Studying why markets fail offers insights

My work as a research economist is interesting but, I think, often misunderstood. Allow me to explain the broad points of economic research.

The earliest recorded human communication is about trade. The barter, exchange and transport of goods is clearly a starting point for any civilization. Economics as a field of study tries to understand that trade in several ways. At the most basic level, economists construct explanations for how different parts of exchange or trade might work. We call these models.

Since the 1940s these models have been very mathematically based. Today, mastery of differential and integral calculus, basic game theory, real analysis, dynamic optimization, advanced linear algebra and doctoral-level statistical work are needed to read and contribute to most economic research. But these are only the tools of a researcher, not the finished project.

Economists build their models around human beings producing and consuming goods. We call these markets, and markets turn out to be lovely ways to think about the ways human beings interact. However, economic research is organized around the circumstances where markets do not work.

We study pollution, monopolies, public goods and taxation, recessions and inflation, regional growth and labor markets, because these are places where simple market theories fail to offer clear answers. This emphasis on research toward what we call “market failure” may be the most powerful distinguishing trait of economic research.

The way we determine markets fail is our second most important feature. Economics is a ruthlessly empirical discipline. The mathematical models we use to explain the world are designed to be subjected to the scientific method. Let me offer an example.

Suppose economic theory suggested a tax cut would lead to higher levels of employment in a region. To test this we would gather data on many regions where tax cuts had occurred and places where they had not. We would also gather data on other factors that might lead to employment growth.

This would provide us the basics of a natural experiment. We would then measure the size of the tax cut and employment impact and determine whether there was correlation beyond that which could happen by chance. We would also test whether or not other aspects of the basic natural experiment might have flaws.

The researcher would publish this study, often after it has been subject to a double-blind peer review process.

Importantly, the profession rewards the scholar for the process, not the results.

For example, my findings that labor markets were not improved by right-to-work legislation nor by increased minimum wages are frequently used by other researchers despite their very different political interpretation.

Economic research is, as with other disciplines, quickly improving. Lessons from empirical psychology, experimental research and game theory are making our theories much more useful, though each of these has their own flaws.

What remains true is the dominance of markets in organizing human affairs. The more we study where markets fail, the clearer their benefits become.

Michael Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to [email protected].