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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