2023) died recently.

As a starting point for understanding his life and his work on growth theory, the Nobel prize website, since he won the award in 1987, includes an overall description, a biographical essay, and his Nobel lecture. I can also strongly recommend an interview that Steven Levitt carried out with Solow last summer.

For those of us who toil in the editorial pits of economics, Solow was among his other gifts one of the best expository writers the profession has known. For a flavor, consider a couple of paragraphs from the Presidential Address he gave to the American Economic Association in 1979, “On Theories of Unemployment,” published in the American Economic Review (March 1980, 70: 1, 1-11). Solow is setting the stage for his discussion of unemployment by talking about a more fundamental issue in economics: the tension between recognizing the advantages of market mechanisms and also recognizing the limitations and costs of market mechanisms. Most economists (perhaps contrary to popular belief?) try to do both. Here, Solow describes his own attempt to hold the balance–which to some extent involves a contrarian reaction to whoever is speaking. As you read, consider in particular Solow’s gift for fluently combining technical and nontechnical language.

There is a long-standing tension in economics between belief in the advantages of the market mechanism and awareness of its imperfections. … I think that outsiders, who tend to see economists as simple-minded marketeers, would be astonished to learn how much of the history of modern economic analysis can be written in terms of the study of the sources of market failure. The catalog runs from natural and artificial monopoly, to monopolistic competition, to the importance of public goods and externalities of many other kinds, to–most recently–a variety of problems connected with the inadequate, imperfect, or asymmetric transmission of information and with the likelihood that there will simply be no markets for some of the relevant goods and services….

There is a large element of Rohrschach test in the way each of us responds to this tension. Some of us see the Smithian virtues as a needle in a haystack, as an island of measure zero in a sea of imperfections. Others see all the potential sources of market failure as so many fleas on the thick hide of an ox, requiring only an occasional flick of the tail to be brushed away. A hopeless eclectic without any strength of character, like me, has a terrible time of it. If I may invoke the names of two of my most awesome predecessors as President of this Association, I need only listen to Milton Friedman talk for a minute and my mind floods with thoughts of increasing returns to scale, oligopolistic interdependence, consumer ignorance, environmental pollution, intergenerational inequity, and on and on. There is almost no cure for it, except to listen for a minute to John Kenneth Galbraith, in which case all I can think of are the discipline of competition, the large number of substitutes for any commodity, the stupidities of regulation, the Pareto optimality of Walrasian equilibrium, the importance of decentralizing decision making to where the knowledge is, and on and on. Sometimes I think it is only my weakness of character that keeps me from making obvious errors.

The critics of the mainstream tradition are mistaken when they attribute to it a built-in Panglossian attitude toward the capitalist economy. The tradition has provided both the foundations for a belief in the efficiency of market allocations and the tools for a powerful critique. Economic analysis by itself has no way of choosing between them; and the immediate prospects for an empirically based model of a whole economy, capable of measuring our actual “distance” from the contract curve, are mighty slim. The missing link has to be a matter of judgment–the Rohrschach test I spoke of a minute ago. For every Dr. Pangloss who makes the ink blot out to be of surpassing beauty, give or take a few minor deviations–the second-best of all possible worlds, you might say–there is a Candide to whom it looks a lot like an ink blot. Maybe there are more Panglosses than Candides. But that was true in Voltaire’s time too–just before the French Revolution, by the way–and has more to do with the state of society than with the nature of economics.