The Three "P"s and the Three "I"s

I channeled my dissertation advisor today and started to teach his rule, you can't get the three "I"s without the three "P"s.

This means that (P)roperty rights, (P)rice mechanisms, and (P)rofit and loss signals are all necessary to get (I)ncentives, (I)nformation, and (I)nnovation.

For the Incentives we have a large body of economic thought which develops the conflict between pro-market and anti-market types over the role that property rights play in aligning incentives.

The basic or first-approximation approach, I argued, was to simply point out that there was free-riding in the absence of well-defined property enforcement regimes. If you simply say "to each according to their need and from each according to their ability," this will end up with little accomplished in groups larger than a family. The next step is to teach the tragedy of the commons. The result of this story is that common property does not work well. Taken literally, the commons could be sold as private property and much of the problem would go away. So far the property rights story seems to be pretty solid.

There is a breakdown when we get to the story of externalities. Because externalities indicate places where property rights are ambiguous and are difficult to enforce, we don't necessarily think that property rights would be easy to define. In the case of planting flowers in your front yard, excluding those that refuse to contribute to their upkeep might be prohibitively difficult.

So, this leads us to a debate, one that is complex and difficult. Without the informational component of prices the property question would only move the debate to the abstract and theoretical level. The beauty of Mises and Hayek is that they make the informational argument so central to their discussion that it does not require the removal of all ambiguity about assigning property rights.

The only limitation that I can think of to the informational argument is that some things cannot be priced. I don't put a price (at least a money price) on love. There is something in us that resists the application of strict measures of scarcity to love. Now, this doesn't mean that we can't compare the marginal benefit another hour with our chosen special one gives us with the marginal benefit from something like writing a blog post. What it does say is that these calculations are going to be more difficult when the market is not thick and the transactions are not cleanly observable. Who is to actually price my preferences but me?

The final leg of this discussion is in Schumpeter. His creative destruction relies on change and it is no accident that Hayek in "The Use of Knowledge in Society"ends with Schumpeter (even if he is critiquing him). Schumpeter allows for change as the entrepreneur recognizes the opportunities to put innovation into effect. Schumpeter distinguishes between innovation and invention because invention doesn't do any good until it is applied to some purpose. The very possibility of change makes economics necessary (otherwise we would only solve the economic problem once and be done).

The link of these three "I"s to the Three "P"s is strong. Prices generate information, but only in the presence of profit and loss. Property rights give incentives and help prices to form better information. Innovation is not possible without some picture of the world created by the entrepreneur who has local knowledge.

Thank you Peter B.