Monday, August 31, 2009

Beyond The Facts

Anthony North posts in Beyond the Blog HERE:

“Let me make something very clear. Greed is not bad. In order to succeed both individually and as a society, we need to be stimulated. Due to this, we have urges. Without them I doubt if humanity would have advanced at all – and greed is one of those urges.

The problem comes in the level of greed we display. Be too greedy and we hurt both ourselves and society, so it’s a matter of balance. Sadly, though, in today’s capitalism we have a glorification of greed, with it getting out of control. This was not how capitalism was meant to be, originally devised by Adam Smith as a
philosophy to go alongside thrift. We seem to have turned something noble into a feeding trough.”

“Greed is one of those urges” but is it predominant? Is everybody greedy for everything all of the time? I don’t think so. Life would be pretty grim if it was.

Bernard Mandeville, author of “The Fable of the Bees” (1724), developed a whole philosophy on the basis that greed predominated and he gave it his blessing (“Private Vice, Public Virtue”).

Ayn Rand modernised the idea that selfishness was a virtue and created a school for her philosophy (“Objectivism”) which found popularity undergraduates philosophy classes. (You can find some of her lectures on U-Tube, with wide-eyed students listening in awe).

However, greed and selfishness were never popular with Adam Smith. He called Mandeville’s philosophy “licentious” but plausible in parts as an observation of an aspect of human nature in his book The Theory of Moral Sentiments (1759).

Anthony asserts that “in today’s capitalism we have a glorification of greed, with it getting out of control.” Well, is a point of view, though you can read 18th-cxentury sermons in the same tone, and I doubt whether you will find examples throughout history where similar sentiments have not been expressed by someone about their contemporaries.

But Anthony also asserts “This was not how capitalism was meant to be, originally devised by Adam Smith as a philosophy to go alongside thrift.” Where does Anthony get the mishmash of erroneous ideas to compose such a sentence?

There is no such way in which ‘capitalism was meant to be’. Social systems are not ‘designed’ by anyone. The appear in various forms and experience different histories according to how individuals react to circumstances.

Hayek, and others, refer to this as a ‘spontaneous’, or ‘emergent’ order, unintentionally arising by the independent actions of people. That, if I may say so, is their strength. No single person could undertake the myriad of actions that would enable an economy to establish itself, for good or ill.

Which makes the second part of his paragraph, “originally devised by Adam Smith as a philosophy to go alongside thrift”, a misreading of both the emergence of what we call now call capitalism and a misattribution to Adam Smith of that which he had no conscious part.

For a start, Smith neither knew the word, nor the phenomenon of ‘capitalism’. The word itself was first used in English (Oxford English Dictionary) in 1854 by Makepeace Thackeray in his novel, The Newcomes. Smith died in 1790. He couldn’t devise that which did not yet exist, and couldn’t devise a complex economic system even if he had wanted to. In fact, he warned against ‘men of system’ who, ‘wise in their conceit’, force their designs upon others.

Adam Smith was a moral philosopher and saw his scholarly duty as ‘doing nothing, but observing everything’. He analysed how commercial societies functioned in 18th-century Britain – already a major trading economy and major political player in Europe – and wrote in his Wealth Of Nations a devastating critique of mercantile political economy, as practised in Europe.

The players in commercial society dispersed in their private lives did not conform to a master plan for commerce or government. Depending on their history and circumstances their commercial societies grew ‘slowly and gradually’ (some of which struggled because state interventions held back their natural courses and all were affected by the usual ‘jealousies of trade’, petty wars of dynastic succession, legislated anti-competitive tariffs, protections and prohibitions, and the vagaries of different personalities.

To see history as a journey from a sort of ‘ideal’ design towards “a feeding trough” is quite inadequate. Anthony North should re-think his assessments, perhaps read a bit more Adam Smith, and reflect on his current opinions.

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Sunday, August 30, 2009

Edmund Gets It Wrong Too

Edmund Conway, apparently the economics editor, writes in The Telegraph (London) HERE:

What Gordon Gekko got wrong”

The "invisible hand" is shorthand for the law of supply and demand and explains how the pull and push of these two factors serve to benefit society as a whole. The simple conceit is as follows: there is nothing wrong with people acting in their self-interest. In a free market, the combined force of everyone pursuing his or her own individual interests is to the benefit of society as a whole, enriching everyone.

Smith used the phrase only three times in his 1776 masterpiece The Wealth of Nations, but one key passage underlines its importance: "[Every individual] by directing [his] industry in such a manner as its produce may be of the greatest value he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good

Edmund Conway gets it wrong too.

Geko’s script writer was expressing Bernard Mandeville’s philosophy (The Fable of the Bees, 1724), and, in modern form, the ideas of Ayn Rand. He was not expressing anything written by Adam Smith.

Adam Smith’s use of the popular 18th-century metaphor of ‘an invisible hand’ in Wealth Of Nations (1776) had nothing to do with his exposition of supply and demand. Smith clearly states his theory of supply an demand in Books I and II of Wealth Of Nations without once mentioning ‘an invisible hand’.

Edmund Conway discloses, inadvertently I am sure, that he has never read Wealth Of Nations:

Smith used the phrase only three times in his 1776 masterpiece The Wealth of Nations

If he had read it even once he would know that Smith only used the metaphor, ‘an invisible hand’ ONCE in all 900-plus pages of Wealth Of Nations, in Book IV, chapter 2, paragraph 9, page 456 (Oxford University Press, 1976).

I wonder where the other two references are? If Edmund Conway can show us any other references to the metaphor in Wealth Of Nations, I and most other Adam Smith scholars would be most surprised to say the least.

As a journalist, Edmund should know that statements claiming to be fact should always be checked and then double-checked by Editors, especially economics editors.

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The Hesitant Hand by Steven Medema (Princeton University Press), Part 7

Chapter 6: Marginalising Government II: the rise of public choice analysis)

A central axiom of modern economics has long been the rational, self-interested agent; public choice was largely about the application of that assumption to the political process (from Homo economicus to Homo politicus; with my apologies to Latin scholars).

Among the major figures in this new school were James Buchanan, Gordon Tulloch and Warren Nutter, and this chapter takes a close look at their work and influence, which towards the end of the chapter gets very close with an almost blow-by-blow account of its leading professors struggling to maintain their legitimacy within departmental economics, already narrowing down its core interests within mathematics (‘political economy’ was long dead since Marshall).

Naïve analysis of government relied on almost altruistic officials working for the public good through their conception of a ‘public welfare function’, as if legislators were ‘neutral’ between factional interests and worked solely for the whole community. Buchanan and company were not so naïve
Virginia, where they worked, is very close to Washington, D.C.).

Politicians were not quite neutral, nor were they mere technical translators of the public will into public policy. They too maximised their self-interest (primarily to be re-elected) and they did whatever it takes to build a large enough coalition of voters that supports their election (and re-election).

Disappointedly, Steve holds back from developing an account of the analyses of public choice theory in much detail and refers his readers to Dennis Mueller’s Public Choice (3rd edition, Cambridge University Press), and for the political process model he refers to Buchanan and Tullock’s seminal text, The Calculus of Consent (1962: Michigan University Press). I mention that last book (with Anthony Downs’s An Economic Theory of Democracy (1957) because it was from reading them in the late 1960s that I began my own drift away from student political activism (I even wrote a long forgettable essay applying the general idea of self-interested politics to left and right conflicts in the university).

However, Steve’s account of public choice theory is a neat, clear summary and will inform, or remind, readers of its main ideas, plus an adequate account of the work of Arrow (his ‘possibility theorem’: voting preferences do not promote ‘optimality’) and Black (committees and elections).

As is his outline of the difficulties of the public choice school in overcoming general indifference (and, later outright, hostility) among academic economists, an attitude replicated among academic political scientists. This left a formidable gap between the reality of political processes and the conventional assumptions of democratic political conduct, partly manifested in the lack of attention to government failure, at least not to the degree to which market failure is acknowledged and used to justify government interventions to ‘correct’ the alleged failures of markets.

The last 15 pages of Steve’s chapter is a detailed account of the struggle for the recognition of public choice theory as a scientific subject worthy of a higher status with the subject areas where it rightly claims a place. I shall not review their contents on this occasion, except to say the conduct of (self-interested) academics, while in my view is disappointing, it is also a classic example of the vindication of public choice theory in action – perhaps someone should re-write those 15 pages as a case study.

[Part 8: “Legal Fiction: The Coase theorem and the evolution of law and economics” is up next.

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Thursday, August 27, 2009

Ron Mwangaguhunga writes in the Awareness Blog HERE

Revisiting Adam Smith's "Invisible Hand"

Chinese Premier Wen Jiabao said:

“If you are familiar with the classical works of Adam Smith, you know that there are two famous works of his. One is 'The Wealth of Nations.' The other is the book on the morality and ethics. And 'The Wealth of Nations' deals more with the invisible hand, that is, there are the market forces. And the other book deals with social equity and justice. And in the other book he wrote, he stressed the importance of playing the regulatory role of the government to fairly distribute the wealth among the people.

If in a country most of the wealth is concentrated in the hands of the few, then this country can hardly witness harmony and stability.

"Harmony," granted is an organic part of Chinese thinking (as, say, "liberty" is a part of the American political vernacular). Still, Jiabao has a point despite his own country's profound deficits of freedom (Averted Gaze). This Sunday's New York Times Book Review also revisited Smith, noting, ".. as the historian Emma Rothschild has noted, 'The Wealth of Nations' uses the phrase 'invisible hand' precisely once. In the 1,231-page Bantam edition, it appears on Page 572." Only once!

It is interesting that the "invisible hand" has, over the years, become an almost inarguable Archimedian point as to how human beings make economic decisions. Did that "invisible hand" simply vanish the Scottish author's other long-forgotten book, Theory of Moral Sentiments?"

Wen Jibao
has been saying the same thing for at least a year. I do not recognise anything in Moral Sentiments about redistributing wealth (not a common idea in the 18th century as we understand it).

Ron Mwangaguhunga may be giving a free paraphrase of what Wen said, or Wen may be freely paraphrasing Adam Smith knowing how few people in the West read either of his books.

But Ron quotes what many will find surprising – though no regular reader of Lost Legacy will be among them – from Emma Rothschild that Smith only mentions the so-called invisible hand metaphor only once in Wealth Of Nations and only once in Moral Sentiments (it didn’t ‘vanish’ at all).

Ron is correct in saying “the "invisible hand" has, over the years, become an almost inarguable Archimedian point as to how human beings make economic decisions”. How and why is the subject of a paper I am preparing for next year’s conference season (“An Invisible Hand: from myth to modern icon”).


Apologies for my apparent intermittent posting.

With invited house guests in France, it is incumbent on me to be a participative host and I can only slip away during afternoon ‘siesta’ times (when not afflicted with a need to rest my eyes too!).

We return to Edinburgh on Saturday and will (nearly) be in the normal routine, except that Wednesday-Thursday, I am in Manchester at the UK History of Economic Thought annual conference, but I hope to avoid the usual internet connection problems.

Also, it is fairly quiet on the Google Alerts from with a Congressman Adam Smith (D) dominating the flow of alerts, rather than the Adam Smith born in Kirkcaldy in 1723.


The Hesitant Hand by Steven Medema (Princeton University Press): Part 6: ‘Coase’s Challenge’.

Steve Medema’s account of Ronald Coase’s major contributions to economics is strengthened by his knowledge of the circumstances in which he addressed and defended his seminal article, ‘The Problem of Social Cost’ (1960).

Coase worked on practical proposals, and the theory behind them, of how to use a market to allocate broadcast frequencies to privately-owned radio stations regulated by the US Federal Communications Commission, assuming that the pricing mechanism and property rights worked well enough to allow broadcasting rights to flow ‘towards their highest valued uses’ and users.

Surprisingly, perhaps, economists from the University of Chicago, led by Milton Friendman, George Stigler and Aaron Director, and 17 others, disagreed with Coase’s approach at first, but changed their minds after hours of debate. This became the seminal article in Journal of Law and Economics in 1960, and the rest is history.

The party causing harm to another was no longer the obvious candidate for a tax related to the damages it caused. If A harms B, how should A be restrained, because when A causes harm to B, avoiding harm to B inflicts harm on A, and the question is now should A be allowed to harm B, or should B be allowed to inflict harm on A?

Economists know harms inflicted on others as externalities and Coase realised that the rights assigned to A simultaneously may expose B to the consequences of A exercising her rights. Among the consequences may be the infliction of losses from costs to B arising from A’s rights. But this has deeper significance: whose rights prevail, A’s or B’s? Merely restraining the polluter damages the polluter and does not include the costs of that restraint.

Here Pigou’s taxation of the polluter does not necessarily maximise national welfare when the costs of one, and not the costs of both parties, are considered. This reduced to the existing legal system and how rights are distributed among the affected parties.

Most econ students become familiar with Coase’s Rancher/Farmer problem. Cattle wandering into the farmer’s fields to graze impose costs on the farmer (lost crops) and add to the rancher’s gross income. To fence off his fields costs the farmer the expence of erecting and maintaining a fence; to add cattle to his herds adds to the rancher’s profits. A exercising his rights imposes costs of B; B exercising his rights imposes costs on A.

Coase showed there was a level of compensation payable by A or B that would be acceptable to both parties that would leave them both better off than an imposed choice of winner or loser. The amount of compensation offered and accepted could be determined by voluntary negotiation by A and B that reflected their respective valuations of harm, and thereby achieve the efficient bargained outcome through the price mechanism.

Coase solutions were consistent with Adam Smith’s expectation that resources gravitate towards their highest-value uses (p111). At a stroke, legal-rule determined Pigouvian taxation/subsidies theories were discarded (in theory). No wonder Friedman and Stigler bowed to Coase’s contentions in their 1959 debate.

Of course there are transaction costs in determining who compensates who, whether by administrative fiat, legal judgment, or private bargaining (which is where Coase first made his mark in his seminal "Nature of the Firm”, 1937), and Steve leads the reader through the practical consequences of this field with impressive clarity.

Anybody who has spent time bargaining for something that matters to the parties (assuming you have found the right people to bargain with) will know of the real costs of such activity, even before a contract is formalised and agreed, plus the après-contract work of monitoring performance of the other party during implementation, with the ever present possibility of contract breakdown and resort to legal sanctions.

In my experience, judges often hear (or read) the submissions of the parties and then tell them to go away and sort out a solution upon which she will rule, rather than sit and listen to disputatious parties though long hours (days, weeks) of expensive adversarial confrontations.

However, Steve explores how Pigovian state remedies also take up expensive time and resources, though neatly stepped over as costless transactions by assumption. Yet corporate resistance to social costs judgements face major political pressures, lobbyists, media influences, and civil service mind-sets, all of which add to decision costs. Public enquires can take years too. For certain, transaction costs are not zero.

It’s not that Coase claimed that markets are universally less costly than applying Pigovian solutions because either can be the most expensive; they both face costs in dealing with externalities. It is the case that market solutions, partial or total, in many cases are more efficient that sole use of public-based solutions and regulatory monitoring. These options are worth exploring, argued Coase. Just assuming that public measures are least expensive is based on ignoring transaction costs and assuming “that government interference will improve matters” (p. 117).

The problem, says Steve, lies in the formulation of the divergence between “marginal private net product and marginal social net product” rather than comparing total social product yielded by the different arrangements. It is easier, Steve concludes, reporting on Coase, to conceive of “better worlds” than to “devise practical arrangements which will correct defects in one part of the system without causing more serious harm in other parts” (p 121).

Steve’s presentation of what is known as the Coase theorem is the best I have seen over many years since the 1960s (when I was an undergraduate).

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Monday, August 24, 2009

Adam Smith's Legacy Understood at the Top

Coincidentally, two correspondents of Lost Legacy both sent me emails this morning about the same article that appeared in The New York Times (19 August) by David Leonhardt: “Theory and Morality in the New EconomyHERE:

Leonhardt’s theme begins conventionally, judging by recent spates of articles assessing Keynes’s solution to depression versus the alleged views of Adam Smith, usually wrapped in nonsense about his supposed preference for ‘laissez-faire’ (a policy phrase he never mentioned), and absurd proposition that the US economy has pursued such a policy for several decades leading to the ‘credit’ (more likely ‘debt’) crunch.

But then, Leonhardt changes gears:

Yet here is where the story becomes a little complicated. Six years ago, Bantam Classic published a mass-market volume of Smith’s 1776 masterwork, “The Wealth of Nations,” with an introduction by Alan B. Krueger, an economics professor at Princeton. Krueger argued that Smith’s modern image had become unhinged from his actual writings. “Smith was a nuanced thinker. He was not nearly as doctrinaire a defender of unfettered free enterprise as many of his late-20th-century followers have made him out to be,” Krueger wrote. “He recognized that human judgment was not infallible.”

Here is where I sat up and paid attention, and I was rewarded with the first article that I can remember these past months that demolished the myth that Adam Smith’s ideas were followed by US (and UK) governments in events leading to our present sorry condition. Alan Krueger plays his role in what follows.

Smith was indeed a champion of individual liberty and worried about how governments might muck up an economy. But he also wrote that the goal of employers, “always and everywhere,” was to keep wages as low as possible. “When the regulation, therefore, is in favor of the workmen, it is always just and equitable; but it is sometimes otherwise when in favor of the masters,” he concluded. He supported a tax on luxury carriages and taxes on alcohol, sugar and tobacco. He said that “negligence and profusion” inevitably occur when corporate managers control shareholders’ money. And as the historian Emma Rothschild has noted, “The Wealth of Nations” uses the phrase “invisible hand” precisely once. In the 1,231-page Bantam edition, it appears on Page 572.”

Having set the scene, Leonhardt explores current commentary in the context of Adam Smith with which readers of Lost Legacy ought to be familiar. Here is a sample:

The principles of laissez-faire capitalism were elevated to the status of religious scripture, with Alan Greenspan as high priest. In “The Cost of Capitalism,” Robert J. Barbera, a longtime Wall Street economist, notes that Greenspan and others confused the fact that market capitalism was the best economic system with the misguided notion that it was the perfect system.”

Read the full article in the New York Times for more examples, especially Leonhardt’s quotation from an interview he did with President Obama, who replied to a question by introducing Adam Smith into his answer:

Adam Smith, at the same time as he was writing about the invisible hand, he was also writing about that moral sense — that human ecology — that allows a market to work: the sense that if I bring my goods into the market, someone is not going to hit me over the head; the sense that because I am trading with this guy often enough, that I know that the scales aren’t tampered with,” Obama said. “That compact that we make is not just legalistic. It has to do also with our politics and our culture, and when that starts eroding it inhibits economic growth as well.”

If the top understands the issues like that, supported, I hope, by diligent staff- work by those who influence the top and construct the policy options, then I for one find it encouraging.


Sunday, August 23, 2009

Self-Interest and Copyright

William Patry writes the Blog, Moral Panics and Copyright Wars (‘a blog about copyright discourse’) which is about his book of the same name, published by Oxford University Press’ HERE:

Adam Smith and the invisible hand of copyright” (22 August):

“Adam Smith’s theory was that “individuals were led in the pursuit of their own self-interest by an invisible hand to pursue the nation’s interest, but also that this pursuit of self-interest was a far more reliable way to ensure that the public interest would be served than any alternative,” especially government intervention. Joseph Stiglitz, however, rejoined that “the invisible hand often seemed invisible because it was not there.” (Page 98). John Maynard Keynes also rejected this view:

It is not a correct deduction from the Principles of Economics that
enlightened self-interest always operates in the public interest. Nor is
it true that self-interest generally is enlightened; more often individuals
acting separately to promote their own ends are too ignorant or too
weak to attain even these. (See pages 98-100 of the book).”

Copyright is the 'price' exacted by authors (and publishers) for potentially acting in the public interest (creating and publishing works which the public purchases from the publishers, a small portion of which goes to the authors).

Whether individual products are really in the public interest are separate issues – the bulk of books do not sell out their first printing; do not make a profit; often do not cover their costs; and sometimes do not cover their author’s advances (though some, such as David Hume’s, 1739-40 Treatise, ‘which dropped from the press stillborn’, but become a major contribution of philosophy and are still in print in the 21st century).

No alternative system of mobilising the efforts of authors, covering the financial risks of the publishers and, in the wider sense, serving the public interest, has been devised so far.

Besides setting the rules of copyright in laws, the state has a minimal role in deciding what may be written and published by laws on defamation, libel, plagiarism, inappropriate language and subject, the administration of which is subject to a legal process, not the executive (in non-totalitarian societies).

Where I may disagree with William is the above repetition of errors about Adam Smith’s views on self-interest, such as the false characterisation that Smith asserted: “individuals were led in the pursuit of their own self-interest by an invisible hand to pursue the nation’s interest”.

This was a specific, not a general, assertion by Adam Smith in a single instance in his 900-page, Wealth Of Nations (Book IV) in the case of some, but not all, merchants investing locally and in aggregate thereby increasing the annual output of “necessaries, conveniences, and amusements of life”.

This was occasioned by some, but not all, merchants being risk-averse about investing in foreign trade, as he states quite clearly in chapter ii, of Book IV. Their ‘risk-aversion’ led them to do so, which Smith capped with a well-know 17th-18th century metaphor of “an invisible hand” to give a more “striking” representation of the link between their risk-aversion and a nation’s interest. (Metaphors are not real!).

It was not a universal rule, though it has been made into one by modern economists, few of whom ever read Wealth Of Nations, and is passed around by repetition since the mid-1940s.

The idea that Smith’s understanding of self-interest led him to assert the easily refutable notion that a mystical entity intervenes in the economy to lead self-interest individuals to benefit the national interest is a insult to his scholarship.

He never said such a thing.

Indeed, in Books I and II of Wealth Of Nations he gives over 60 examples of self-interested actions in which individuals act in a manner contrary to the national (even local) interest.

Consider his suspicious opinions of the behaviours (many of which he documented) throughout Wealth Of Nations, including in Book IV, before and after the single instance of his use of the metaphor of “an invisible hand”, of “merchants and manufacturers”, “legislators” and those who influenced them, and national governments, and then explain these widespread behaviours, based on the self-interests of the individuals concerned, with the alleged statement attributed to Adam Smith that, somehow, individuals end up achieving something manifestly at odds with what they actually achieve.

Smith’s ideas about self-interest were not “nuanced”; they were starkly clear and did not include the attribution modern economists give to him. I concur with Keynes and Stiglitz in their quoted assessments.


William writes that he was quoting Stiglitz on Adam Smith's reference to the invisible hand.

That is not as clear the way the Blog is written, but I accept that William is innocent and Stiglitz is the guilty party.

Either way, the assertion that Smith wrote the ideas I criticise in my post remains an error of attribution by modern economists.

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Saturday, August 22, 2009

Matt Ridley on Consistency - or Lack Thereof

Matt Ridley writes the Natural Order of Things in The Spectator HERE:

Today, generally, Adam Smith is claimed by the Right, Darwin by the Left. In the American South and Midwest, where Smith’s individualist, libertarian, small-government philosophy is all the rage, Darwin is reviled for his contradiction of creation. Yet if the market needs no central planner, why should life need an intelligent designer? Conversely, in the average European biology laboratory you will find fervent believers in the individualist, emergent, decentralised properties of genomes who prefer dirigiste determinism to bring order to the economy.”

This article is an excellent read and I highly recommend it you. The paragraph is but a taste.

Ridley makes an interesting case, slightly off centre in his depiction of Adam Smith, though what is attributed to Smith in the American South is probably as stated, but is somewhat at variance with his actual views, not that I would expect many on the Right to realise their misperceptions.

As for Darwin, I hadn’t thought of him as particularly in tune with leftwing thinking, as Ridley brings out the “individualist, emergent, decentralised properties of genomes”, which is a long way from the left’s passion for central control and regulation.

Yes, it is an uncomfortable clash of opposites, making consistency a rare dish for those with an appetite for it.

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Friday, August 21, 2009

Lost in Translation

The Hesitant Hand by Steven Medema (Princeton University Press): Part 5: ‘Marginalizing Government'

Medema reviews development in Italia, mainly in theories of public finance, and while I enjoyed the journey, I cannot say I am any more impressed with the Italian contributions than I was when I used to teach my Public Finance course in the 70s and 80s.

The whole project of Italian pubic finance science seemed to me a dead-end. They were trying to fit government into a marginal calculus which bore limited resemblance to any form of government then operating or likely to operate. Hence, I taught the subject using Musgrave as the main text.

I didn’t go as far as calling their efforts “a mass of intellectual confusion and dangerous half-truths” as Henry Simons let fly, when reviewing Antonio De Viti de Marco’s First Principles of Public Finance (1936) in AER, 1937).

Steve’s discussion of the Italian contribution does not leave me feeling that Simons must have had a long lunch and got stuck with the bill, having lost the toss. Of course, the Italian tradition includes Vilfredo Pareto, of whom I have never noticed anything negative said about him.

The problem of public finance vis a vis economics is that one is a collective provision of goods (the amount, content, and distribution of which are determined by different criteria and means compared to private goods). Trying to mirror one with the other for analysis is difficult despite decades of trying to do so.

Marginalism is about individuals, whose exclusive consumption maybe aggregated in markets; public goods (excluding welfare) are provided from the top downwards, already aggregated, if you like, and consumed by individuals, mostly non-exclusively.

Medema’s discussion of the complications for the Italians arising from public demand and public provision is crafted well, it being a difficult task to select enough to make sense of it without getting lost in it.

His account of Pantaleoni’s cumbersome attempt at deciding on government expenditure (p83) using weighted marginal utilities of possible expenditures against ‘marginal sacrifices’ of taxation to pay for them, predicated on public benefits equal or exceeding their costs and the equation of the marginal utilities across uses are equated, is clear. I am minded here of a statement by Pigou that the ‘marginal utility of the last penny spent on a battleship should equal the last penny spent on welfare(from memory, freely composed), the point being that it was operationally of no value to decision making (try teaching senior military officers Pigou's proposition).

However, the Italians were working away trying to do what Cambridge neglected, and little cross dialogue was undertaken between the economists working in different languages. Even the perceptions of the behaviour of government ‘agents’ differed, from ‘ineptness’ (UK: beyond their abilities) to efficient rational calculators (Italy). The latter approach is, as Steve notes ‘a far cry from Adam Smith’s portrait’ of the capabilities of government agencies (p 85). And that is the problem with the early Italian work in this area: their marginal utility models ran away from reality.

The picture changes in early 20th century. The coercive powers of the state are admitted in taxation and borrowing (the latter more attractive as the costs are less obvious in the immediate debt burden than they are in taxation – the 101 lesson in the management of government treasuries still today). The difference with public over private provision is that public provision is paid for by taxation, plus borrowing (itself paid for by more borrowing plus taxation) but consumed (and not consumed) individually, whereas private production is delivered to individual purchasers on payment of individual prices.

Trying to fit both public and private supply and demand into the same model is not possible except by sacrificing reality. This did not deter the Italians and their valiant attempts to do so also teach valuable lessons about public finance, including its coercive role.

Steve introduces Wicksell into this account. He sought a ‘comprehensive and internally coherent system’ while disregarding its practical value (p 93); in his models of abstraction he did not seek practicality, preferring understanding of what was involved over practicality.

When an individual’s marginal utility for a public good is less than the sacrifice of their tax share, she will feel overburdened, even if the total utility of the public good exceeds the total tax sacrifice across the community. If the majority of voters feel similarly about the tax burden they would vote against the provision; if they are a minority they have to put up with it.

It then comes down to the composition of the legislature, leading Wicksell to require a unanimity rule to ensure voluntary consent which, in the absence of a modified unanimity rule (p 94), surely brings us back to same problem of the coercive role to government?).Steve links this debate to Buchanan and Tulloch’s ‘Calculus of Consent’, 1962.

Clearly a unanimous decision, which makes nobody worse off, guarantees the efficacy (and efficiency) of the decision. It is easier to compile arguments against non-unanimous decisions, where majorities oppress minorities, to find practical examples of unanimity working in practice, where minorities oppress majorities (WTO?).

Finding ways round all the problems associated with the unanimity rule in an elected legislature forms an interesting discussion – the efficiency of majority rule versus the efficiency of unanimity is a debate about both process and outcome, which is an irresolvable dilemma. Majority rule leaves a coerced minority disenfranchised; the unanimity rule leaves the interests of the majority disenfranchised.

I consider there is much for economists to think about in this chapter of The Hesitant Hand and once again recommend you acquire Steve Medema’s book (Princeton University Press) and read it carefully.

Next Up is Coase's Challenge (Part 6)

Monday, August 17, 2009

Memories of a Wasted Youth

The Hesitant Hand by Steven Medema (Princeton University Press, 2009) Part Four: Chapter 3

This book gets more and more interesting as the author develops his theme of tracing how self-interest was gradually addressed by successive generations of economists and how it both changed its meaning and its application from the classical through to the neoclassical schools.

Chapter 3 is headed : ‘Marginalising the Market: Marshall, Pigou and the Pigovian Tradition’. It sets out the story of how Marshall, followed by his successor, Pigou, changed the terms of the debate through to the 1930s.

In what is called the classical school, ‘laissez-faire’ dominated the policy debate, though whether the participants in academe and the policy makers in the state (and those who influenced them), plus of course the business entrepreneurs, all agreed on what their respective roles were, or even what they thought the roles of the other participants were, is an altogether different matter.

One thing had certainly changed since Smith’s time. The size, importance, and independence of the state (legislators and civil service), and its prospective roles as the decades slipped by, certainly was very different from the smaller, more widely corrupt and corrupting, and largely not very competent performer, of the 18th - early 19th centuries, was by the 1870s onwards a larger, less criminally corrupt (though persuadable by informal relationships, now professionalised as lobbyists), and more competent administration than ever before.

The duties of the state were no longer only as set out in Wealth Of Nations, or Mill; they had become diverse at national and local government in levels. Public finance was giving way to what became public choice, with political and economic analysis to match.

Marshall was suspicious of old ideas of laissez-faire, which in the form it had taken was regarded all round (Sidgwick) as less than reliable, and anyway did not address how public goods fitted into the frame. Much was spoken about how markets were better than alternatives – they were, but not in isolation from the burgeoning roles taken on by governments, and nor was laissez-faire typical of competition (certainly as seen by business – and politicians – who, it is suspected never really understood what laissez-faire meant in practice.

Marshall sought a means to justify the social superiority of competitive markets and came up with ‘consumer surplus’; Pigou took it further with his model of market failure in ‘net social product’ and ‘net private product’, both entwined with notions of ‘decreasing’, ‘constant’ and ‘increasing’ returns. Their cases were almost convincing, though whether anybody could apply them in practice was another matter.

Pigou’s ideas were the most developed and appealed at the macro-level, at least to theorists and politicians (and their civil servants). In the latter case, the theoretical case for bigger roles for the state was welcome; in the former the incitement to theoretical development was irresistible, and fashioned a spate of high theory in welfare economics, competition theory, including monopoly, oligopoly, and monopolistic competition, and, of course, the Keynesian decades. All of which was accompanied by the longish march to mathematics and the goal of economics as the undisputed champion of science among its less scientific sister and, more distant, co-disciplines.

Pigou’s role is clearly explained by Steve Medema – the best part of The Hesitant Hand so far – and it is all the more instructive for that. It was not a case of state action and laissez-faire being sharply different – even at odds with each – but of their necessary dependence on each other (massively increased by the vast public expense of the recent war).

A modern state could not finance itself adequately without the productivity of the competitive market and a competitive market cannot be productive without the functions of an efficient state (‘unless robbery under arms is restrained by law, fraud repressed, and contracts which have been formally accepted enforced’, wrote Pigou in 1935).

Perceptive readers will find much in Pigou that lines him up with Adam Smith, although vulgar epigones will confront an Adam Smith , from Kirkcaldy, who is a complete stranger to those who have never seriously read his books, and who spout with the total conviction of the ill- informed a completely alien set of thinking about what Adam Smith actually observed and pragmatically advised.

Pigou had the measure of the those who went beyond the role of the state within its level of competences, who looking backwards and can see where current business policies began to go wrong – firms both made money and lost it because their futures are unknowable, except afterwards - whereas armed with the certainties of the present about the past, the public servants develop an overblown enthusiasm for state planning (‘spotting winners’, etc.,), for which Britain, among other European countries, adopted a taste for from the 30s onwards.

With laissez-faire (the name awarded to the fiction that Britain had such an economy) and the fiction that business and government were separate entities, run by disinterested public servants (actually as self-interested as anybody else, but with the public funds and the weight of public problems self-evident before them), the debate about policy issues became completely muddled, mixed as it was with the electoral arithmetic complicated by notions of socialism in its various guises.

As Steve concludes, quoting Pigou:

What this theory (neoclassical welfare analysis) demonstrated, in a nutshell, was the perfect markets work perfectly, imperfect markets work imperfectly, and perfect government can cause imperfect markets to also function perfectly. ....The role of government vis-a-vis the market was no longer an a priori set of assumptions nor an opinion based upon casual empiricism; it was demonstrable in a “scientific” sense’ (p76).

As a student of the 1960s, I recognise the truth of Steve’s summary, and the analysis of Pigou’s largely unread work, somewhat overshadowed by Keynes (I have a copy of Pigou's Welfare Economics in my library) leading up to it, and all the events following it.

What a wasted youth that amounts to!

I recommend readers to read Steve Medema’s Hesitant Hand (Princeton University Press).

[Next up is my review of Steve’s treatment of Italian public finance.]

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Connection Problems

Yes, I got connected but the laptop has crashed twice now.

This meant re-writing entire earlier version of a paper for the Econ Watch Journal (my response to the earlier debate with Daniel Kline).

The computer flashes up 'The current system memory has changed. If you did not change the memory ... To resolve the issue try to restart the memory'.

I have no idea what this means.

I shall try to find out.

Meanwhile Part 4 of my review of Steve Medema's book The Hesitant Hand (Princeton UP) is on hold, which I shall try to post today.


Friday, August 14, 2009

Interruption to Posting

I am getting ready to return to France Saturday morning.

We came back to Edinburgh quickly when a memebr of the family had an appointment for treatment on the National Health Service, much in the news at the moment. The treatment over - so far the prospects are looking good and the scan proved negative, which is even better news - it's time to re-start our holiday.

I note the US media and blogland is enteratining some pretty ferocious propaganda against a possible 'free-at-the-point-of-service' of medical provision in the US. I am not inclined to comment on a country's domestic policies other than the country I vote in, so I have nothing to say about the US health debate.

I can only say that I have had occasion to use the British NHS on several occasions in the past few years and that wherever the much-touted problems with the NHS are happening, they are not happpening in Edinburgh. (I have also had occasion to 'go private' in Edinburgh and I have no complaints either.)

I simply do not recognise the lurid language spoken here and there by some politicians about the state of 'our' NHS. A cartoon of President Obama with a Hitler moustache is demeaning of the people who believe it appropriate.

Anyway, Lost Legacy posting will be limited until Saturday or Sunday, whichever moment I re-connect to the Internet from France.


Wednesday, August 12, 2009

An Author on the Money

Jed Graham of Investors Business Daily (HERE) writes:

Adam Smith Was On The Money”

“In the fateful year 1776, Adam Smith took aim at Britain's heavy-handed rule of the American Colonies.

"To prohibit a great people ... from making all that they can of every part of their own produce, or from employing their stock and industry in the way that they judge most advantageous to themselves, is a manifest violation of the most sacred rights of mankind," he wrote in "An Inquiry Into the Nature and Causes of the Wealth of Nations."

... In a 1780 letter, he labeled his work, in part, as "a very violent attack ... upon the whole commercial system of Great Britain."

In the first three books of the 900-page tome credited with laying the foundation for modern economics, Smith revealed the "invisible hand" that unites the productive force of self-interested parties for the common good.

His work, which earned his place as the most influential economist in history, wasn't just timeless. It also addressed the most pressing issues of his day.
Smith made not just a humanitarian case against colonial suppression, but also an economic one.

He argued that the cost of monopolizing trade with the 13 Colonies wasn't worth the benefit — a marginal increase in the profit that British businessmen might earn: "It is ... a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation whose government is influenced by shopkeepers."…

Having opted not to follow the religious career path dictated by his scholarship, Smith returned to Scotland. There he studied while living with his mother for two years.

Then opportunity struck. Smith was invited by the Philosophical Society of Edinburgh to deliver lectures. They were a hit, earning him an appointment as professor of logic at the University of Glasgow.

Smith's ambition was grand. At the end of his first book, "The Theory of Moral Sentiments," which explained the natural link between self-interest and morality, he previewed future endeavors. He would attempt to give the world "a system of those principles which ought to run through and be the foundation of the laws of all nations."

"Wealth of Nations," published 17 years later, fulfilled part of his pledge. It was far more than an economic work, Glenn Morrow said in a lecture on its 150th anniversary. "It is a history and a criticism of all European civilization." …

Inspired by Newton, whose law of gravity explained planetary movement, Smith sought a connecting principle governing economics.

Smith perceived man's propensity to barter or exchange skill and labor as central to economic progress. This facilitates a division of labor that, in Smith's example of a pin factory, let 10 workers make 48,000 pins in one day, while a single untrained worker might be hard-pressed to make one.

Smith's intellectual labors were driven by a sense of mission. In his analysis, self-interest spurs innovation and is the surest way to spread wealth to all income groups.

Smith saw dramatic disparities in living standards. In his day, great wealth and overcrowded slums existed in close proximity on the Royal Mile in Edinburgh, says James Otteson, an economics professor at New York's Yeshiva University, whose introduction to Smith's work will be published by Continuum next year.

"He was concerned with figuring out ways to make the people at the lowest end of the economic spectrum better off," Otteson told IBD.

Smith tested his big-picture ideas with the most painstaking analysis.
Taking a decade to write "Wealth of Nations," he collected a wealth of anecdotal and historical information to explain his arguments.

His data ranged from wheat prices dating to 1200 to the price of butcher's meat paid by Prince Henry early in the 17th century.

"The philosophical base of 'The Wealth of Nations' is implicit in all the explicit reasoning about the real world, which Smith has observed in minute detail," wrote Nobel Prize economist Lawrence Klein.

His "Wealth of Nations" provided the first systematic explanation of how an economy functions.

Smith complemented exceptional training with real-world observation and data collection to inform and support his analysis.”

On the whole I found this an impressive, refreshingly original approach in a short piece on Adam Smith’s life and contribution to moral philosophy and political economy. Readers of Investment Business Daily, new to the authentic Adam Smith, will learn a great deal about him otherwise not available in the thousands of usually, low quality, short-journalistic articles reporting the usual wrong clichés about the philosopher.

Jed Graham cites Professors Jim Otteson (Yeshiva University), one of the younger, outstanding Smith scholars writing today, and Lawrence Kline, recent Nobel Prize winner.

However, I have one minor quibble with Jed Graham, and regular readers of Lost Legacy should have spotted it:

In the first three books of the 900-page tome credited with laying the foundation for modern economics, Smith revealed the "invisible hand" that unites the productive force of self-interested parties for the common good.”

The first two books of Wealth Of Nations contain his analysis wrapped in Smith’s historical approach, neither of which mention the ‘invisible hand’. Book III is a broader sweep across history; it doesn’t mention the ‘invisible hand’.

Book IV is a central piece of Smith’s work in a detailed critique of mercantile political economy, which had dominated British government’s political economy since the 1600s (and, would argue, still does to some extent). Only in Book IV does he mention (only once) ‘an invisible hand’, as a metaphor for the conduct of some, but not all, merchants in their preference for the home trade rather than cope with the risks of foreign trade.

The driver was not the metaphor of ‘an invisible hand’ – a metaphor presents a grammatical object in a more ‘interesting’ way. It was in fact the risk aversion of the some merchants that led them to invest locally, even if it was less profitable than investing in cargoes to send or import from abroad.

OK, having said that, let us be clear on the mighty positives in Jed Graham’s piece. He correctly identifies the Wealth Of Nations as a critique of UK mercantile policy, not as textbook of ‘capitalism’, as usually presented by people unaware that ‘capitalism’, as a word, let alone the phenomenon, was not invented in Smith’s life time. The word was first used in English in 1854; the phenomenon of capitalism, as the word implies, emerged from mid-19th century as numerous large capital accumulations became available for serious capital intensive, profit-driven investments.

Jed notes that the propensity to ‘truck, barter, and exchange’ was the main behavioural trait that gradually spread into human relationships from pre-history, with the division of labour within processes and along the supply chains of commercial society, to distinguish some societies that had achieved small but significant advances in the annual output of the ‘necessities, conveniences, and amusements of life’, from those societies that remained fairly primitive in their material products.

Dramatic as were the living standards of the citizens of Edinburgh (living cheek by jowl in Edinburgh’s Old Town - and still standing), they were as nothong compared to the differences in the dependent situation of the meanest ‘savage’ compared to his savage ‘king’, who had the lives of his subjects at his disposal.

Follow the link; Jed Graham’s short piece in Investors Business Daily is worth reading.


Tuesday, August 11, 2009

The Hesitant Hand by Steve Medema, Part 3: Chapter 2:

[Posting is a trifle slow this week due to matters related to our sudden return from France]

This is where Steve’s book begins to look new (to me) and very interesting. He is beginning to enter into his theme (‘Taming Self-Interest in History of Economic Ideas’).

Steve writes a brisk but purposeful account of the evolution of political economy towards economics in the 19th century. Apart from the residual dominance of Adam Smith, present but not necessarily in charge, there is that enigma called Jeremy Bentham, of whom, I for one have never been comfortable around people with their feet firmly planted in the clouds.

Bentham's utilitarian approach was itself utopian in its pewrspective of how people behave (a way too improbable a calculus for the bulk of people to abide by) and the institutional arrangements of his proposed schemes in society were just as utopian. Nowhere is just about as close as you can get to finding a society that would incorporate his imaginative ideas.

The 19th-century enduring illusion of laissez-faire, wrongly attributed (still!) to Adam Smith, pervades popular discourse throughout but most serious economists controlled themselves, so to speak, in their appreciation of its unrealistic applicability. Market competition, yes, but blind faith in laissez-faire, no. It was more of a phrase embedded in political agitation and journalism (The Economist) than other than a limited panacea among serious economists.

Steve quotes J. E. Cairns asserting that ‘the maxim laissez-faire … has no scientific basis whatever’ (31), which seems appropriate for a phrase first uttered in 1680 by a ‘plain spoken’ merchant, M. le Gendre, when asked by the French Finance Minister, Colbert, what he wanted from the government (‘leave us alone!’). A thin reed, surely, on which to analyse society and later promote it to a principle of economic policy, echoed on the streets of France by the French political agitator, Pierre Poujade in the 1950s.

Steve gently guides readers from the streets to the constructive perspectives of how to draw the mercantile state from policies favouring special interest groups towards those that would benefit the general population. This meant becoming realistic about government activity – necessary not overly interventionist in creating monopolies

Primarily, he is concerned with the ideas of John Stuart Mill and Henry Sidgwick on self-interest in the context of growing realisation of the possibilities of local market failure, a relatively new idea among 19th-century economists. The commercial society of which Adam Smith wrote had changed, and would continue to change, throughout the 19th century, and with the changes came changing concerns of what was agenda for economics.

Steve wanders slightly into a Venn diagram in an attempt to illustrate Mill’s view of overlapping interests where self-interest is superseded by morality, and the slide to welfare economics begins in pursuit of the legitimate functions of government, particularly that of law making, where the appropriate solution to certain conflicts of interest is not obvious. There is no easy rule that resolves all conflicts where there are clear beneficiaries and clear losers. Mill, typically, seeks a ‘solution’ in ‘expediency’, which boils down to the arrangement that can be imposed (or left alone) causing the least disturbance.

Mill’s views of government – its ‘natural tendency towards collective mediocrity’ (41) – did not lead to ‘government by the brightest’ because if too many ‘bright people’ leave non-government, the quality of an outside check on the errors of government would be weakened. Even then, ‘government by the brightest’ would not be better than ‘government by the mediocre’.

Mill returned to the mystique of ‘laissez-faire’ (with its unsubstantiated superiority to other arrangements) and warned against departing from it (42). I always think that while we know what M. le Gendre wanted from M. Colbert, we don’t know what M. le Gendre’s customers wanted – as usual the consumers’ interests are trumped by the producer’s, and probably worsened by the government’s. Laissez-faire is the cry of producers; Adam Smith spoke up for consumers. Advocates of laissez-faire (which did not include Smith, but did include Mill) should avoid confusing laissez-faire with liberty for all.

Steve moves on to Henry Sidgwick, Mill’s contemporary, and author of Methods of Ethics (1874) and Principles of Political Economy (1901), thus spanning Marginalist and Marshallian thinking.

For Sidgwick, self-interest was the central assumption upon which ethics and economics could be founded, but Natural Liberty could be ‘dismantled’. He considered that ‘extreme laissez-faire’ and the assumption that self-interest is ‘universally beneficent’ and ‘harmonious’, ‘should be banished to the remotest available planet’ (43), which message could be validly expressed today in some circles given the widespread misunderstanding of those who wildly misquote (indeed, often make up) Adam Smith’s views on these subjects.

I found this section of the chapter most valuable, not being familiar with Sidgwick’s thinking. He spotted errors in laissez-faire, particularly its non-conformity with actual practice. It had negative spillover effects in one party’s ‘use’ of a finite resource, in certain contracts that harmed a third party, and, of course, where monopolies were present(44).

With government, too far then the scale of interventions, narrowed the sphere appropriate for private enterprise; too little government exposed the community to higher risks of disagreeable outcomes. The ‘Goldilocks’ solution is self-evident, but realising it not, nor easy.

This seems typical of Sidgwick from what Steve says about him, and probably in the category of ‘motherhood and apple-pie’ - he may be too intellectual to be practical. Perhaps he recognised this by asserting that ‘in human affairs we have often only a choice of evils’. (45)

[Part 4 is on ‘Marginalizing the Market’]

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Saturday, August 08, 2009

A Confusing Commentator at Work

On “thought leader” by Mail and Guardian online (HERE), Sentletse Diakanyo writes:

“The financial crisis and rise of pseudo-socialists”

It is important that we allow the market economy to function within the sensible parameters of oversight by the state. Adam Smith alluded to the “invisible hand” necessary to curtail the unbridled capitalist destruction of the economy. The fatal mistake made by politicians in the past was the general assumption that when the economy veers off its original path, competitive forces will intervene and ensure self-correction. The opposite proved true with disastrous consequences. What we cannot allow is paternal interventionism by the state that serves to disrupt economic progress and breeds crony capitalism.”


I have no idea what Sentletse Diakanyo is talking about, either in respect of socialist/Marxist/leftwing dictators in South America, or Adam Smith.

That he asserts that “Adam Smith alluded to the ‘invisible hand’ necessary to curtail the unbridled capitalist destruction of the economy” is beyond any explanation (or parody) I can give, and his article certainly is of no help.


Friday, August 07, 2009

Almost Entirely Wrong

One STDV (“Daily, Politically Incorrect Musings on Race, Culture, Intelligence, and Politics”)HERE:(6 August) posts:

Darwin Takes on Adam Smith's "Invisble Hand" Theory”

Via Lover of Wisdom comes this article applying Darwin's theory of natural selection to economics. The author contends Adam Smith's "invisible hand" idea doesn't apply in markets where relative success is important.
“Smith is celebrated for his “invisible hand” theory, which holds that when greedy people trade for their own advantage in unfettered private markets, they will often be led, as if by an invisible hand, to produce the greatest good for all... My prediction is that it will eventually be supplanted by a version of Darwin’s more general narrative

The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests.”

A mixture of misinformation, myth, and acute observation! In short, he gets Adam Smith mostly wrong and Charles Darwin mostly right.

Adam Smith didn’t have a theory of ‘an invisible hand’. It was a metaphor for people sometimes responding to their perceptions of whatever they considered important that sometimes, but not always, had beneficial outcomes for them and sometimes, but not always, unintentionally had beneficial outcomes for the group (or society).

Smith never opined the view that “when greedy people trade for their own advantage in unfettered private markets, they will often be led, as if by an invisible hand, to produce the greatest good for all...”.

Smith considered selfish acts as anti-social and ‘licentious’. He never said that ‘they will often be led, as if by an invisible hand’. That is pure tosh. Nor did he think that such behaviour would ‘produce the greatest good for all.’ That is wishful nonsense.

I am relaxed about people being ‘politically incorrect’, but I prefer that people are correct in what they attribute to Adam Smith.

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Early return to Edinburgh

A family medical situation requires an immediate return to Edinburgh Saturday morning, hence I am unlikely to Blog until Sunday.

I am almost finished Part 3 of my review of Steven Medema's excellent new Book, The Hesitant Hand (Princeton University Press), but you will understand I am rather busy.

Thanks for understanding (it doesn't stop you commenting on Parts 1 and 2!).

Wednesday, August 05, 2009

The Hesitant Hand by Steve Medema: Review Part 2

In the ‘Hands of Adam’ Steve Medema shows his class as an historian of economic ideas. I found his account of the role of self-interest in commercial society very fair, without the usual cliché errors found in many accounts.

Starting from the proposition in Moral Sentiments that our benevolence towards others diminishes as social distance increases without damaging the social fabric because all others have degrees of overlapping benevolence right across society, and benevolence is not, and cannot be, the sole, or even major force, for exchange behaviour, and, fortunately for human habitation and procreation, it is not necessary that it be so.

A society, we are reminded in TMS can exist with loving relationships, and it is well when it does, but it can also exist without such feelings provided there is a ‘mercenary exchange of good offices’.

Enter here the famous assertion by Smith of the ‘butcher, the brewer, and the baker’ and our need when engaged in an exchange transaction to appeal to their interests not ours (be ‘other centred’; never selfish). Steve shows that for Smith, self-interest is not a ‘one way street’ – what a lot of senseless twaddle would be saved if miss-readers of Smith would get that right!

Steve correctly sets out self-interest in Smith’s lexicon:

‘that the pursuit of self-interest serves the best interests of society as a whole, that self-interest and the social interests are partners rather than enemies’ (19). Self-interest should be facilitated rather than restrained.

The explanation of why this was true for Smith is wonderfully clear, though, Steve notes, ‘Smith is at once vividly descriptive and maddeningly vague’. Echoing Mirabeau (thinking you serve yourself, you serve others), the individual attempts to employ his capital where he expects to earn the highest return, and in doing so, he generally neither intends to promote the public interest, nor knows how much he is promoting it’, followed by the famous metaphor of ‘an invisible hand’.

Steve comments:

‘An invisible hand – this is a specific as Smith gets. What Smith meant by this is anyone’s guess, and plenty of guesses have been offered, ranging from God to government’. But whatever it is, Smith was convinced of its propensity to channel self-interest in socially useful directs’(20).

I can agree with that formulation as it encompasses Smith’s proper use of a metaphor, which is to explain something by adding ‘beauty’ when ‘so adapted that it gives due strength of expression to the object to be described and at the same time does so in a more striking and interesting manner’ (Smith: Lectures in Rhetoric and Belles Lettres, 1763).

A great deal of wasted ink and paper would be spared if only economists would read the nine paragraphs of Wealth Of Nations leading to the metaphor of the invisible hand and see how simply caps his technical description of economic and social process leading to people thinking they are serving themselves when in fact they serve general society, by his employing the common 18th-century metaphor of ‘an invisible hand’. Steve’s compromise treatment is masterly.

Smith develops the sense of ‘congruence’ (Steve’s word), even ‘harmony’ as ‘some would say’ (I prefer potential ‘congruence’) between private and social interests, to his critique of mercantile political economy and Physiocracy, both of which, Steve shows, inevitably distort by monopolies and misguided government interventions (those promoted by lobbying for special, especially corrupt, interests) and thereby interfering with the otherwise free actions of individuals judging their best interests in moral and legally constrained codes of behaviour and acting accordingly.

Here Steve highlights something that is worth developing (21). The absence in Smith’s work of a critique of the ‘internal logic’ of mercantile or Physiocratic thinking: on their own terms they promote the ends they seek (the accumulation of gold or the growth of agriculture output) – as China seems to be sliding towards in buying up the planet with its mountains of US treasury bills and hoping to hold down peasant incomes.

Smith disagreed with their consequences – state action by the former theories (necessarily at the sacrifice of liberty) versus growth of real wealth (the annual output of the ‘necessities, conveniences, and amusements of life’) through individual self-interest in conditions of liberty.

Steve confronts the conundrum of self-interested actions can be malign. Some voices, bought and paid for, advocate absolute freedom for corporations and individuals, the consequences of which are discussed widely. Unfortunately, the remedies (especially from the environmental lobby) of which involve draconian interventions by uncontrollable governments, agencies and neighbourly busy-bodies, plus ‘that insidious and crafty animal, vulgarly called a statesmen or politician’ (WN IV.ii.39).

Steve recognises that Smith was never a one-track voice for everything changing at once. He was far more pragmatic; never an ideologue. He did not make many predictions, nor did he expect much to change, except ‘slowly and gradually’, perhaps in many cases never quite reaching its end goal. He said as much in respect of free trade ever becoming accepted in Great Britain this side of ‘utopia’.

His message was that competitive markets were generally better than state grand plans. He didn’t even consider that ‘natural liberty’, as was envisaged by the Physiocrats, was a necessary condition for the spread of opulence – if it was, he opined, it is unlikely that any country would ever have progressed towards it (WN ix.28: 674).

Nor, Steve observes, were the necessary roles of government minimal (23) – Smith was not a laissez-faire purist or even near being so. The list of proposed roles for the state, collected in Book V and elsewhere scattered throughout Wealth Of Nations, is quite long, and probably much longer than the purveyors of Smith, the laissez-faire advocate, realise. Steve covers this material with both conviction and economically.

Smith, says Steve:

‘was not, as some have imagined, a proto-modern. Smith’s view of man is not economic man with his rational, single-minded pursuit of his self-interest’. Furthermore, Smith did not argue that private action was optimal, in the modern efficiency sense, nor even that it was superior to governmental alternatives. Smith considered the link between private and social interests partial and imperfect, but he was also of the mind that self-interest, properly channelle, tended to engender positive results, rather than negative ones, and that government interference with its operation in the economic sphere would generally lead to inferior results’ (25).

I think we can sum up Smith’s approach as being: ‘markets where possible; the state where necessary’.

Steve’s last line in this chapter is evocative:

Self-interest, then, had finally found legitimacy’.

[In Part 3 we move on to the ‘Harnessing of Self-Interest’ with ‘Mill and Sidgwick and the evolution of market failure’.]

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Monday, August 03, 2009

"The Hesitant Hand" by Steven Medema: Review, Part One:

Steve Madema opens his book, The Hesitant Hand, with a Prologue that spells out where he is going with his main theme on the part played by self-interest in society as a whole and how philosophers like Adam Smith and those before him approached the question. With an economy of style he gets down to business quickly.

Smith was not the first, nor the only, philosopher to focus on self-interest. Decades before 1776 (Wealth Of Nations), others had made explicit reference to self-interest. My first slight concern occurs here because Steve associates these interests of others and Smith with laissez-faire, a uniquely French term, which was not mentioned by Adam Smith in any of his works or correspondence, though he was familiar with it from his contacts with the French Physiocrats and their publications.

There is today an assumption that Smith’s preference for competition and reduced interventions of the kind practised by European governments in their mercantile legislative policies was in essence a policy of laissez-faire, which, strictly, it was not. Not all Physiocrats advocated laissez-faire – in fact some of their policies were interventionist, as were some of Smith’s.

It could be argued that such quibbles were outwith the thematic realm of Steve’s book – he wants to get on with his narrative, absent such scholarly niceties – and ordinarily I would agree with him, but just as the term had specific meanings for Vincent de Gournay, who popularised the term in his debate with Colbert, the Finance Minister of Louse XIV (“laissez-faire, laissez- passer”), about freedom from the stifling regulations pertaining to the conduct of commerce in France, it has come to have specific meanings for modern economists of the extreme libertarian school – the absence of government - neither of which can be said to be particularly Smithian in content or application.

However, Steve's Prologue is a masterly entre to what follows, especially in Chapter 1, “Adam Smith and His Ancestors” (5-25). This opens with Adam Smith and “an invisible hand” which would tend to “harmonise individual and social interests” and “attempts by the state to interfere with this would run counter to the national interest”. “Competition”, says Steve, “was hampered on all sides” (5).

Much of the legal structure was inimical to economic growth and this structure was the creation of governments following, or initiating, assertions about appropriate economic policy, mixed with religious or contemporary moral philosophies, from the
Greeks onwards.

Steve marches through this history at a brisk, readable pace, which economists who read the chapter would do well to take on board (or be reminded of). Plato, Aristotle, Aquinas, and the Scholastics, are buried in continuing economic thinking, despite the best efforts of modern economists to purge anything that cannot be modelled mathematically.

Rulers prefer subjects who submit to their rule by identifying their self-interest with the Sovereign, and still today they seek enforcement of their writ where their subjects do not do what is wanted of them (in Britain and the US we have petty bureaucrats, in Iran we have black-clothed thugs on motor-cycles, in Pakistan, police with canes, and China their versions of the Gulag). Learn about the past and you understand the present.

Steve covers Scholastic thinking neatly, with comments on much Christian thinking (the will of God) and how it related to, then, contemporary problems of taxation, the sovereign’s appetite for expenditure, regal lifestyles, monuments to their greatness, and the morality of borrowing (usury debates). Into this mix the self-interest of commoners and crown conflicted (the king debased his currency and his subjects ‘clipped’ it), as they did in debates over private and public property (sound familiar in echoes of the tragedy of the commons?).

As the power of the state increased from the 16th century, Steve notes that the influence of theologians declined and that of merchants rose (11), the latter with a self-interested motive to try to influence government policy, based on the well-known (and perpetuating knack for presenting their otherwise blatant self-interest in terms that appealed to the ‘national interest’, which was of greater concern to the sovereign than the petty wishes of seedy merchants). It was, and still is, the way of the lobbyist.

A small quibble emerges for me in Steve’s assertion that the term ‘mercantilism’ was coined in the 1760s (11); I have always understood that it originated from the German word in late 19th century and transferred to English from the late 19th century.

Of no doubt though, the critique of mercantile policy emerged in the late 18th century, particularly in Smith’s Wealth Of Nations in Book IV. While often presented as a critique of bullion accumulation, it goes much deeper than that, summed as the policies associated with what Hume called ‘Jealousy of Trade’.

Steve’s account of the debate is another example of his masterly exposition style which makes the subject interesting (11-13).

The subject is a clear example of the self-interested actions of individual merchants, in alliance with legislators and those who influenced them, that were, in Smith’s and in others’ view, contrary to the national interest.

Self-interest, clearly, does not necessarily result in some way in the public interest (and it remains a mystery to me why proponents of such a view continue to attribute it to Adam Smith – presumably they have never read Book IV!).

If you are not sure what the issues were (and, regrettably still are today) in the mercantile policy debate, Steve’s exposition will remove all doubts and uncertainties. He quotes from the inimitable Jacob Viner to great effect (13) on the appeal of mercantile advocates to Providence for chauvinistic support for their doctrines.

Moving on to the Physiocrats and the economic policy regime of Jean Baptiste Colbert (1619-83), Steve uses 17th-century France as a case study in all that was wrong with mercantile interventionist policy. He discusses their strong points (identified by Adam Smith, who admired them personally) and their ‘errors’ - the superiority of agriculture (produit net) versus the ‘sterility’ of manufactures. They related their ideas to their version of ‘natural law’. (15) As Steve points out the Physiocratic programme required a strong state led by ‘experts’.

This brings Steve to Adam Smith and his works.
However, apologies (I am supposed to be on holiday, and family demands on my attention interrupt my section on Adam Smith - I shall finish it tomorrow and post it then.

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A Book Review Suggestion

The Hesitant Hand: taming self-interest in the history of economic ideas
Steven G. Medema, Professor of Economics, University of Colorado, Denver; pp 230, Princeton: Princeton University Press, ISBN 978-0-691-12296-2, £24.95

I received Steve Medema's book for review and shortly into it I realised that it is more than ‘just-another-book-on-economics-to-join-dozens more'. It is an excellent, unique book worthy of detailed consideration by economists, historians, political scientists, and social commentators trying to make sense of the way the world works by unravelling the past, recent past, and present at a time when events are throwing up questions about the central ideas that mould the actions of all of us, conscious of them or not.

Its central theme is the idea of self-interest and to what extent interpretations of that idea have shaped explanations, and expectations, of the behaviours ostensibly flowing from it.

The usual two-page review would not do justice to Medema’s scholarship, or his fluency as a writer (for ten years he was the editor of the Journal of the History of Economic Thought and those editorial skills are evident in his selection of which contributions to his book’s subject are crucial from those that are merely interesting).

Therefore, I propose to review ‘The Hidden Hand’ in several contributions to Lost Legacy.

I invite readers to add their comments and contributions as I go through it – it’s a long canter of a journey from Adam Smith’s predecessors to recent debates – and I invite your comments and contributions as my familiarity with some current scholarship is thin enough to warrant your assistance.

I have almost completed my first review-contribution and shall post it this week.