Applications of Economics to an Imperfect World

Abstract

Coming to me as it did after almost a decade's absence from the academic profession, I accepted this invitation only with trepidation. While the profession has been extending the frontiers of economics, I have been operating deep within its margin, first discovering how dismal our science really can be as it applies to the finances of private universities, and then, during the past four years, applying to the real world economic principles that Alfred Marshall would have had no difficulty recognizing. I have no particular interest in describing the first of these experiences. Its only lessons were that' the laws of economics are truly made of iron; and that any organization that hopes to make the best use of its limited resources had better be organized more hierarchically than a university. The experience of being a practitioner of regulation, in contrast, has been immensely satisfying, because it has afforded almost unlimited opportunity for the application of simple micro-economic principles to the real world. The applicable principles are easy to characterize: that economic efficiency calls for prices equated to marginal social opportunity costs; and that, whenever it is technologically feasible, competition is the best institutional mechanism for achieving that result, as well as for minimizing X-inefficiency and ensuring the optimum rate of innovation. What has been especially intriguing about my experience is that it has embraced two quite different regulatory situations-one, the traditional public utilities, where competition seems for the most part infeasible, and the economistregulator is moved to play an active role in trying to produce efficient results; the other, airlines, in which it appears the prime obstacle to efficiency has been regulation itself, and the most creative thing a regulator can do is remove his (and her) body from the market entryway. But the process of applying these principles-even of simply getting out of the wayhas been far from simple. The slate on which the economist-regulator writes is scribbled with the scratchings of lawyers, jurists, and politicians; the world to which he would apply his principles is excruciatingly imperfect and resistant; and the compass he needs is one that would help him thread his way through the thickets of second best. The really challenging job is deciding not what the ultimate economically rational equilibrium should look like, but what is economically rational in an irrational world, and how best to get from here to there. That, too, turns out to be a kind of frontier; and life on it is full of excitement.