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Market Failure 8: Non-Efficiency policy goals (The right tool for the right job)

Policy analysis is client-oriented advice relevant to public decisions and informed by social values.

David L Weimer and Aidan R Vining, Policy Analysis: Concepts and Practice (3rd Edition)

Microeconomics as a discipline is focused on allocative efficiency as a goal. The entire structure of market failure economics is an attempt to answer the question of what kinds of government intervention will be allocatively efficient. But while allocative efficiency is very important, it is not the only goal policy-makers (or their constituents) value. These other goals do not fall neatly into the structure of microeconomics, but there are still some pieces of general advice I can give.

The sorts of non-efficiency policy goals I’m thinking of are:

  1. Changing the distribution of incomes in society (e.g. welfare)
  2. Providing of social services that are considered moral necessities (healthcare, public housing)
  3. Supporting an industry for cultural or historical reasons (indigenous fishing rights, protecting traditional production of a good or service)
  4. Economic policies enacted for national security reasons (18th Century Britain’s Navigation Act, or requirements that defence contractors produce their goods domestically)

Each of these policies has different rationales and effects, so rather than go through every possible intervention, I want to outline some points to bear in mind. Most of these are worth remembering no matter what kind of intervention you are planning.

The market has not failed. As I noted in Part One, the market’s function is to efficiently match demand and supply using the price mechanism. Market failures are phenomena that prevent the market from doing that properly. The market is not able to produce arbitrary income or wealth distributions, or promote certain industries out of proportion to market demand. This does not mean the market has failed, but merely that it is not capable of achieving every possible goal. Your car can’t fly, but that doesn’t make your car defective. What is does mean is that if you want to fly you won’t be able to use your car to do it. Similarly, if you want something other than allocative efficiency, you need to consider alternatives to market mechanisms. Your goal here is not to “fix” the market, but rather to get to your goal by working around the market as much as possible.

Efficiency is still important. Allocative efficiency isn’t everything, but it is very important. Efficiency is a measure of how well society is using limited resources to improve human well-being. No matter what you are trying to achieve, that matters. Be aware that any change you make to relative prices (the mechanism the market uses to convey information) will come at a cost to the well-being of consumers even if it is not immediately visible. That may be a price worth paying, but it is a price, and you should be aware of what you are sacrificing. You should also be aware of the welfare implications of your intervention. Know who your intervention is likely to harm.

Avoid distorting the market more than necessary. Since the market is doing what it is supposed to be doing you should endeavour to avoid messing with it more than you have to. There is a spectrum of intervention in the economy that looks something like this (from least intervention to most):

  • Do Nothing
  • Moral Suasion (asking people to do or not do something)
  • Choice Architecture / Nudging
  • Taxes or subsidies
  • Regulations that don’t directly control prices and quantities (quality standards, disclosure requirements etc.)
  • Regulations that do directly control prices and quantities (price floors or ceilings)
  • Direct government control of production or consumption
  • Outright ban of good or service

Think about how interventionist the government needs to be to achieve your goal. Can you support traditional industry with a subsidy of a handful of model producers rather than tariffs or price supports? If people can’t afford to purchase something essential, can you just give them a cash transfer (funded by relatively neutral methods such as income or consumption taxes) rather than having the government produce the good or service directly? Just because the price of intervening may be worth paying doesn’t mean that you shouldn’t try to make that price as low as you can.

There are also a few things that are worth bearing in mind for any policy intervention:

Simplify where possible. Complex interventions are harder for the public to understand and therefore it is harder for the public to hold the government to account over a complex intervention that doesn’t live up to its promises. Furthermore, the more things that have to go right for your intervention to work, the more likely it is that something will go wrong. Your interventions should have a clearly specified goal and ideally a reasonably straightforward intervention logic.

Separate out your interventions. On a related note, it’s a lot easier to understand several simple interventions rather than one complex one. The danger of trying to make the one intervention do several things is that it will probably do none of them very well, and it will insulate itself from criticism by pointing to its diverse mandate. I know you will want to protect your intervention from you political opponents. After all that’s a natural human response. But if you can’t admit when you are wrong, you can’t improve. And it is the people you are trying to help that will suffer for your failure to learn all the lessons you can.

Focus on your objective. Many people will suggest any number of policy options to achieve your objective. Few of them will have a good handle on how to craft a good policy intervention. Some people will naively suggest an intervention because it was the first thing that popped into their mind, or because some other country has implemented something like it. Other people will make suggestions that will be of advantage to them personally. The question you should always keep in mind is “Is this the most efficient method of achieving the goal?” You can’t let the perfect be the enemy of the good, but you should let the good be the enemy of the bad. It’s very easy to get caught up in partisan wrangling, but if you look for opportunities to advocate for good policy, you can make a positive difference.

Learn from experience. You will never know enough when you set your intervention up. Given the complexity of the market system, any policy intervention you implement will almost certainly have several important details wrong. If you wish to succeed, you need to monitor your intervention’s effects over time to make sure they are achieving what you set out to achieve. (This is one of the reasons defining your goal is so important.) Ideally, you should set up your interventions so they can be easily evaluated, but at the very least you should have a protocol set up in advance for evaluating your intervention, with clear criteria for what success and failure look like.

Listen to the experts. While these posts give you some of the basics, policy-making expertise requires more knowledge than a few blog posts can convey. Knowledgeable experts can help you design a policy to best achieve your goals. They can also help you figure out who is most likely to win or lose from a given intervention and by how much, and design a robust protocol for working out how well the intervention does against its goals. You don’t have to obey expert advice, your values may differ after all, but at least hear them out – you may be pleasantly surprised.

And that brings us to the end of this series. I hope you have found it interesting.

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James is a government policy analyst, and lives in Wellington, New Zealand. His interests including wargaming, computer gaming (especially RPGs and strategy games), Dungeons & Dragons and scepticism. No part of any of his posts or comments should be construed as the position of any part of the New Zealand government, or indeed any agency he may be associated with.

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30 thoughts on “Market Failure 8: Non-Efficiency policy goals (The right tool for the right job)

  1. I’m not so sure regulators / politicians look at avoiding as much distortion as possible when crafting “solutions” for issues. Seems they only have a limited play book.

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  2. Ideally, you should set up your interventions so they can be easily evaluated, but at the very least you should have a protocol set up in advance for evaluating your intervention, with clear criteria for what success and failure look like.

    This is usually my biggest criticism of a given regulation/intervention – either there is no plan for measuring the efficacy, or the intervention is too complex to be properly measured.

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    • This is the argument the permanent non-partisan staff at the Colorado legislature lost the most often while I was there. We had people who personally favored bigger government and people who favored smaller government, but when we had our professional hats on the two questions that were always asked was “Can we reduce the number of moving parts?” and “How can we measure the results?”

      To be honest, of course, some of those bits that look like they were bolted on as an afterthought were what it took to get the last vote or two to approve the legislation. Or to get a regulation approved by a political-appointee assistant department head. Systems analysis often takes a back seat to politics and ideology in the process of governing.

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        • In some number of cases, absolutely. Speaking in the sponsors’ voice, “We need two rural votes in the House; add this related thing to make them happy. We need Sen. Smith’s urban vote in the Senate; change this bit so that it applies to some odd urban situation. We know the budget staff want to measure six things, but the department is pushing back on having to write another annual report, so only measure these three.” Twain, sausage, law. I have a friend who’s an economist and has spent most of a decade at the FCC, one level down from the political appointment level. On the now rare occasions when we get together, we drink and whine.

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  3. James:

    (1) David L Weimer and Aidan R Vining, Policy Analysis: Concepts and Practice (3rd Edition)

    I found this book really really useful, it’s the text we used in my Policy Analysis class in grad school. Is this sort of the default textbook for Policy Analysis more or less, or is it just a coincidence that you quoted it at the beginning of the piece?

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  4. Great series.

    I respectfully request a 9th, Market Failures in the Provision of Government Services.

    Here, and elsewhere, the argument is made that the government should run more like a business. I don’t think I’m surprising anybody by taking the position that I completely disagree. But from water to roads to libraries to schools, lots of people talk about ‘markets’ for government-provided goods.

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    • @oscar-gordon

      Now the series is complete you’ve received an introductory outline of market failure. Based on the series, what would say are the best arguments for a government role in water, roads, libraries and schools? Base don the market failures that motivate the government action in each case, what do you think the best interventions are in each case?

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      • I’m with Francis that I don’t think government should run like a business, but that also means government should not be involved in providing services that should be run like a business.

        I can see the benefit in government providing for certain infrastructure. A network of private roads could very easily become overly cumbersome to travelers as everyone attempted to navigate and pay for those roads via permits & tolls. Delivered infrastructure (water, electricity, gas) can be a bit more market based, but still probably needs a great deal of government involvement since it involves common delivery infrastructure (I can envision a delivery infrastructure that would allow for more market involvement, but it would probably be considerably more expensive to implement except in well planned out communities).

        I’m not convinced schools, hospitals, & libraries are necessarily best provided by government, but I can see the argument that they should be subsidized by it to some degree in order to maintain the openness that allows such institutions to be most effective for society. I understand the failures that prompted such interventions to begin with, I just think that such interventions should be reviewed regularly to see if they are still necessary (note I did not say justified, because depending on one’s ideology, that can always or never be justified).

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      • Government should provide those services that the electorate demands.

        A well-educated electorate might recognize that they are paying more in taxes than they would in direct payments to a private provider for certain goods and then demand that the government exit that business. But that’s a really heavy lift for the campaigner. It’s easy to promise to cut taxes. It’s a lot tougher to tell your constituents that they are now at the mercy of the marketplace.

        In the West, the provision of water is a classic government service. Only governments could borrow the enormous sums necessary to build the regional infrastructure. Retail service can be offered either by government or a heavily regulated public utility. (I’ve always found the public utility model to be weird. We have a private company getting a guaranteed profit?)

        While private companies can build toll roads, government is so heavily involved in transportation that again these efforts look a lot like regulated utilities. In the contracts I’ve seen, the toll road provider was insisting that the government not build infrastructure that could reduce the demand for the road. Neat trick, that.

        Libraries and schools are government business because innovation and an educated populace are enormously important public goods.

        The financing of the delivery of health care is a public good because as a society we have decided that people too poor to pay for their health care should nevertheless receive it.

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  5. This has been a valuable and interesting series, and I thank you writing it.

    My primary issue is this: while you are correct that the market–when there is a real market–is an effective means of allocative efficiency, there is an underlying presumption that “human welfare” is primarily–or soley–a matter of ownership of tangible items (televisions, healthcare, Twinkies and Rolexes).

    I would contend that are vast swaths of human life that are outside that paradigm: an ever-growing portion, as we build a post-industrial “prosperity economy.” If you consider the core attributes of human nature, viewing society through a purely economic model leads to distortions of social and political choices that lead to less human happiness and fulfillment, not more.

    Looking at the purely economic realm, we live in a pretty amazing age. “Goodies” and luxuries are comparatively cheaper than ever before: big screen, high-definition TVs cost the average person only a week’s salary; we all carry around computers that 30 years ago would have filled rooms, there are more books being published in a year than in all of the 18th century.

    Nevertheless, the price of necessities–housing, healthcare, education–have risen faster than inflation, and–more importantly–faster than income growth. So we have the perverse result that, in this age of unprecedented prosperity and choice, people are working more hours, and have more anxiety in their life than any time since the 30s.

    I share some of your awe at the efficiency, flexibility, and adaptability of the market, but am increasingly uncomfortable with its primacy as the central organizing paradigm of our society. I would, instead, advocate regarding it as a tool: good for some things, and not so much for others.

    As a consequence of our near-worship of the economic marketplace as the hallmark of freedom, we increasingly ignore such core human needs as:

    Affiliation: We are a deeply social species, and a full life includes deep ties to family, community, and society at large; all of which is actively undermined by the workings of the marketplace. Indeed, outside of our tight social circles, human relationships have increasingly been subverted into purely economic consumer-provider terms. We don’t, as a rule, go to the village pub, but to Chili’s, or Hooters or Denny’s.

    Efficacy: We all need to feel like we matter: that we are the “masters of our own destiny,” and that our moral and life choices have some great contributory contribution to the tenor of our lives. While that is the case in many aspects of our existence, the domains in which this is fully true are more and more constrained to our economic activities: our value as an employee, our ability to buy goods, and our ability to exercise social and economic power over others. For vast swaths of our society, these kinds of personal efficacy are increasingly moot. We receive most of our information from commercial media, our food is manufactured and partly opaque to us (e.g. GMOs), social currency has been recast as “status”, and our power vis-a-vis our employers, our communities, and our politics is one of relative leverage, most of that “leverage” coming from economic status.

    Autonomy and self-determination. Society means interdependence: it’s a trade-off we are all aware of, even if we don’t consciously sign on to the program. We still live in a society in which it is a possible choice to go move to a cabin in remote Montana. But when self-determination is increasingly defined as the ability to choose among lifestyles or products, it is hollowed.

    Security. Finally, it seems to me, that it is a deep-seated human need to “put down roots” and build some surety in life, location and circumstances. But the press of increasingly competitive marketplace demands constrains security: houses in many parts of the country have become so expensive (largely as the result of the political and economic choices of elites) that even relatively short periods of unemployment or lowered income can threaten continued ownership (in my area, the median housing price is $640,000)

    I don’t really have answers, or prescriptions, just a deep gut feeling that largely economic consideration of “social good” leaves out much of what makes us human, and much of what what constitutes a good, meaningful life.

    So I guess I’d prefer to be ruled by a wise philosopher-king, who can balance all these different aspects of a good human life. I am worried by the tendency to defer these issues to the marketplace, just because it seems objective, self-governing, and scientific.

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    • Nevertheless, the price of necessities–housing, healthcare, education–have risen faster than inflation, and–more importantly–faster than income growth.

      Compare housing in 2016 to housing in… when? How far back do you want to go? If I google “average size house in usa”, the top answer is here (well, for me… google might give other people a different answer but I doubt that there’s *THAT* much variance between two different people on this question).

      The average size of homes built last year hit 2,600 square feet, an all-time high that surpassed even the housing bubble years, when homes averaged around 2,400 square feet, according to the Census Bureau.

      2,600 square feet! Holy crap! So I refine my search to “average size house in usa 1970s” and get here (warning, PDF). Between 1973 and 2010 (that’s what I have numbers for), the median square feet has gone up more than 600 square feet and the average square feet has gone up more than 700 square feet.

      Am I smart enough to crunch the numbers to check to see if the price of a square foot has gone up or down in real dollars since 1973? Let’s find out! Here’s the price of homes according to the census.

      I debated using January or December for 1973, shrugged and figured “July” would work. Go to the Inflation Calculator here

      And we find 34,200 (the median price of a home, I don’t have the numbers for the average) has the same buying power in 1973 as $167,962 in 2010.

      Divide 167,962 bucks by 1525 square feet and we get 110.13 bucks per square foot. (Divide it by 1660 and get 101 bucks per square foot.)

      So we jump up to 2010 (so we no longer need the inflation calculator) and divide $212,100 (the median price of a home) by 2169 and get… 97 bucks per square foot. (Divide by 2392 and we get 88 bucks per square foot.)

      The price per square foot has gone down. I’m sure that if you wanted a 1973 house, you could buy one for less, adjusted for inflation, than you’d pay in 1973.

      That took longer than I thought.

      Anyway, the price of housing has not gone up. It’s gone done. (It may have gone up in “hot” places like San Francisco. We can debate whether we should use places like San Francisco as our measuring stick.)

      When it comes to healthcare, the numbers are weird. It seems to me that we should compare the life expectancies of a 10 year old in 1973 to a 10 year old in 2016 and then say something like “look at what our new and improved health care *BUYS* us!”

      I’m sure that if you were willing to purchase only 1973 levels of health care, you could get it for a hell of a lot cheaper than you could buy 2016 health care. Your tradeoff might be a 1973 life expectancy… but you get what you pay for. I’m not sure that there’s apples to orange comparisons possible here. I’ll just say that health care is a lot more important, it’s a lot more complex, and people like a lot longer now than they did when health care was much more affordable.

      As for education: sure. The price has skyrocketed. No argument here. I don’t know how to do apples to apples there, though. I might be willing to say the value of a bachelor’s degree has gone *DOWN* since 1973, but we already talked about how a medical professional in 1973 didn’t have to know as much stuff as one today does. I’d be interested in knowing whether a generalist fresh out of residency in 2016 would know more about the endocrine system than an endocrine *SPECIALIST* in 1973. (That strikes me as a maybe, maybe not… but I’d be interested in seeing that explored.) At the same time, is a kid who graduates with a degree in the Humanities in 2016 better educated than one with an identically named degree in 1973? I dunno.

      I will say that the price of education has far, far outstripped inflation and, more than that, it’s not obvious that there is a commensurate increase in the value of a bachelor’s degree.

      All that to say, yes. I agree about Education.

      But I disagree wholeheartedly about the price of housing and I disagree (with caveats) about the price of health care.

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      • Jaybird –

        To my mind, that’s a good example of the dangers of using purely economic means to assess “human welfare.” Nevertheless, the gauntlet has been thrown, and I’ll try to catch it.

        I live in Southern California, and while the housing prices here are different (i.e. higher) than non-coastal rural and suburban housing nationwide, let’s take a look at what actually has happened to housing prices: here are five good charts that show the overall picture:

        Housing inflation charts

        Note in particular the price-to-income chart. From 1979 to 2015, housing prices have grown from 250% of median income to about 300% nationally, and in the cities, have grown from 300% to 570% (New York), 420% to 850% (Los Angeles), or 300% to 500% (Boston). In the case of Los Angeles (which I grew up in), my starting point (1979) followed an decade in which the real price of housing almost doubled: but I couldn’t find any nifty charts that have a starting point 10 years earlier).

        Housing size has grown, for new stock, but this is more a function of developers focusing on the upper portions of the market.

        Health care costs has grown, in absolute terms, from about 5% of GDP to 18% of GDP from 1960 til now, and until 2010, its rate of inflation exceeded that of the economy at large by about 3 percentage points. (Thank you Obamacare)

        While the march of progress in medicine does continue, it’s not by as much as you might suggest. Just taking a crude measure, like life expectancy, it has grown from 68 to 76 (for white males) since 1960, but mostly as a consequence of public health measures (mosquito abatement, sanitation, food standards, environmental regulation) rather than health care. The CDC estimates that 25 of the 28 years we’ve increased our lifespan since 1900 are the result of these public health measures.

        In recent years, the life expectancy has been decreasing for most of the population. A more telling measure might be to look at the life expectancy at age 60: in this case, it hase grown from 16 years to 21. That’s not nothing, but at 18% of GDP, we are spending about one year working to pay for health care for every year that it’s added to our lives. That may be a trade-off worth making, but it doesn’t seem all that impressive to me.

        In all three cases cited, the growth of fundaments are pretty much direct results of ill-considered market interventions (In the case of housing: NIMBY zoning, immigration policy, and the financialization of the mortgage industry, for medicine: the consolidation of the health industry, and the establishment of pay-per-service insurance and Medicare reimbursement norms).

        With the exception of food (which has gone dramatically down as a portion of income, but has suffered great dimunitions of nutritive quality), the unavoidable fundaments of life have become more dramatically more expensive in the last couple generations. Even if the quality of these goods has markedly improved–a debatable proposition–it makes life considerably more challenging for those on the bottom third of the income distribution.

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        • The benefit of using economic means to assess human welfare is pretty much solely the fact that we can compare apples to apples. That’s not nothing, but, yeah. It’s pretty paltry.

          However, if we want to use other stuff to make the comparisons, we’re stuck with comparing intangibles to intangibles. Which can be seriously interesting but is equally likely to get us into “yes it is” “no it isn’t” fights.


          Yeah, I am looking at the “price to income” chart for the US and see the following: it was at 3 in 1979, wandered down to 2.75 from 84-97, then exploded all the way up to 4 until it corrected back down to… 1979 levels. It seems to be wandering up to 3.25 currently.

          That more tells me that we’re in another bubble than that there’s a problem that needs addressing.

          (And I have to take Maribou to the library. Brb.)

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          • As for health care costs, I agree that there does seem to be something going on. But one of the things intertwined with the something going on is the fact that we have so much better health care today than we did in 1973. We have pills for stuff now that we used to need surgery for. The medical tech we have today is leaps and bounds ahead of back then. (Compare Pong to the PS4. Medical Tech is no different.)

            We’re spending a lot more than we used to be, sure. But we’re getting returns on that money that are measurable.

            If we weren’t seeing those returns, I’d agree with you. As it is, I’m stuck wondering how much you’d have to pay for top-of-the-line 1973-level medical care today. And if you’d see that as worth the price.

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            • Again, I would contest that medical care is all that much better. Cancer care is markedly better. So is epidemiology. And medical prosthetics. But, by all evidence, the mainstream of medical care is only marginally better than in 1973. We have pharmaceutical alternatives that didn’t exist back then, but most of them are only incrementally better than before.

              It may surprise you to find out that modern antidepressants are not detectably better than 1973 antidepressants at relieving depression. They have more tolerable side-effect profiles, and they’re more widely used (as they are incentivized in our healthcare system). Modern antihistimines don’t make you as sleepy, but they don’t make you sniff appreciably less than the older ones.

              In short, we’ve seen the consumerization of healthcare. There is more medicine to relieve discomfort, and to make taking medicine more tolerable, and there are more medicines that treat formerly sub-clinical syndromes that had been previously ignored (e.g. “restless leg” syndrome, or “over-active bladder”). But spending on pharmaceutical products has risen 350% in real dollars over the last 30 years. Have we seen a commensurate increase in welfare?

              Markets are terrifically effective in incentivizing things that people are willing to pay for, or that one can build a business model around. But we have already reached the point where there have evolved bacteria that are resistant to every commercial antibiotic, and because there’s no business model there, no company is putting anything substantial into R&D to replace them.

              Granted, the market is good at doing what a market does. And that is centered largely in the measurable, the quantifiable, and the profitable.

              What I’m advocating for is a broader conception of human welfare, that includes less measurable goals as mental and spiritual health, community, autonomy, and self-direction. Each of these may include items that are, from an economist or businessman’s perspective, without value.

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                • More to the point, that in talking about “market failures,” there is generally no talk about things that markets don’t do at all. Or that optimal public policy must include considerations that are outside of–or in contradiction to–the market and corporate paradigm.

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                  • Perhaps I am reading you wrong, but my impression is that we just got treated to a wonderful, 8 part series on the design and construction of commercial airliners, and you are critical of it because the engineering and design don’t include those giant airplane parachutes , or how far apart the seats are, or the comfort of the bathrooms, etc.

                    Those are good topics, but not really on point.

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    • First off, I would echo on housing and health. To say people are spending more of their income on these goods is not the same as saying they have gotten more expensive.

      In any case, if there is a problem in any of these markets that is causing them to grow more expensive (or even to change composition so that cheaper options are disappearing, leading only to very expensive options to be available) then we to understand exactly what is going on if we want to do anything about it. Since we seem to be short of philosopher-kings at the moment, let’s see if we can figure out what the answer to the problem is on our own. And to do that you’re going to need a framework like this series.

      I do agree with you about efficacy, though I can’t imagine what a government could do about. But on autonomy and affiliation, I disagree to some extent. There is nothing about our modern society that prevents people from forming tight-knit communities – in some ways the Internet makes it easier. In the same way, as you note people can live a largely self-sufficient existence if they want. I infer that people don’t do these things because they don’t want to.

      People like to wax nostalgic about simpler times, but people have been moving from the country to the cities since there have been cities. This phenomenon does not seem to be bounded by geography or culture – the majority of people seem to genuinely prefer the greater standard-of-living made possible by complex economies to self sufficiency or tight-knit communities.

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