MUNICH – There is much to criticize in economics nowadays. For example, the profession focuses far too little on political issues and far too much on beating students to death with mathematics. But much current criticism of the profession is based on misunderstanding and ignorance.
Consider Adam Smith’s concept of the “invisible hand,” which implies that a market equilibrium is efficient if perfect competition prevails and well-defined property rights exist. Contrary to what many critics suppose, mainstream economists do not assume that these ideal conditions are always present. On the contrary, economists tend to use these conditions as a benchmark for analyzing market failures. Like sniffer dogs, they search the economy for such defects and ponder how they can be corrected through intelligent state intervention.
In this respect, economists are like doctors, who have to know what a healthy body looks like before they can diagnose disease and prescribe treatment. A good doctor does not intervene arbitrarily in the body’s processes, but only in cases where there is objective proof of a disease and an effective treatment can be prescribed.
Environmental regulation addresses a particularly striking example of market failure. Markets are generally efficient if companies’ revenues correctly reflect all the benefits that their output bestows on third parties, while their costs reflect all the harms. In this case, maximizing profit leads to maximizing social welfare.