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IV: IV Economic Schools and Analysis - Leonard P. Liggio, Literature of Liberty, April/June 1979, vol. 2, No. 2 [1979]

Edition used:

Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.

Part of: Literature of Liberty: A Review of Contemporary Liberal Thought, 20 vols. 19781-982

About Liberty Fund:

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.


IV

IV Economic Schools and Analysis

Economic thought and analysis arose in the West among the ancient Greek philosophers, Plato, Xenophon, and Aristotle, all of whom viewed economic affairs from an ethical and rational perspective. Later economic thought became immeshed in religious doctrines (such as the ban on interest as “usury”), and the marketplace became subject to rival interpretations of God's will. The more secular Greek economic analysis returned to the West, paradoxically, by a harmonious collaboration of Christian, Jewish, and Moslem scholars.

As the “heirs to Greece,” the Arabs continued Greek scientific traditions when they conquered Alexandria in 639. During the ninth century, a Nestorian Christian, Hunain ibn Ishaq (809–872) made Baghdad a center for translating Greek treatises into Arabic and Syriac. Still later, the Arab empire together with the Byzantine Greeks “met together in Western Europe, carrying with them the seeds of the Renaissance.” In particular, Moslem Spain acted as the principal channel through which Greek economic ideas passed into the west (see Marjorie Grice-Hutchinson, Early Economic Thought in Spain 1177–1740. London: George Allen & Unwin, 1978).

The following summaries explore selected strands and issues in economic history and analysis, beginning in ancient Greek economic thought and ranging through the influential Scholastic economic doctrines, mercantilism, economic liberalism, Adam Smith, and the modern period. The last six summaries examine methodological and ideological issues that touch on the nature of economics as a discipline and its relationship to the social sciences, politics, and society.

Ancient Greek Economic Thought

S. Todd Lowry

  • Washington and Lee University

“Recent Literature on Ancient Greek Economic Thought.” Journal of Economic Literature 17 (March 1979): 65–86.

Although many contend that economic science began with either the Physiocrats or Adam Smith's Wealth of Nations in the eighteenth century, significantly the name of economics itself derives from the more ancient Greek discipline of oikonomia, which designated estate management and public administration. The well-known influence of classical Greek literature on European education from the medieval Aquinas to the present day should make us open to the possible contribution of ancient Greek thought on later economics. Even Joseph A. Schumpeter, who dismissed strict economic analysis in Xenophon's Oeconomicus or Plato's writings, recognized in Aristotle's Politics (Book I) and Nichomachean Ethics (Book 5) the “beginnings of formal analytic techniques applied to economic subjects.” Schumpeter further judged that the first five chapters of Adam Smith's Wealth of Nations recapitulated Aristotle's economic contributions on barter, exchange, and the division of labor. Schumpeter, however, overlooked the possibility of subjective relativism in Aristotle's theory of money.

In fact the economic contributions of the Greeks were far more profound than even Schumpeter allowed and influenced such matters as spontaneous market harmony, equilibrium processes, subjective utility, proto-marginalist concepts, and monetary theory. These contributions are discussed in: Henry Spiegel's The Growth of Economic Thought (1971); Glauco Tozzi's Economisti greci e romani (1961); and Barry Gordon's Economic Analysis Before Adam Smith (1975).

Tozzi's volume is especially important since (1) he draws extensively on French and Italian economic history scholarship that has never entered the English tradition; and (2) he poses “the question of an abstract empiricist view of justice, i.e., can justice be built as a social concept from the subjective self-interest of the individual participants in the political structure.” Gordon's work notes the importance of Scholastic interpretations of Aristotle's theory of money exchange as “unnatural” because it was unlimited by natural and moderate human needs. This concept, together with the ancient and invidious comparison between noble oikonomia (public administration of the economy) and morally suspect chrematistike (private commercial activity or wealth-getting) supported the belief that public intervention on the economy was necessary.

Some 124 items of scholarship are cited in this far-ranging and suggestive assessment of ancient economic thought.

Scholastic Economic Thought

Julius Kirshner

  • University of Chicago

“Raymond de Roover on Scholastic Economic Thought.” In Business, Banking, and Economic Thought. Edited by Julius Kirshner. Chicago: University of Chicago Press, 1974.

Scholastic economic thought has frequently been characterized as a forerunner of nineteenth-century socialist economics and a barrier to the development of medieval economic freedom. Others have claimed that the economic teachings of the Scholastics were totally irrelevant to the course of medieval economic history. Max Weber and Richard H. Tawney popularized the belief that medieval men disliked competition, condemned personal profit, and scorned acquisitive activity as a necessary evil. Raymond de Roover's scholarship reveals a far different picture of economic thought and practice during the Middle Ages. De Roover stressed the continuity of Scholastic economic thought with modern views on such topics as monopoly, value, price, and usury.

De Roover places Adam Smith's attack on monopolies within a tradition embracing Aristotle, Roman law, and the Schoolmen. Scholastic monopoly theory rests on the doctrine of just price. The “just price” is the competitive market price, subject to some government regulation. Because monopoly-creating agreements were often thought to result in artificial scarcity and price inflation, monopoly appeared to sin against brotherly love.

The concept of just price, in turn, rested on a subjective theory of value equating value with the relative scarcity of a good and its ability to satisfy wants. In the 1960s de Roover discovered that Scholastic economic writers such as St. Bernardine and St. Antonine had borrowed this concept of utility from a Franciscan, Peter Olivi who lived a life of poverty and led the spiritual party of his order. In addition to a subjective theory of value, Scholastic writers like John Buridan identified and attempted to solve the “paradox of value.”

De Roover challenged Tawney's charge that Aquinas was a precursor of Marx. Aquinas, with most of his contemporaries, held that the just price was the market price. Moreover, this equation was extended to cover wages as well, and Scholastic writers vigorously criticized the medieval guilds for their monopolistic practices.

For de Roover the weakness of Scholastic economics was opposing usury. Yet even here the Schoolmen developed several doctrines that, in effect, allowed loans at interest. One of these was based on a two-tiered theory of money which distinguishes (sterile) pecunia from (fertile) capitale. Since capitale, unlike pecunia, has a seminal quality of generating profit, writers like Olivi, Bernardine, and Antonine countenanced loans of capitale being repaid with interest. A more controversial doctrine, lucrum cessans, allowed a lender to claim a return beyond principal if to make the loan he had given up an opportunity to invest his capital in what appeared to be a profitable enterprise. Finally, the banking and exchange system was used to circumvent the usury doctrine by claiming that the exchange transaction was a buying and selling of foreign currency, not a loan.

Profit, Tawney and Weber notwithstanding, was not viewed as evil per se. Business was a legitimate activity if it performed a socially useful role by manufacturing, transporting, or distributing goods. Profit was seen as compensation for the labor and risks undertaken by the businessman. Schoolmen such as Aquinas, Scotus, Bernardine, and Antonine only condemned the craving of profit as an end in itself.

In sum, de Roover's revisionist portrait of medieval economic thought should lead to a substantial revision of the historical development of economic theory.

Scholasticism and Austrian Economics

Murray Rothbard

  • Polytechnic Institute of New York

“New Light on the Prehistory of the Austrian School.” In The Foundations of Modern Austrian Economics. Edited by Edwin G. Dolan. Kansas City: Sheed & Ward, 1976, pp. 52–74.

Professor Rothbard focuses on the post World War II literature reinterpreting the development of subjectivist-marginalist economics, particularly the Austrian School. The Scholastics played a key role in this development according to the new interpretation. Joseph Schumpeter, Marjorie Grice-Hutchinson, and Raymond de Roover have demolished the view that the Scholastics believed in the labor theory of value, the doctrine of the just price, and the immorality of trade. Instead these revisionists demonstrated that the most important Scholastic thinkers were precursors of the Austrian School of economics, which began in the 1870s.

The Scholastic thinkers specifically denied that labor or other costs determine price, but rather spoke of the scarcity or abundance of goods, and how this supply was valued by the community. In other words, they had discovered the role of utility and scarcity in value determination, lacking only the concept of the margin. They scorned the notion that embodied-labor could or should determine price. On the question of the just price, a number of the Scholastics, including Thomas Aquinas, asserted that the market price is the just price. The Scholastics' view of trade evolved from a position of suspicion to one of support. Trade came to be viewed as mutually beneficial.

The Scholastic views survived the Reformation, influencing even some of the new Protestant thinkers, such as Grotius. Grotius even cited two of the Spanish Scholastics, evidence of the penetrating nature of their analysis. Pufendorf adopted Grotius's economic doctrines, along with his legal ones, but he dropped all references to Catholic Scholastics. When Pufendorf was translated into English, the Scholastic origins of his doctrines were lost. Francis Hutcheson weakened the utility doctrine by introducing cost of production analysis; this was absorbed by Adam Smith. This analysis partially vindicates the view that Smith and Ricardo shunted economics onto the wrong track.

On the continent, the older utility doctrine lasted longer. In France, Condillac, Turgot, Quesnay, the Physiocrats, and J. B. Say preserved the doctrine. But British cost doctrines were to sweep the continent too. Rothbard leaves open the question whether Emil Kauder's analysis of eighteenth-century developments is correct. Noting that the utility doctrine persisted on the continent, especially among Catholic writers, while the cost doctrines gained the allegiance of British Calvinist-Protestants, Kauder hypothesized that the Catholic Church's Aristotelian-Thomistic tradition approved of moderate pleasure-seeking, focusing attention on utility as the motive of economic action. Calvinism, on the other hand, glorified labor and denigrated pleasure.

Rothbard notes that the Austrians can now be seen, not as erecting a new theoretical edifice upon British classical political economy, but as reviving and developing an older tradition shunted aside by classical political economy.

Mercantilism vs. Economic Liberalism

Joyce Oldham Appleby

  • San Diego State University

“A New Argument for Economic Freedom.” In Economic Thought and Ideology in Seventeenth Century England. Princeton. Princeton University Press, 1978, pp. 158–198.

By the early seventeenth century wealth was associated with a favorable balance of trade, that is, with an excess of goods exported over those imported. This view evolved into a theory of economic growth which emphasized foreign trade's capacity to generate specie or wealth. This theory gave primacy to commercial over political factors, an innovation crucial for subsequent theoretical developments. Attention was focused on the production of goods for sale, with almost no notice of consumption's role in economic progress. Linked with this one-sided view of economic activity was the treatment of trade as a “zero-sum game”—what one party to an exchange gained, the other party lost. Economic theorizing was often thinly disguised special-pleading by such groups as the clothiers, who wanted restrictions on imports of competing goods. To them, internal trade consisted merely of money transfers; consumption was “a necessary evil at best.”

The balance-of-trade doctrine was an economic ideology for an era of intense political rivalries. Nation competed against nation, politically and economically, but in this ideology members of a society were to be united in one enterprise. The economic aspect of this enterprise consisted in selling surplus goods abroad to obtain specie (wealth).

Rising levels of income and consumption challenged the old mercantilist position and led to revolutionary changes in attitudes and analyses. Prosperity was not only associated with increased consumption, but also with increased imports, particularly East India fabrics. Observors such as Henry Martyn launched an attack on the very idea of a need for political stimulation of employment and political controls on consumption and trade. In this conceptualization of the economy, individuals occupied center stage. Individuals not only competed in production, but they had different wants, which could best be served by the production and importation of the greatest variety of consummables. Competition and economic freedom were extolled. Consumption was analyzed as a constructive activity, part of a dynamic process stimulating exertion, inventions, the entrepreneurial spirit, and ever greater production. Wealth was no longer viewed as a specific commodity, but as the capacity to purchase. Consumption was treated as the end of economic activity and trade as mutually beneficial. The emphasis on economic freedom and the conclusions of the arguments for this freedom all ran counter to the old mercantilist position.

The new pamphleteers and writers developed a coherent and sometimes sophisticated picture of trade and commerce, of production and consumption, and of economic activity in general, all without recourse to equations. They did so by switching analysis from a static view of commerce to one in which commerce played a dynamic role in translating consumption wants into increased production. Moreover, this dynamic process was a coordinated one that could function without outside direction. Not anarchy, but lawful behavior based on natural forces would proceed from economic freedom.

Spokesmen for the privileged economic groups counterattacked, not by meeting the sophisticated arguments of the new economic theorists, but by appeals to patriotism, xenophobia, and “common sense.” They explicitly divorced private profit and the public weal, both denying the chief argument of economic liberalism and anticipating twentieth-century responses to free market ideas. The conclusion of this debate was only worked out in the latter part of the eighteenth century.

The Social Meaning of Economic Liberalism

Joyce Oldham Appleby

  • San Diego State University

“Ideology and Theory: The Tension between Political and Economic Liberalism in Seventeenth-Century England.” The American Historical Review 81 (June 1976): 499–515.

By the end of the seventeenth century—ninety years before Adam Smith's Wealth of Nations was published—British writers on political economy had challenged the cruder mercantilist fallacies. Yet in the eighteenth century the “balance-of-trade” doctrine was reasserted in its crudest forms. The author seeks the answer to this paradox in the tension and interplay between theory and ideology.

The balance-of-trade doctrine focused on production for the foreign market as the source of specie, and hence, of wealth. Domestic consumption robbed the nation's store of capital. Therefore, foreign markets for British goods were sought. This view conceived of the whole nation as one patriotic unit or enterprise. There was scant appreciation of individuals' particular interests and desires.

The balance-of-trade theory could not explain Britain's economic growth, especially the great rise in domestic consumption (which should have impoverished the nation). Writers of political economy such as Henry Martyn, Nicholas Barbon, Daniel Defoe, and Bernard Mandeville fashioned a new social view challenging the foundations of the old. They viewed society as an agglomeration of self-interested individuals, and they extolled the role of domestic consumption for its effects on economic growth. These writers also stressed the dynamic interaction between growing consumption wants and increased effort and increased production. Not only would new products meet a demand, but consumers, having discovered products heretofore undreamed of, would be stimulated to work harder and produce more. Growth would be “self-sustaining.”

If crude errors had been decisively rejected by the end of the seventeenth century, why were the new ideas not developed? Appleby argues that ideology was a barrier to further theorizing along new lines. The prevalent ideology enshrined an idea of upper class governance and lower class deference and discipline. The socio-political structure would have been threatened by the new ideas. Among other things, the new view suggested that the poor could improve themselves through individual effort—too democratic a view for the times.

Businessmen sought freedom for themselves, including freedom from the bonds of a traditional society. They nonetheless accepted the permanent rule of the lower classes by an elite, of which they were now members. A theory in which the poor's interests were one with the ruling class's, in which the poor could improve themselves through effort, and in which the consumption of the lowest classes was elevated to the end of production, clashed too strongly with the dominant ideology and with class interests.

Adam Smith Scholarship

E. G. West

  • Carleton University

“Scotland's Resurgent Economist: A Survey of the New Literature on Adam Smith.” Southern Economic Journal 45 (October 1978): 343–369.

Professor West surveys fifty-eight studies in a critical review of the important developments of the literature on the Wealth of Nations (WN) in the last thirty years. He steers a middle course between the over-exuberant interpreters who see Smith presaging neoclassical economics, and those critics who fail to consider the historical and social circumstances in which Smith wrote. Paul Samuelson falls in the first category, seeing Smith as an always logical and consistent analyst who anticipated “general equilibrium modelling.” But this view ignores Smith's advocacy of removing governmental restraints on the economy in order to end monopolies and improve efficiency.

In his criticism of Smith's political advice to sovereigns, George Stigler overlooks the political realities of the seven-teeth century and misunderstands Smith's task in the WN. Smith was interested in constitutional reform, not the day-to-day calculus of the vote-grubbing politician.

What emerges from West's summary is the traditional liberal interpretation of the WN reaffirmed and strengthened. Smith was “a ‘total political economist’, a man who has not only competent analysis but economic judgment and a full sense of what issues are relevant.” West finds Smith an advocate of markets freer of substantial political interference than was heretofore believed. Government should exist only to permit a liberal civil and commercial society to prosper, and not to pursue other goals, however laudable. Smith's “concessions” on government economic activity in the provision of highways, bridges, and canals represent misunderstandings. He advocated not government's providing these goods, but legal permission for joint-stock enterprises to provide these “public works.” Once again misinterpretation arises from the failure of modern readers to appreciate eighteenth-century institutional realities.

The WN compares favorably with modern neoclassical economic analysis in two critical areas: the treatment of institutions and the view of competition. Modern economics is all but devoid of institutional considerations. The social, legal, and political institutions played a central role in Smith's analysis, with much of the WN advocating changes in British laws of trade, tariffs, and monopolies.

Smith viewed competition as a process, whereas most modern theorists treat it statically, as a state of affairs (“perfect competition”). In recent times, Smith's approach to the theory of competition has been advocated by relatively few theorists, F. A. Hayek being the most prominent among these. The only modern economic school following Smith in this area is the Austrian. In this view, competition is a dynamic process occurring precisely because we are not in an “equilibrium.” Divergence of expectations, change, invention, and profits and losses characterize this process. All this is absent from modern analysis.

The Smithian view of competition is integrated with his institutional emphasis. In an uncertain world, we seek not those “experts” who know best, but those institutional arrangements best suited to facilitating unknown individuals' using their talents and knowledge to their advantage and thus to society's.

Jevons and Laissez-faire

Ellen Frankel Paul

  • Miami University

“W. Stanley Jevons: Economic Revolutionary, Political Utilitarian.” Journal of the History of Ideas 40 (April/June 1979): 267–283.

In the last quarter of the nineteenth century, the fundamental principles upon which classical economics had been founded were questioned and in most instances found wanting. Primary among these was the labor or cost of production theory of value which W. Stanley Jevons completely overturned with his final utility theory of value. Other important components of the classical framework were also shattered, such as the Malthusian population theory; the projection of a future stationary state; the Ricardian “iron law” of wages; and the macroeconomic approach to determining the shares distributed to each class in the production process. What is truly remarkable, however, is that despite these dramatic alterations in economic theory per se, little direct effect can be seen from this quarter on the question of the government's role in the economy. There was no essential break between John Stuart Mill and Jevons in their approaches to this question, for both were Utilitarians, and, hence, they both advocated an ad hoc evaluation of each particular proposal for governmental intervention.

The movement away from laissez-faire which was begun in the third quarter of the nineteenth century came to completion in this later period. It was no longer necessary to disavow any connection between economics as a science and the doctrine of laissez-faire. Laissez-faire had become something of a dead issue resulting from the combined influences of attacks by J.S. Mill, Henry Sidgwick, and J.E. Cairnes, plus the rise of trade unions, and practical men's demands for an increased regulatory role for the state enabling it to deal with the pressing social questions of the day. Thus for economists of this later period, such as Jevons, Wicksteed, and Marshall, it was no longer necessary to prefer even the formalistic, and largely empty, obeisance to laissez-faire that Mill uttered before examining the particular cases for governmental intervention. Their approach, then, was entirely empirical, proceeding with no preconceived preference for either state action or unfettered, free competition. The two were placed more nearly upon an equal footing. In this development, there was no decided break with their immediate predecessors, rather, they completed the disassociation with laissez-faire that the last generation had begun.

Jevons was more extreme than Mill in his enthronement of utility and expediency as respectively the objective and the test of legislation, and in his all but complete disavowal of laissez-faire as the regnant principle governing state intervention in the economy. When it came down to actual proposals, Jevons was, however, not nearly as adventuristic as Mill, and he did not display Mill's enthusiasm for socialistic ventures, although he had no preconceived hostility towards them. He was perfectly willing to adopt such measures if they proved their suitability for maximizing general happiness. While Adam Smith on several occasions dismissed various state activities by saying that they constituted violations of the right to property, Jevons, in contrast, says that any violation of property is valid so long as it can be scientifically shown to increase the general good. This comparison of Smith and Jevons sharply focuses on the contrast between the moral theories of Lockean natural rights and Benthamite utility as they affected the question of the proper role of government in the economy.

The principle of utility coexisted with laissez-faire governmental policies for a time, particularly in Bentham and to a lesser extent in Mill, but in Jevons's laissez-faire the former was finally victorious over the latter. On the question of the proper limits of the government's interference in the economy, Jevons completed the work of Mill; i.e., he abandoned all a priori opposition to state regulation and subjected each case to the test of expediency with the Utilitarian end of general happiness. Jevons held the Ricardian-Millian economics in nothing short of utter contempt, yet on the level of political theory his revolutionary economics did not lead him to question the assumptions and conclusions of the Utilitarian School.

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Social Sciences and the “Methodenstreit”

Samuel Bostaph

  • Western Maryland College

“The Methodological Debate Between Carl Menger and the German Historical School.” Atlantic Economic Journal 6 (September 1978): 3–16.

The “war of methods” (Methodenstreit) began with the publication of Carl Menger's Untersuchungen über die Methode der Socialwissenschaften und der Politischen Oekonomie Insbesondere in 1883 (translated as Problems of Economics and Sociology). In that volume Menger both presented his positive position on the scope and method of the social sciences and criticized the position of the intellectually-dominant German historical school. The dean of the younger German historical school, Gustav Schmoller, responded in a caustic review of Menger's book. A highly polemical exchange ensued that involved each scholar's followers.

The debate pitted two radically different methodological positions against one another. The “Austrian” positions argued that economic theory can and should discover “absolute” laws of economic behavior, and held that these laws are discoverable using methodological individualism. The result would be abstract laws that are “exact,” i.e., necessarily true. The “German” position denied the possibility of discovering universally true economic laws and hence denied the possibility of constructing an economic theory in the Austrian sense. Schmoller adopted “methodological collectivism” in seeking to discover contingent economic laws by observing the formation of actual social institutions. Such laws would only be applicable in a cultural context.

Historians of thought have generally been critical of this methodological debate. Besides noting its polemical nature, they point to the inability of the participants to resolve any of the issues involved. Historians have generally concluded that the differences were minor compared to the similarities between the schools. Both “induction” and “deduction” are necessary.

In an important historical reinterpretation, Bostaph argues that the differences between Menger and Schmoller were far greater than even they realized. The debate raged so long and so furiously, not because methodological debates are fruitless, but because most historians never identified the fundamental basis of disagreement.

Ultimately, Menger and Schmoller disagreed over epistemology, particularly over the theory of concepts. Schmoller as a nominalist, believed that only the names men choose arbitrarily to ascribe to phenomena are universal, not the phenomena themselves. For the nominalist there are no universal characteristics (essences) of phenomena having independent ontological status. Hence, there can be no necessary causal connections between phenomena. The search for absolute or universal laws would consequently be a fruitless one. Bostaph links the historical school's position on causality to Hume's.

Menger adopted an Aristotelian position in which phenomena themselves are viewed as possessing essential properties that characterize all instances of an ontological type. By abstracting from the individual elements of the phenomena one can discover these essences, as well as necessary causal connections among elements of the phenomena. By building up from the simplest elements and relationships, one can reconstruct and understand the complex social phenomena we actually observe. For the methodological individualist, like Menger, one can only understand the complex phenomena by developing an abstract theory built up from an investigation of the micro elements of the phenomena. Menger's methodological individualism is distinct from Schmoller's methodological holism, in which one attempts to understand complex phenomena by collecting data on the macro phenomena directly.

As Bostaph observes, the two approaches of the Methodenstreit are not complementary, but are the result of widely divergent views on the scope and logic of economic and social-scientific inquiry (Socialwissenschaften). The issues cannot be swept aside by arguing for an eclectic approach. Bad methodology may condemn modern economic researchers to a lifetime of wasted effort.

The Limits of Mechanistic Economics

John C. Moorhouse

  • Wake Forest University

“The Mechanistic Foundations of Economic Analysis.” Reason Papers 4 (Winter 1978): 49–67.

The neoclassical paradigm that dictates the methodology of mainstream economics limits the problems analyzed within economics and shapes their solution. Whatever success economics enjoys among the social sciences stems from the set of questions it considers appropriate. In pursuing this Kuhnian analysis, Moorhouse also draws support from F. A. Hayek's critique of the methodology of economics. Hayek argues that, as a social science, economics requires a methodology distinct from that of the natural sciences.

Economics enthusiastically borrowed its methodology from classical (mechanical) physics. Basically, those methods are analytic reduction and isolation, the assumption of reversibility, and the framing of questions in terms of equilibrium. The role of each of these methods in both physics and economics is sketched and then discussed in terms of their inappropriateness in economics. This criticism arises from the fact that economic systems involve human actions. Whereas mechanical processes are reversible, human beings learn from experience—so that initial conditions can never be restored. In a mechanical process, the equilibrium state and adjustment path are uniquely determined by the initial conditions; however, human actions are adaptive and purposive — so that far different sets of economic conditions can produce the same equilibrium, and a stochastic shock to an economic process may not affect the final equilibrium. While the mathematical techniques associated with equilibrium/maximization work with known factors in physics, knowledge of the means and ends relevant to the economic system is dispersed among individual persons—so that the use of such techniques is limited in economics. Whereas we can successfully apply the analytic tools of reduction and isolation to reversible mechanical processes in closed systems and in experimental settings, human action adds qualitative, adaptive, and subjective dimensions to the processes under study. This makes it difficult to isolate economic relationships from impinging factors, and the economic system is only misleadingly divisible into units of analysis.

These limitations of the neoclassical paradigm suggest that economists could explore an alternative paradigm that takes as given the complexity of economic systems and sets out to explain their qualitative change and evolution.

Governmental attempts to regulate and direct the economy are based on the same mechanistic assumptions that have allowed the success of economics in limited respects but have hampered any fundamental understanding of economic systems. Examining these assumptions can help to explain the inherent difficulties and recognized failures of such governmental attempts, and can redirect the discipline of economics and the course of government-economy relations.

The Limits of Mechanistic Economics

Douglass C. North

  • University of Washington

“Structure and Performance: The Task of Economic History.” Journal of Economic Literature 16 (September 1978): 963–978.

Economic history, by adopting quantitative methods and the analytical framework of neoclassical economics, has “gained in rigor and scientific pretension.” But this rigor has neglected the vital relationship between changes in economic structure and changes in economic performance. North characterizes economics as a theory of choice subject to constraints, and he believes that economic history's task is to theorize about the forces shaping the evolution of those constraints. With this framework, how do we explain the transformation of the American economy in the last century?

The past 100 years has profoundly transformed the structure of the American economy. In the century since 1875, government expenditures have ballooned from 2-3% of GNP to about 24% of GNP, and the proliferation of regulatory agencies has made access to government influence a key factor in economic decision making. These, and other changes that have altered the structure of the economy, are not explained by the cliometric efforts of the “new” economic historians. The work of Joseph Schumpeter fares better when measured against this standard, but seems fundamentally flawed because Schumpeter's framework lacks an explicit analysis of the political process.

In developing an analytical framework useful to the economic historian, one must begin by examining the constitutional structure established by the Founding Fathers. The Constitution imposes heavy costs on attempts to use the political process to redistribute wealth and income. The critical question in light of the developments of the last 100 years, is “What energized groups to undertake the private costs of altering the political-legal structure?” Three lines of inquiry account for economic historians' perplexity in explaining the transformation of economic structure.

  • (1) “Neoclassical theory simply ignores the losers. . . .” These losers seek to avoid the costs of being losers through political intervention in the market. Most importantly, the losers who undertook changing the political-legal system to reduce their losses were not the “proletarian losers” of the nineteenth century (e.g., Indians, exslaves), but propertied groups such as farmers.
  • (2) Economic historians have not grasped the organizational implications of science and technology's application to economic activity in the past century. This produced a radical reduction in production costs; the growth of large scale enterprise; the creation of an urban society; a reduction in the cost of measuring the dimensions of the goods or services exchanged; and a reduction in the costs of measuring the externalities generated by economic activity. But the underlying cause of these changes was the enormous change in transaction costs that occurred. In addition, the advent of a highly technological economy has sharply decreased the costs of information and transportation that has widened the individual's range of effective choice.
  • (3) “Tastes do change.” North notes that some studies show that the best indicator of legislative voting behavior is not visible economic interest but ideological attitudes. In general, political and judicial conceptions of the “public good” have changed in the last century. Understanding ideological change is one important key to understanding popular, legislative, and judicial behavior.

Austrian Economics vs. the Mixed Economy

S. C. Littlechild

  • University of Birmingham

The Fallacy of the Mixed Economy. London: The Institute of Economic Affairs (1978) 83 pp. Reprint. San Francisco: Cato Papers (1978).

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At once an historical sketch of the Austrian economic school and a brief outline of Austrian economics, this monograph both explains Austrianism and contrasts it with economic theory in the neoclassical mainstream. One of the most engaging aspects of the monograph is Professor Littlechild's use of Professor James Meade's The Intelligent Radical's Guide to Economic Policy: The Mixed Economy to illustrate the differences between Austrianism and neoclassical economics. Meade's work marshalls the full theoretical forces of neoclassical economics to defend the “mixed economy” against its socialist critics. Littlechild considers Meade's theoretical arguments, provides an Austrian critique, and then shows that the economic policies which Meade supports will frustrate or impede the very achievement of his policy goals. In addition to considering Meade's views, Littlechild also considers in generic form the various arguments offered by neoclassical economists for governmental economic intervention. The result is an effective presentation of how Austrian economists take subjectivism and methodological individualism more seriously than their mainstream counterparts.

In the course of his exposition Littlechild moves from a discussion of Austrian economy theory to “Austrian policy.” Since policy conclusions do not follow immediately from economic theory, Littlechild implicitly imputes certain value judgments to Austrian economists in order to formulate “Austrian policy.” The values Professor Littlechild employs to formulate “Austrian policy” are held by many but not all Austrians.

Macroeconomic Formalism vs. Human Action

Ludwig Lachmann

  • New York University

Macro-economic Thinking. Studies in Economics No. 6. Menlo Park, Calif.: Institute for Human Studies (1978) 48 pp.

Professor Lachmann outlines the debate between two schools of economic thought: Cambridge (U.S.) and Cambridge (U.K.). These schools represent, respectively, neoclassical and post-Keynesian economics. Though the debate is ostensibly about capital theory and theoretically abstract, Lachmann points out its wider implications.

Cambridge (U.K.) economists have continued the attack of economist Piero Sraffa on marginalism in economic theory, denying in particular its applicability to factor pricing. This attack is the key element in their general critique of the market economy. The American neoclassical response has been ineffectual because these economists have evidenced no enthusiasm for defending the market economy. Their reluctance bespeaks the remoteness from reality of the neoclassical model. In particular, neoclassical economists view the world through the eyes of their model of perfect competition, a perspective from which real world competition will always be questioned and criticized.

The debate is further narrowed because of the limiting context of macro economic equilibrium. In this context, the focus is on long-term economic forces and their effects on highly aggregated variables like national income or “investment.” This macro perspective avoids any appreciation of human action in the real world of constant change—a world in which there is no equilibrium, though there are equilibrating forces. Though the protagonists give lip service to the need for microeconomic, causal explanations of macro phenomena, these admissions do not in practice affect their thinking. As Lachmann puts it: “Economic events are the result of some kind of collective process of decision-making the modus operandi of which is never explained. Imaginary beings take the place of real people.”

Lachmann, critical of both schools, adopts the perspective of Austrian economics, which focuses on human choice and human action in an uncertain world. He emphasizes the need to coordinate individual plans, an insight that directs attention to the market process instead of equilibrium states. The Austrian approach directs one's attention from macroeconomic formalism to microeconomic processes. This in turn enables one to understand how much Cambridge (U.S.) has conceded to Cambridge (U.K.) by accepting macro-formalism as the proper approach to economic questions.