How Insurance Works

Applied Mainline Economics with Matt Mitchell & Peter Boettke

(piano music) – So you look around the world
and you see huge disparity in the human condition. You see some people that
are desperately poor, you see others that
are living in opulence. What is determining these
differences in the human condition? Why are some societies working
well compared to others, and why are some not working. The tools of economics
particularly the tools in mainline economics can shed light
on this, they can help us understand how does culture
and institution shape the decisions that humans make. How can we change the
incentives of policy makers through institutional change
so that they can create better rules to help us
live in peace and prosperity with one another. These ideas that were
pioneered by Adam Smith they’re very much alive
right now, they’re people that are trying to apply
these insights from the mainline of economics,
to try to make our world a better place. (orchestral music) Mainline economics is based
on three propositions. The first is that humans
have a natural desire to exchange with one
another, truck, barter and exchange as Adam Smith said. And this exchange is
a process of exchange, number two is that this
process of exchange is profoundly influenced
by the culture and the institutions within which it takes place. You get very different
outcomes based on different culture and different institutions. And three, these
institutional differences are themselves the product of exchange, except it’s exchange often
in the political marketplace not in the private marketplace. That’s actually I think
probably one of the strengths of mainline economics
is its analytical focus is on the imperfections of
institutions and how we can improve them and reduce frictions. So if you think about
one version of mainstream economics, it’s just to
assume in this highly mathematized model of
reality we call perfect competition, that you
know you have multiple buyers and multiple sellers
and they’re interacting in a frictionless
environment in which property rights are perfectly protected,
contracts are complete, information is complete,
you have zero transactions cost. It’s basically this antiseptic,
you know really clean and elegant mathematical
model but it assumes away all the important and
interesting characteristics of what makes societies work
well or not work so well. Mainline economics really
shines a light on those institutional differences
to understand under what circumstances are property
rights more or less complete, under what circumstances
are transaction costs high or low, under what circumstances
are the norms of culture such that people feel that
they can interact with one another and trust one
another, and have lower transactions costs so they
can exchange with those with whom they stand to gain. Now mainline economics is
really focused on in many ways those important frictions
that can stand between mutually beneficial exchange. – It’s only through the
existence of property, contract and consent that individuals
pursuing their own self interest can be lead
to promote the interest of society as a whole. It wasn’t that anytime I
pursue my self interest I’m gonna generate a positive outcome it was instead very
institutionally contingent and that basic idea runs from
Adam Smith to John Baptiste to say to John Stuart Mill
into the early 20th century including F.A. Hayek and James
Buchanan and Ronald Coase and Doug North and Vernon
Smith and Elinor Ostrom. Mainstream economics is
just whatever’s currently fashionable at the time, if
you think about it in a very simple sense it’s what’s
currently being considered the cutting edge of science
and everyone considers that to be the fashion. Sometimes the mainstream is
the mainline and sometimes there’s huge divorce between
the mainstream and the mainline and when there’s a huge divergence
between those two things it takes entrepreneurial action
by individuals such as the ones I just mentioned that
won the Nobel Prize to pull economics back to its core
teachings from Adam Smith to Vernon Smith. There’s a great claim by
John Stuart Mill in his book the Principles of Political
Economy, where he notices in passing the great
rapidity with which countries bounce back from war,
famine, hurricanes and fire and how they come back
within a generation. But the question was, how
is it that they come back? Mill just sorta says it’s
a great mystery to us. And so instead we’re
trying to explore that here and we started our work at
Mercatus by studying the failed and weak states and
the collapse of communism in the less developed
countries so we sort of use this three legged bar stool
idea, so imagine you have a three legged bar stool
and each of the legs of the bar stool represents the
economic and financial institutions in your society,
the social and cultural institutions in your
society, and the legal and political institutions in your society. Now what you’re gonna do
is put stress on that bar stool, and if you put
stress on that bar stool but if one of the legs is
weak, what’s gonna happen? The bar stool will topple over. So that bar stool can only
hold if those legs are strong. And so the question was
what happens when we have to re form because we’ve
wiped away those legs? From the barstool. And so Hurricane Katrina
gave us a natural experiment in this and to look at
the way in which political and legal institutions
interact with economic and financial institutions
and social and cultural institutions. And so what we did was we
put three different teams into the field so one team
studying the legal and political, other teams
studying the commercial and entrepreneurial, and
another one’s studying the social and cultural capital. What we found by the way was
that the social and cultural building, civil society,
co evolves, and in fact strengthens commercial
relationships as well as under girding the political
and legal environment and that too often in
times in the current system the political and legal
environment is a block to the interactions between
the social and cultural and the commercial relations
in a society and so that’s been a major part of our
research here and it applies even to things like other crises. Cause again you can have
crises that come about because of things like
financial crisis and how is it that you can rebuild
you know cities after that. It could come about through
technological innovation and cities actually that used
to be the hub of economic activity are now no
longer the hub of economic activity. How does Youngstown, Ohio
after the steel industry try to come back? Can we talk about something
and learn something from the difference
between the way Detroit has had to react after the
decline in the auto industry and Pittsburgh after the
decline in the steel industry. How these cities rebuild
themselves and what is the crisis and how is it
that social and cultural, political and legal and
economic and financial institutions either work
together to help transition a society or fight against
one another and keep us from allowing that kind
of growth and development. Well I think the biggest
problem that a mainline economics faces is the same
challenge that Adam Smith faced, which is that
economists are talking a lesson to politicians which
politicians don’t want to hear. And so as a result since
politicians have to hear it in order to implement
it, but they don’t want to heart it because it puts
constraints on their behavior that communication gap is
always something that we have to work at. And there becomes only very
significant small windows of opportunity when real
social change can happen. And the question is can
you capture those strategic moments? We at Mercatus are involved
in the ideas business and that’s our main focus
is to actually work on ideas to again social understanding
and social criticism, but there might be a
time when based on our social understanding and
based on our social criticism there might be a opportunity
to introduce real ideas for change and that is what
we have to sort of work on doing but our primary
responsibility is first and foremost as scholars and
scientists and that is focusing on social understanding
and improving our social understanding and that’s
what we’re trying to do with our different research
initiatives and educational initiatives here at Mercatus. (upbeat music)

Reader Comments

  1. The audio level is too low. And it looks like there is a waxed paper filter over everything. This is distracting and unfortunate given the quality of the content.

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