In a 1969 article, “Information and Efficiency: Another Viewpoint,” Demsetz accused fellow economist Kenneth Arrow of taking the “Nirvana approach” and recommended instead a “comparative institutions approach.” He wrote, “[T]hose who adopt the nirvana viewpoint seek to discover discrepancies between the ideal and the real and if discrepancies are found, they deduce that the real is inefficient.” Specifically, Arrow showed ways in which the free market might provide too little innovation, but then simply assumed that government intervention would get the economy closer to the optimum. Demsetz conceded that ideal government intervention might improve things, but he noted that Arrow, like many economists, had failed to show that actual government intervention would do so. Economists have slightly changed the label on Demsetz’s insight: they now refer to it as the “Nirvana fallacy.”
This is from “Harold Demsetz, 1930-2019,” in David R. Henderson, ed., The Concise Encyclopedia of Economics. It was recently put on line.
I had a good time writing it. Demsetz was the person who persuaded me, when I was just 19 years old, that I could make it at a top U.S. graduate school.
One of my other favorite paragraphs because it’s so Demsetz:
In 1963, when Demsetz was on the UCLA faculty, a University of Chicago economist named Reuben Kessel asked him if he was happy there. Demsetz, sensing an offer in the works, answered, “Make me unhappy.” The University of Chicago did just that, and Demsetz moved to Chicago for eight productive years.
READER COMMENTS
Jon Murphy
May 12 2020 at 9:17am
Demsetz was the rare breed of economist who could pack a ton of wisdom into a short article. His insights were always brilliant. For example, his 1982 AER paper Barriers to Entry is both short but very important. I thought I know what barriers to entry were until I read that paper.
If I end up being 1/100 the economist Demsetz was, I will consider myself a roaring success.
David Seltzer
May 12 2020 at 6:54pm
Jon, When I got to Chicago in 1970, Demsetz was a student favorite because of his clarity of thought and kindly demeanor.
David Seltzer
May 12 2020 at 6:50pm
Nice tribute. I wish there were more like him teaching not only econ but critical thinking as well.
Thomas Hutcheson
May 13 2020 at 11:02am
I guess you could assume that some specific actual government can nudge the economy closer to Nirvana on some specific dimension or you could assume the opposite.
Maybe there needs to be some specialization. People like Arrow work like a pure researcher looking for theoretical optima and people like Demsetz work like an engineer seeing how an actual government could put the discovery into practice or make previously botched practices less costly.
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