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Democracy Against Capitalism: The Separation Of Politics and Economics

Democracy Against Capitalism is a collection of essays written by Ellen Meiksins Wood. In the first essay, she says that many contemporary Marxists have abandoned the historical materialism which is central to Marx’ own thought. Here’s how she describes historical materialism:

A materialist understanding of the world, then, is an understanding of the social activity and the social relations through which human beings interact with nature in producing the conditions of life; and it is a historical understanding which acknowledges that the products of social activity, the forms of social interaction produced by human beings, themselves become material forces, no less than are natural givens. (Kindle Locations 491-494.)

This seems uncontroversial, in fact It’s really hard to believe anyone disagrees without relying on some other human-made theory.

She illustrates this idea with a sketch of the history of the development of capitalism, showing how capitalism separates politics and economics. This isn’t about the academic study of these fields, but about the way capitalism flowed from earlier times, primarily in the UK.

She starts with the proposition that a central problem for any society is producing the necessities of life and allocation of the production among members. That decision is political, not economic. The explanation begins with a definition of the state as the “complex of institutions” through which society organizes itself. This organization is an instrument of power, and exercises coercion through various means, including violence. Smaller social units, families or clans, owe certain common duties to the whole.

She says that in the earlier times, decisions about production and allocation were made by “public or communal authority”. (Kindle Loc. 676).

Whether or not the essential object of the state is to maintain exploitation, its performance of social functions implies a social division of labour and the appropriation by some social groups of surplus produced by others. It seems reasonable to suppose, then, that however this ‘complex of institutions’ came into being, the state emerged as a means of appropriating surplus product – perhaps even as a means of intensifying production in order to increase surplus – and as a mode of distributing that surplus in one way or another. Kindle Loc. 597.

I’m not sure what to make of this quote. She cites a book by Marshall Sahlins, Stone Age Economics for this proposition.

In the imperial period of Roman government, the supremacy of private property was reasonably well established, When the Roman Empire broke up, the state fragmented. Local feudal lords maintained control by a combination of feudal rights under whatever was left of a central authority, the offer of protection to the local people, and brute force.

Feudal Lords carried out the functions of the state in vestigial form, dispensing justice and providing and organizing defense, social responsibilities that went with their control over production and allocation. Gradually the central authority regained strength, and Feudal Lords ceded some of their duties and powers, but not control of the land or the work done by the people on the land or the right to control allocation of production. The story continues to the present, with the owners of private property maintaining their power to organize production and expropriate the surplus for themselves through their absolute right of control and ownership.

Wood only provides a sketch, and my retelling is a sketch of a sketch, but it’s compelling once you grant the premise that decisions about production and allocation are political issues. Of course, we don’t know how our Stone Age ancestors handled these things. Even so, the assertion that matters of organization of production and allocation of the products is a social matter is quite reasonable. After all, the rules that force that outcome are upheld by the power of the state, through violence and otherwise.

From there, the part of the story that starts in Feudal societies makes good sense. A lot of this history can be seen in the fights over English Land Law, the change from a political system where the king owned all the land to vesting of full title in aristocrats and eventually in the hands of ordinary people. Here’s the Wikipedia version.

This story helps us to see how we got to the place where absolute control of private property became central to our social structures. It wasn’t inevitable. The story is quite different in other countries. For example, in France, the King maintained his central role in the economy much longer, until the French Revolution. For an interesting discussion of the role of the King in the bread markets of France, particularly Paris, see Bernard Harcourt’s excellent book The Illusion of Free Markets, which I discussed here. Harcourt also discusses the arrangement that government should control punishment.

Perhaps as a result, even today the state plays a larger role in the French economy than in the US or the UK. As an example, the telecommunications businesses there are privately owned, but the government regulates the business tightly and insures competition. That keeps prices very low, and services high.

Along with the power to organize production, the capitalist system gives private interests the absolute right to whatever profits it can extract. This fact has such a long history, it appears to be the result of impersonal natural law to economists and others. In part this is because the absolute right to profit is hidden inside the absolute right to property. To the workers, the struggle for wages appears to be an economic struggle, not a political one. To the State, it means that there is little legislation and little regulation to protect ordinary citizens as workers or consumers, or the land, and the courts are always ready to strike down the new laws or to construe them so narrowly as to make them useless. And for most of its history, the US has seen fit to allow private interests to control Polanyi’s third fictitious commodity, money.

When economics began to emerge as a separate academic discipline in the 19th Century, it confronted this situation, and never questioned any of the social structures it found in place, especially the right of owners of capital to extract all profit, control the organization and production of most goods and services, and control the lives of the workers. The existing structures were written into the foundations of the two separated disciplines.

The leftist view, that such decisions are political, continued into the New Deal era, when government began to side with the workers and ordinary people. One landmark piece of legislation was the pro-union Wagner Act. Then, in the 1970s, Democrats joined what C. Wright Mills called the Capitalist Celebration, embracing capitalism as explained by economics. This led to the New Democrats, the Third Way Dems, the Blue Dogs, and the rest of the corporatist Democratic politicians. For the last 40 years, no one has seriously questioned this allocation of power.

There is a curious divide in the understanding of the allocation of production. Workers who own farms, for example, or artists, consider that the things they produce belong to them, and can be used or sold by them without regard to others. Workers who work for other people never make that connection. They do not think of the things they produce as theirs, or even partly theirs. They just assume that these things belong to the owners of capital. But consider this. Suppose a person who works for a tech company dreams up a new idea. Who owns that new idea? Probably the worker has the better claim. As a result tech companies routinely make employees sign contracts giving them ownership, and even that is not necessarily conclusive.

If all workers thought of themselves as having claims to their work product, we’d have a different kind of capitalism.

The Productivity Problem

Productivity growth is apparently trending downward around the globe. The problem is addressed in Focus Economics, Why is Productivity Growth So Low: 23 Economic Experts Weigh In. The author, whose name I can’t find, begins by explaining the problem as economists see it.

Productivity is considered by some to be the most important area of economics and yet one of the least understood. Its simplest definition is output per hour worked, however, productivity in the real world is not that simple. Productivity is a major factor in an economy’s ability to grow and therefore is the greatest determinant of the standard of living for a given person or group of people. It is the reason why a worker today makes much more than a century ago, because each hour of work produces more output of goods and services.

It’s certainly true that the concept is important. The simple definition gives us the rough idea but the details are very difficult indeed. The text gives us the example of productivity at a branch bank.

Bill Conerly put it well in an article for Forbes: “Take banking, for example. Your checking account is clear as mud. The bank provides to you the service of processing checks, for which you don’t pay (aside from exorbitant fees for bounced checks and stop-payments). However, the bank does not pay you a market rate of interest on the money you keep in your checking account. It’s a trade: free services in exchange for free account balances. Government statisticians estimate the dollar value of the trade, so that the productivity of bankers can be assessed, but the figures are not very precise.

At least in that example, we can see how productivity improvement at a bank might improve your standard of living, perhaps indirectly by enabling the bank to pay a bit more interest on your checking account. Here are three different kinds of examples, in which we can see how improvements in reported productivity result in worse outcomes for us.

Productivity is defined as the ratio of output to hours worked. Output is measured by receipts to the producer. Hours worked are collected by the Census Bureau.

1. A pharmaceutical company raises the price of its generic drugs with no change in its costs. Its receipts go up while hours worked remain the same. Under the definition, productivity goes up.

2. A high frequency trading company inserts itself into an increasing number of purchases of securities on stock exchanges. The purchaser pays a higher price. The HFT company has higher revenue but hours worked remain the same. Again, by this definition, productivity goes up.

3. Two dominant corporations in the same industry merge. The new company fires a lot of people. Hours worked go down. Prices remain the same in the short run, and rise as the new entity exercises oligopoly power. With hours down and receipts up, productivity rises by definition.

Are these examples realistic? In the medicine example, this article lays out the issues. For those interested, this chart shows the value of pharmaceuticals and medicines shipped by manufacturers beginning in 2000. It shows that there was a steady rise, with a sudden jump in 2013. This chart shows that per capita expenditure on pharmaceuticals and other medical products has nearly doubled since 2000.

It’s likely that there are several causes for this, not least the startling prices sought for new drugs. Government productivity figures do not take into account any improvement in the results that new drugs bring, although quality adjustments are made in calculating inflation figures. Given the increased pressure from insurers and doctors to switch to generics, and increased focus on drug prices as a problem, it’s reasonable to see this data and various reports as support for my drugs example. But it’s hard to put a dollar value on it.

On the second example, here’s an article from CFA Magazine written in 2011, detailing the costs of high frequency trading. More recent reports say that the problems are going away, and who knows because it’s hidden behind a wall of words mostly from the people who run the systems and their friends at the exchanges, and the captured SEC. Here’s a review of the literature (behind a paywall), which concludes with this: “This suggests that the identified economic benefits of HFTs (market making, venue competition, more trading opportunities) outweigh their economic costs (large-order predation and run games).” For my purposes, it’s clear that the older article tells us that initially, at least, HFT operated as my example suggests, raising productivity without doing anything useful.

As to the third example, the impact of private equity on employment is everywhere, and the concentration of economic power in oligopoly control of most industries is obvious. Dave Dayen has been writing about it for some time; here’s a recent example. Oligopolistic control also reduces paychecks for the remaining workers.

In these examples, and I could produce many more, productivity as defined by economists goes up but individual consumers are worse off. That is maddening. Once upon a time, we might have thought we could just ignore this kind of thing as an insignificant part of GNP, but that’s not true today, either in the US or globally. The economy, measured by output, is growing, but it is the opposite of the notion of productivity as good for society: it makes people’s lives worse. Except, of course, for a few rich people.

My three examples are exercises of market power. Here’s a long but worthwhile discussion of the harm it does and its increasing presence in the economy. Market power is not the same as rent-seeking, which is usually defined as an effort to get the government to give special treatment to one of a number of competitors. Both are damaging and both inflate productivity figures.

My examples show that reported productivity growth is most likely higher than the kind of productivity growth that the author discusses, the kind that increases the amount of goods and services available in the economy. It’s not unusual for an economics writer to assume only good people operate in the capitalist economy, and ignore the crooks and the cheats. Suppose the author is right that rising productivity that makes for a better life. If real productivity growth is even lower than the low reported productivity growth, his logic explains why life is getting worse for most of us.

Who Cooked Adam Smith’s Dinner?

Who Cooked Adam Smith’s Dinner? is the title of a 2012 (2016 in the US) book by Katrine Marçal, a Swedish journalist. The title question is based on a famous bit from Adam Smith’ The Wealth of Nations*:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

But the butcher, the brewer and the baker did not cook for Smith. That job went to his mother, Margaret Douglas, later joined by his cousin, Jane Dauglas. These women took care of Smith’s household until they died. Smith never mentions their labor.

Marçal explores the impact of Smith’s omission on the study of economics. One thread is the feminist story: much of the crucial work of care is provided through benevolence, not for money, and so it not considered part of the economy or part of the field studied by economists. Marçal points out that when an economist marries his housekeeper, the GDP goes down.

Smith’s omission makes ti possible to make “markets” the center of the study of economics. Eventually theorists dreamed up the silly story of Homo Economicus with his rational calculation of individual advantage as the essential human characteristic. We identify that rationality as masculine as opposed to feminine in the context of male-centered history and culture. In feminist terms, homo economicus is ungendered and dominant; women are the other in every way.

Instead of this stunted theory, Marçal shows that the economy isn’t just about the production of things for the market. A huge part of the work of any society is care for one another. We care for children, for the aged, the sick, the abandoned, the orphan and the widow, those injured in war and those injured in mind. We care for our planet, our air, our parks and our public spaces, our cities, our lakes and rivers. Much of that care has nothing to do with markets. We do it solely out of benevolence, in direct contradiction to Smith.

If economists are ignoring the importance of care in the functioning of an economy, what are they doing? They tell us that they study the allocation of scarce resources. This is from the introductory textbook Economics by Samuelson and Nordhaus, 18th Ed. 2005:

Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. Id. at 4.

Scarcity and efficiency are the important elements of this definition. Care for the vulnerable must not involve a scarce resource under this definition, probably because everyone blithely assumes that women will do it for free, and there are plenty of women. Importantly, care isn’t controlled by the demands of efficiency. If the baby cries, what does it even mean to talk about efficiency? We do whatever it takes and for as long as it takes. So taking care of each other is excluded from the study of economics from the outset under Samuelson’s definition.

In his textbook Introduction to Macroeconomics, 6th Ed. 2012, N. Gregory Mankiw quotes the 19th C. British economist Alfred Marshall: “Economics is a study of mankind in the ordinary business of life.”. Id. at viii. I’d guess Marshall meant “Malekind”. Mankiw adds that The word economics springs from a Greek word meaning household, and he talks about how households have to make decisions about who goes to work and who cooks, and who gets the extra dessert. Then he drops the idea that cooking dinner is part of the economy. Apparently when Mankiw talks about the ordinary business of life, he means “male business”, not changing poopy diapers or making dinner. It’s funny when you see it from the perspective Marçal demonstrates.

Of course Marçal is right to say that economics ignores a huge chunk of the work necessary to maintain us in the ordinary business of our lives. That doesn’t make it useless, to be sure. Marçal points out the utility of the data and statistics gathered by economists. But it does mean that the models economists are creating are likely to be useless because they purposefully ignore a crucial element of ordinary life. And it means that economics isn’t a plausible basis for thinking about human nature.

The book is informed by feminist theory, but it isn’t theoretical. It is an application of feminist theory to economics. Marçal uses uses words like “gendered”; and she writes:

It’s only woman who has a gender. Man is human. Only one sex exists. The other is a variable, a reflection, complementary. P. 159.

Then she gives concrete examples that make the meanings perfectly clear for people like me who don’t know anything about feminist theory. The result is that I began to leann a little about the theory, and it was much easier than trying to learn it on my own from primary sources**.

Marçal devotes several chapters to eviscerating the economists dream person, Homo Economicus, the ungendered center of their universe, the Man we all must become. These chapters expose the shallow thinking that neoliberal economists like Gary Becker bring to the discussion of human nature. She makes neoliberalism look childish and silly. I particularly liked the discussion of the hidden emotional vulnerabilities of neoliberal Man. We have to coddle Mr. Market, and steady him when he gets the jitters, which happens all the time, and which, of course, requires tons of money.

Marçal writes clear, direct and engaging prose. Like every good book this one clarified several inchoate ideas that have been floating around in my head, and it gave me several new ideas I hope to take up in future posts. I am grateful to my excellent daughter who gave me this book.

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* Here it is in context. I leave for my skeptical readers the pleasure of picking at the holes in this passage.

// In almost every other race of animals, each individual, when it is grown up to maturity, is entirely independent, and in its natural state has occasion for the assistance of no other living creature. But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and shew them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages.//

**Another good book for this purpose is Possession, by A.S. Byatt.

The Great Transformation Part 2: More on Markets

The first two posts in this series are:

The Great Transformation: Mainstream Economics and an Introduction to a New Series

The Great Transformation Part 1: The Market

In Part 1 I discussed the definition of markets in The Great Transformation, and noted that Karl Polanyi gives a definition, while mainstream neoliberal economic theory doesn’t. The absence of a definition in neoliberal theory is crucial to its success. Neoliberal economists do not have to account for the vast differences among markets: they can treat all markets as identical for purposes of their mathematical edifices.

Polanyi’s simple definition enables him to discuss the differences among markets and the different purposes they serve in different societies. In the Mercantilist era, say up to about the early 1800s, Polanyi identifies three different kinds of markets: external, internal and local. Local markets serve the local community as in the case of householding societies. Polanyi says they are not intrinsically competitive, nor are they focused on gain. P. 61

External markets are for long-distance trade, what Polanyi identifies as the carrying trade. They form at natural stops along the trails of transport, at river crossings and ports. They do involve gain, and the propensity of some people for truck and barter, but they are limited to specific sites and specific goods. They are not essentially competitive, Polanyi says. Over time, long-distant market sites turn into towns, and their principle purpose is to manage external trade. They are not a function of the nation state, but of those towns, which work to keep their long-distance markets apart from the lives of those in the countryside.

The [Hanseatic League] were not German merchants; they were a corporation of trading oligarchs, hailing from a number of North Sea and Baltic towns. Far from “nationalizing” German economic life, the [Hanseatic League] deliberately cut off the hinterland from trade. The trade of Antwerp or Hamburg, Venice or Lyons, was in no way Dutch or German, Italian or French. London was no exception: it was as little “English” as Luebeck was “German.” The trade map of Europe in this period should rightly show only towns, and leave blank the countryside—it might as well have not existed as far as organized trade was concerned. P. 66.

The third kind of market, the internal market, is a deliberate creation of the nation-state. As Polanyi explains it, the towns worked to maintain the separation between long distance and local markets, as a matter of self-protection of the town and of the town officials and elites. They feared the destructive impact of mobile capital on their existing institutions, and on their prerogatives and status.

Deliberate action of the state in the fifteenth and sixteenth centuries foisted the mercantile system on the fiercely protectionist towns and principalities. Mercantilism destroyed the outworn particularism of local and intermunicipal trading by breaking down the barriers separating these two types of noncompetitive commerce and thus clearing the way for a national market which increasingly ignored the distinction between town and countryside as well as that between the various towns and provinces. P. 68-9.

This classification of markets by their reach is convenient for the story Polanyi is telling, but there are modern counterparts. In many cities around the country, but especially in Europe, say Paris, there are local market streets, where you can find your daily food and your minor needs, like a plate to replace the one that mysteriously broke. There are weekly or bi-weekly markets where you can find all sorts of things, from a sweater to a giant vat of choucroute garnie, with nearly black juniper berries punctuating the Toulouse sausages and the hunks of pork. These are just like the local markets Polany describes, and just as important to daily life in these otherwise impersonal cities.

Scattered throughout the city, there are stores focused on specific area of France, Auvergne butchers, stores selling Charolais beef, Perigord stores, with their jars and cans of confit du canard, and many others, wine shops specializing in Champagnes or wines from Burgundy. These stores connect people to their roots in the country, and might be regarded as internal markets.

In the wealthier parts of the city there are other kinds of markets. You can find African, Indian and Near Eastern textiles and jewelry, and lots of similar things. There are shops selling Italian shoes and clothes, branded and unbranded. There is fantastic jewelry and jeweled pieces from world makers, and at prices that bug out the eyes. Each of these kinds of stores are grouped together, so that a person searching for antique French furniture only has to visit a few streets to get a good sense of what is available. This view of consumer culture reinforces Polanyi’s view that a market is a place.

Of course, standard economics rejects this simple definition. Here’s a typical reaction, from Santhi Hejeebu & Deirdre McCloskey (H/T commenter Alan)

…Polanyi never got over the noneconomist’s inclination to think of markets as literal marketplaces, rather than relationships among people in many different places…

The authors are both economists, so this is not a mistake. Their definition of a market is “relationships among people in many different places. Let’s try an example. In BKB Properties, LLC v. SunTrust Bank, (MD Tenn. 2011) the owners of the plaintiff wanted a fixed rate loan from SunTrust Bank to build a new building for their car dealership. SunTrust would only agree to a floating rate loan, and offered to sell plaintiff an interest rate swap to create a synthetic fixed rate. Plaintiff agreed. Several years later, when interest rates fell in the wake of the Great Crash, BKB’s owners wanted to refinance the note, and when SunTrust refused, plaintiff exercised its right of prepayment. SunTrust refused to accept the prepayment and release the mortgage on the land unless the plaintiff paid a stiff penalty to cancel the interest rate swap, which had a 10 year term, while the note was prepayable. The Court ruled for SunTrust, saying that this is just a routine contract case, and that the parties are assumed to understand the terms of the documents they signed.

Note that SunTrust could have purchased a swap to protect its interests more intelligently than BKB Properties, Ltd., a shell corporation set up by a car dealer. SunTrust could have canvassed offers from several banks and hedge funds, which at least sounds like a market.

But on the given facts, was this a market transaction? In the world of Hejeebu and McCloskey it certainly is. After all, these are two parties with some kind of relationship who are in different places. Swap creators don’t post prices, don’t disclose transactions in any usable way, and according to the Court don’t have any duties to their customers. The relationships that Hejeebu and McCloskey talk about are limited to Buyer Beware, and that’s good enough for them.

In Polanyi’s world, maybe not. At that time, there was no physical place one could go to buy and sell swaps, at least if you were a car dealer in a suburb of Nashville, TN. Specifically, there was no analogue to the stock market, or an electronic exchange. There was no place to find data, no place to find alternative bids, no quote sheets, and there was often negotiation over the terms of a swap which affected its value to both parties, again with no transparency to outsiders who might have learned of its existence. In sum, there was no place for any activity that sounds market-like.

Definitions matter. Polanyi’s definition gives us a good idea of what he is talking about, and his three kinds of markets are useful and convenient in his analysis. How do we talk sensibly about the “swaps market”? In what way is it like the market for choucroute garnie?

Mankiw’s Principles of Economics Part 3: Rational People Think At The Margin

The introduction to this series is here.
Part 1 is here.
Part 2 is here.

Mankiw’s third principle: Rational People Think At The Margin. His definition is:

Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.” Principles of Macroeconomics 6th Ed. at 6

He defines marginal change: a small incremental adjustment to a plan of action. He teaches that rational people often compare the results of marginal changes to make decisions. Finally we get to his major premise:

A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.

The first example is dinner. The choice, Mankiw says, is not between fasting and eating like a pig, but whether to eat another spoonful of mashed potatoes. At exam time, the choice is not blowing them off versus pulling all-nighters, but whether to put in an hour on your notes or goof off for that hour. His next example is seat prices for airplanes. The airline should sell seats at the price above the marginal cost of flying the passenger. Then we get the water/diamonds example. Water is essential for life, but it’s cheap. Diamonds are an extravagance, but they are very expensive.

All of this is in support of a central element of neoliberal and mainstream economics, that economies can be modeled by treating them as made up of rational agents. This idea fits neatly into Mirowski’s commandments of neoliberalism, specifically number 6: Thou Shalt Become The Manager Of Thyself. This means that individuals must learn to act rationally to decide upon a set of investments in themselves and changes in their behavior that will improve your appeal to people with money so they will give you money to work for them.

The food example is straight-forward enough, but how is the choice made? Some people are raised to clean their plates, and they do even if they could have skipped the last few forkfuls. Some people feel differently about meat than about French fries or carrots. Some people are abstemious, and always leave food. Others make the choice at the outset, by serving themselves a fixed amount and then eating all of it. Suppose the person would prefer to eat the last few bites of pork chop and skip dessert? If all these are rational choices for individuals, what possible generalization about eating is there? What, if anything, can this principle predict? How would Mankiw use that idea to model eating dinner?

The study example is fascinating. I remember my college days, and I ‘m sure I didn’t rationally choose whether to goof off with my friends or to study for finals. I chose, but it was random. And how would you calculate the benefit of one hour of study versus one hour of relaxing? Is that a real possibility?

The airline example is obvious to anyone familiar with basic business principles. It certainly isn’t an indication of “rationality” in the sense Mankiw is using the term. It merely requires an understanding of the difference between fixed costs and variable costs.

Then there’s the water/diamonds example. Here’s Mankiw’s explanation, so you won’t think I’m being snarky:

The reason is that a person’s willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield. The marginal benefit, in turn, depends on how many units a person already has. Water is essential, but the marginal benefit of an extra cup is small because water is plentiful. By contrast, no one needs diamonds to survive, but because diamonds are so rare, people consider the marginal benefit of an extra diamond to be large.

So water is cheap because people have a lot of it? Of course, there is plenty of water in most parts of the country, in our commonly held lakes, rivers, underground acquifers, and water run-off. As a commonly-owned asset, it’s free, if you could get it. But it has to be cleaned, delivered, and disposed of. That means the real question is why do we have a lot of clean water at the tap and few diamonds? The real reason is that our ancestors decided to make sure we all had clean water to drink, and explicitly chose to keep the “free market” out of it.

There are plenty of diamonds, though they are hard to find and dig up. The diamond business is controlled by a monopoly that artificially restricts the supply. Our ancestors made sure that didn’t happen to water. To see this clearly, think about the price of a bottle of water at the movies. There we have artificial scarcity, produced by the theater’s policy against bringing in snacks. Just ask yourself whether you want to buy your water from a profit-maximizing monopoly, say the Comcast or the DeBeers of water. Maybe you’d like to buy your water from the private company that didn’t have a system in place to detect the foul chemicals in the water supply of Charleston, WV?

So now let’s see how this rationality principle works in practice. Consider retirement savings. What would it mean operationally to say that people act rationally when making decisions about saving and preparing for retirement? What does this principle tell them to do? How should they invest? What should they do to protect themselves against losing big in those investments? What happens if they are hurt and can’t work, or if their spouse gets hurt and they need to quit work to take care of them? How do you calculate the value of a dollar today against the value of that dollar in retirement? For a short lesson in the prevalence of financial literacy, look at this paper, or this site.

Finally, it isn’t just one choice. There is a chain of choices in life, each one eliminates other choices and creates new choices and possibilities, each with its own probability of success. In the retirement example, you might have a 75% chance of correctly guessing at how much to save, a 95% chance of getting an honest financial adviser, a 60% chance that the investments will be very successful, and related chances of less good outcomes. Your chances of getting the best result are about 43%, and that’s before you consider the general state of the economy when you need money, continued good health, unexpected possible current uses for your money, good relations with your partner and your partner’s success in contributing, and all the other variables. That tells you that most people will be somewhat successful, a few will be wildly successful, and a fair number will crash and burn. The reality is that most families have very little success, and are dependent on Social Security and Medicare for a decent retirement. Even people who do reasonably well need those social arrangements to secure a good retirement.

This analysis shows that the margin plays little or no role in the lives of ordinary humans. It’s just a construct used to simplify human life in a way that permits economists to justify their use of calculus.

Here are some possible conclusions:

1. This principle makes sense when considered in the very short run, like the mashed potatoes example. For any longer term, it feels more or less random, mostly because there is no way to determine the probabilitiies. Some people get lucky and win the game of life. Others don’t get lucky. The number of things that seem perfectly rational at a point in time either work, or they don’t, and the results are unpredictable. That accords with my understanding of markets as minute by minute affairs. In the longer run, investment and housing markets are a real threat to the marginal thinking of Mankiw’s rational people.

2. We all want to think we are pursuing their goals systematically and purposefully, Mankiw’s definition of rational people. We want to believe our success is the result of their personal skill, and many people apparently feel justified in looking down on, and even punishing, the losers. I’d say the reality is that it’s better to be lucky than rational.

2. By deciding that the economy is full of rational people, the door opens to armchair speculation. Hmmm, says Mankiw, if I were faced with a bowl of mashed potatoes, here’s how I’d decide how much to take. I’m rational, so that means everyone would act that way. So, I’ll model mashed potato eating based on purely rational me. In exactly the same way, they figure out how they prepare for retirement, and draw conclusions about the way rational people act and build that into their models. No.

3. I do not think this is the definitive discussion of the role of rationality in human decision making. The entire subject of rational agents has been subjected to criticism on philosophical and practical grounds, and I hope to get to it at some point.

Paradigms in Economics

I am fascinated by the fact that economists do not seem fazed by the failure of their almost unanimous policy recommendations of deregulation and tax cuts, as I discuss here and here. Almost in unison, they chanted for decades that reducing taxes and regulation would spur growth for the benefit of all of us. The Great Crash didn’t faze them, as these posts show. So why not?

One plausible explanation is that these people are acting in bad faith in the sense Sartre uses this term. They are free to change their minds about their theories, but they are not willing act on, or even to face, that freedom because it might cost them something. This explanation seems to be behind several of Paul Krugman’s recent columns and blog posts, asking how people can have a claim to expertise when they give the same advice no matter the circumstances, and when the evidence and even the structure of their explanations contradict their advice. I think there are plenty of intellectually dishonest economists, but surely there are plenty of intellectually honest economists too.

After my previous posts a correspondent suggested I take a look at Thomas Kuhn’s The Structure of Scientific Revolutions. In the wake of Kuhn’s book, a number of scholars attempted to apply the theory to economics. I think it’s helpful to look at the failures of economics through this lens.

Kuhn starts by describing what he calls normal science: the day to day practice of scientists. Their work is based on an infrastructure consisting of theories of various strengths, instruments, and techniques that together make up a paradigm. This paradigm organizes their thinking so that they have an idea of what they are doing when they do physical and thought experiments. Kuhn says that normal science uses the paradigm to solve puzzles. The puzzles themselves are set up by the paradigm, and the scientist expects to be able to solve them using the rules and equipment of the paradigm.

Here’s an example. One of my brothers was a scientist with a deep interest in the transmission of pain through the nervous system to the brain, and in analgesics, pain-killers. In the 80s, he began to wonder about the pain-killing effect of marijuana. Here’s a reasonably comprehensible paper he co-wrote in 2001, discussing the state of work on cannabinoids.

In the paper he talks about single-cell studies. We talked about this a couple of times while he was doing this work. He told me that his lab had worked out a technique for inserting a tiny filament into a brain cell of an anesthetized rat and counting how many times and how often it fired, and some other things about it. He explained how he thought that happened, and what it meant physically. He described the instruments he used in general terms, and some of the interesting ways he was using computer chips to monitor the results. I asked why. I thought it might be useful, he said.

For him, neurotransmission of pain was a huge puzzle. He wormed away at it most of his adult life. Each little step he took seemed likely to advance a detailed understanding of the puzzle, or create an instrument that might help him and his colleagues take another step. A giant puzzle. A game. The same things were going on in other labs, as the footnotes show. One of the researchers he cites wondered if the body generates substances like cannabinoids. That guy found an endocannabinoid, a naturally occurring cannabinoid, which he named anandamide, from the Sanskrit word for internal bliss. Not only a puzzle, but an opportunity for cool puns.

Kuhn’s examples are older, and from physics and chemistry, but they exhibit the same pattern. In both cases, normal science depends on a collegial understanding of the instruments, the things being measured and a shared general understanding of the way the thing being studied works.

Kuhn offers three foci of normal science: learning about the facts that the paradigm suggests are most revealing about the nature of things; facts that can be used to check the paradigm; and empirical work to articulate the paradigm in the greatest possible detail, clearing up ambiguities and reaching for further problems suggested by the paradigm.

How does economics fit into this picture? What is the paradigm? What are the problems economists are trying to solve? What is “normal economics”?

Here’s one explanation from David Andolfatto of the St. Louis Fed:

But seriously, the delivery of precise time-dated forecasts of events is a mug’s game. If this is your goal, then you probably can’t beat theory-free statistical forecasting techniques. But this is not what economics is about. The goal, instead, is to develop theories that can be used to organize our thinking about various aspects of the way an economy functions. Most of these theories are “partial” in nature, designed to address a specific set of phenomena (there is no “grand unifying theory” so many theories coexist). These theories can also be used to make conditional forecasts: IF a set of circumstances hold, THEN a number of events are likely to follow. The models based on these theories can be used as laboratories to test and measure the effect, and desirability, of alternative hypothetical policy interventions (something not possible with purely statistical forecasting models).

In previous posts I note that recommendations arising from models that do not and cannot predict crashes is worse than useless, it’s downright dangerous. Another kind of problem is that there are big disagreements about the models: whether the assumptions are correct, what they actually model, how they do it, why and whether they work and under what circumstances. Further, there are a number of schools of economics each with its own models and its own set of assumptions, overt and covert. In fact, it isn’t quite clear what the economics paradigm is, or are. These and other issues are for another day.

Will Economists Replace Lawyers as First Against the Wall?

The field [economics] is filled with anxious introspection, prompted by economists’ feeling that they are powerful but unloved, and by robust empirical evidence that they are different.
The Superiority of Economists, by Marion Fourcade, Etienne Ollion and Yan Algan.

In this post at Naked Capitalism, I explain that one big reason normal people don’t love economists is that they refuse to take any blame for causing the Great Crash. As a group, economists insisted that it would be great to tear down the New Deal financial regulatory system, without ever considering the potential costs of a crash. It wasn’t just that their models didn’t predict the Great Crash, it’s that their models won’t ever predict crashes. Until someone got around to tweaking them, their models did not even predict the damage a crash might cause. They had no way to evaluate the costs of crashes, but they ignored those costs, mostly on ideological grounds. They insisted to policy makers, legislators, regulators and politicians, and not least, their wealthy supporters, that things would be great if we just got rid of regulation. They were proven absolutely wrong. Then they insisted that more of the same garbage was the right solution, and their supporters agreed. And so it came to pass that we got a lousy recovery that only benefited their patrons. But that’s hardly the only reason people don’t love economists.

You’d expect some self-criticism from even the most narcissistic economists in the wake of their utter failure, but that didn’t happen. Here’s an interview of Gary Becker of the University of Chicago in December 2010 by economist Catherine Herfeld who begins by asking him whether the economics profession is in crisis. No, says Becker. Economists might begin to consider some mildly different problems, maybe, but no. Models can’t be expected to predict crashes, he says, and people respond to incentives. Economists already knew those things, so the Great Crash has no lessons for them.

Almost all economists agree with Becker’s two points. Their models and their methodology are not a problem, and do not require major changes. One crucial assumption of economists is that consumers are rational actors. When Herfeld presses Becker on the issue of the validity of that assumption and the risks that assumption entails, Becker explains so what? What’s your theory? “You need a theory to beat a theory,” he says. Policy advice based on Becker’s theories has been tried out. That advice sucks. We’d have been better off doing nothing than crashing the economy as an empirical test of his assumptions and the theories based on them. So, no. You don’t need a theory to beat a theory. Adults change their minds when their ideas fail. That’s another reason people despise these guys.

But that kind of intellectual arrogance is typical of economists, as we learn from The Superiority of Economists, by Marion Fourcade, Etienne Ollion and Yan Algan. The authors show that as a group economists are known for their absolute confidence in their ability to understand the economy and prescribe for us lesser mortals. They also show that economists are an insular group, not much interested in the work done in other fields of study. Here’s a demonstration of that. Herfeld asks Gary Becker this question:

[R}ationality is a concept that originated in philosophy and its various economic formulations and uses have been discussed extensively in the philosophical literature on the methodology of economics, such as by Alexander Rosenberg, Philip Mirowski, D. Wade Hands, and Mark Blaug. Were you ever interested in that literature? Or where did you get inspiration from when thinking about improving how rationality is conceived of in economics?

[Becker] Primarily, I get inspiration from my own discipline, economics. For example, I wrote my doctoral dissertation on racial discrimination. …

Becker can’t see any reason to learn what scholars in other fields think of rationality, or, apparently, racial discrimination, or anything else, for that matter, because, you know, he was a student of Milton Friedman, and he read Popper and Carnap. The rest of this answer and the next few show how Becker conceives of the intellectual life. It is exactly what Fourcade et al. describe, insular, hierarchical and to me at least, undeservedly arrogant. They describe the influence of economists in a lengthy section including this:

The upshot of economists’ confident attitude toward their own interventions in the world is that economics, unlike sociology or political science, has become a powerful transformative force. Economists do not simply depict a reality out there, they also make it happen by disseminating their advice and tools. In sociological terms, they “perform” reality. Aspects of economic theories and techniques become embedded in real-life economic processes, and become part of the equipment that economic actors and ordinary citizens use in their day-to-day economic interactions. In some cases, the practical use of economic technologies may actually align people’s behavior with its depiction by economic models. By changing the nature of economic processes from within, economics then has the power to make economic theories truer. Cites omitted.

So, there’s a third reason to loathe economists. They think human nature can and should change to match their models and their value systems, which are based on economic efficiency and unfettered markets. I don’t agree. Among other things, as I discuss in detail here, markets deal only with short run decisions, not with the long-term consequences of those decisions, which can easily lead to disastrous results. Just ask yourself how markets will allocate precious ground water in California, and ask how many almonds and how much cheap oil today are worth the end of the water supply that grows much of our food.

Here’s the fourth reason. Of course people respond to incentives, though that’s just one of a large number of influences on decisions. The question is who comes up with the incentives. Becker points out that people who took out subprime loans were responding to incentives, as if those borrowers caused the Great Crash. Who set those incentives up? Was it the poor people who got clobbered by those loans? Of course not. It was the lenders who were freed from all restraints by economists and their enablers among the rich and the politicians. Those economists who provided the policy justifications had no conception of the risks they were encouraging others to take while they pocketed their consulting fees. And after the crash, they, and specifically Becker, defended themselves by blaming the victim.

No wonder normal people don’t care for these people.