RICARDO HAUSMANN ON STATES AND MARKETS

“The disappearance of Malaysia Airlines Flight 370 shows how wrong Smith was, for it highlights the intricate interaction between modern production and the state. To make air travel feasible and safe, states ensure that pilots know how to fly and that aircraft pass stringent tests. They build airports and provide radar and satellites that can track planes, air traffic controllers to keep them apart, and security services to keep terrorists on the ground. And, when something goes wrong, it is not peace, easy taxes, and justice that are called in to assist; it is professional, well-resourced government agencies.

All advanced economies today seem to need much more than the young Smith assumed. And their governments are not only large and complex, encompassing thousands of agencies that administer millions of pages of rules and regulations; they are also democratic — and not just because they hold elections every so often. Why?

By the time he published The Wealth of Nations, at the age of 43, Smith had become the first complexity scientist. He understood that the economy was a complex system that needed to co-ordinate the work of thousands of people just to make things as simple as a meal or a suit.

But Smith also understood that while the economy was too intricate to be organised by anybody, it had the capacity to self-organise. It possesses an "invisible hand", which operates through market prices to provide an information system that can be used to calculate whether using resources for a given purpose is worthwhile — that is, profitable.

Profit is an incentive system that leads firms and individuals to respond to the information provided by prices. And capital markets are a resource-mobilisation system that provides money to those companies and projects that are expected to be profitable — that is, the ones that respond adequately to market prices.

But modern production requires many inputs that markets do not provide. And, as in the case of airlines, these inputs — rules, standards, certifications, infrastructure, schools and training centres, scientific labs, security services — are deeply complementary to the ones that can be procured in markets. They interact in the most intricate ways with the activities that markets organise.

Comment

I do not intend to conduct a line-by-line polemic against Professor Hausmann’s rich tableaux of ideas, mainly because I agree with many of them.  I prefer instead to place his ideas in context where I agree with him and why, simultaneously, I differ on aspects of his thinking, not least where I believe he misses important aspects of Adam Smith’s thinking, given the information he had in the 18th century that can be reframed today to bridge the initial gulf between Hausmann and me to a clearer understanding.

First, let us agree that all human societies have had some instrument in their arrangements that performed roles to which we attribute in the modern world to states.

In the simplest human groups, bands, tribes and such like, modern words like ‘government’, or ‘state’ can be misleading and missed when the governing ‘agency’ is not as visible as it is today.  In short ‘states’ have always existed vested in a single individual or family or group of elders.  Somehow, the group of hunters or gatherers each morning have to decide in which direction to go to hunt or gather their food.  Anarchy has never been a viable survival strategy, though no doubt tried from time and circumstance.

Leaping forward, with population and economies emerging, the idea that markets can be perfectly free is illusionary, and therefore political, as is the opposite ideology that states can exist and grow without any vestige of markets.  (Plundering neighbours is not a viable strategy). The empirical evidence is all around in performance (stagnant GDP/per head and in the ruins of past civilisations ran by oligarchies).

Only commercial markets have enabled civilisations to perform for a while, sometimes millennia long, and modern tourists can visit them as spectators and wonder at their stone detritus spread around the ancient world.  But only democratic states with commercial sectors can subsist and grow in GDP/capita at the historically high levels experienced under what is called ‘capitalism' with entrepreneurial innovations, albeit in ‘managed markets’ when the ‘statists’ (social-democrats) turn to government and ‘freer’ markets when its the ‘(soft) Libertarians’ turn in government.

Stable democratic governments under the rule of law and justice (Smith’s initial thinking) work. The rest don’t.

So much I agree with Ricardo Hausmann.  It would help if he would read Adam Smith and not be influenced too much by modern epigones as represented in the sentence of complex economies possessing “an invisible hand", which operates in markets. Bluntly there is no “invisible hand” as understood today.  It does not exist and a moment’s reflection (OK, perhaps several moments) would show this. 

Market prices … provide an information system that can be used to calculate whether using resources for a given purpose is worthwhile — that is, profitable.”    But that has nothing to do with Smith’s “invisible hand” (see Lost Legacy passim).  True markets operate by “prices” as Smith showed.  What does an “invisible hand” metaphor add to this truth?  And Smith never said it did.  

By “invisible hand” Smith referred to the hidden and disparate motives of agents who act in accordance with their motives which “leads” them to act, nothing more! (The story of why modern economists came to believe in the myth of the IH see Gavin Kennedy, (2010): ‘Paul Samuelson and the Invention of the Modern Economics of the Invisible Hand’, History of Economic Ideas. XVIII (3) 105-19.) 

Smith added that their motivated actions had both “intended consequences" and “untended consequences”, which seems to have confused some modern economists into believing this was the “invisible hand”.

Hausmann is absolutely right: “Profit is an incentive system that leads firms and individuals to respond to the information provided by prices. And capital markets are a resource-mobilisation system that provides money to those companies and projects that are expected to be profitable — that is, the ones that respond adequately to market prices.” 

Again with VISIBLE prices there is absolutely no need for the metaphor of “an invisible hand” for markets and economies to work. But we need States to exist for markets to operate - liberty and justice and, where necessary, “regulations” for them to work safely and honestly.

That is why I present the necessary dual role of markets and government as: “markets where possible, state where necessary”.

On that basis, I can agree with Ricardo Hausmann as a SMITHIAN libertarian social democrat and I can recommend readers to read his blog post” RICARDO HAUSMANN, 28 MARCH, on Business Day Live HERE