Front Page Titles (by Subject) IV: Political Economy and Theory - Literature of Liberty, Winter 1980, vol. 3, No. 4
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IV: Political Economy and Theory - Leonard P. Liggio, Literature of Liberty, Winter 1980, vol. 3, No. 4 
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.
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Political Economy and Theory
The following summaries on political economy raise issues of near-equal importance to human welfare as those raised in the previous section on “War and the State.” In fact, as Richard Wagner's article implies, the economic crises we experience are usually connected with the inflationary pressures of war and government deficit spending to finance wars. Other pressing issues of economic theory and analysis are surveyed to shed light on current issues of economic methodology and policy.
Three Kinds of “Capitalism”
“Will Capitalism Survive?” The Wilson Quarterly 4(Spring 1980):108–116.
Though challenged by crises, modern western “capitalism” is not a “sick man” about to expire. We need, however, to carefully distinguish various meanings of “capitalism.”
Capitalism is not a newcomer. We may debate its origins and biography, but its essential spirit—going back to the dawn of history—is its creative entrepreneurship, the ability to discover profitable possibilities in changing conditions. The secret behind capitalism's vitality is the freedom to choose and to be open to adaptive change.
Capitalism is not simply an “economic system” but is immeshed in its total society, interacting with government and culture. “State and capital—or at least that of the massive firms, the big companies, and the monopolies—make good bedfellows...” Corporate state capitalism “lives shamelessly off the subsidies of the state.”
The longevity of capitalism earns its tradition's stamp of approval, despite its inequalities and privileges. Rival systems, such as socialist economies, have failed to do the job better: removing economic hierarchies, socialism has not created a society of equality, liberty, or abundance. It is difficult to see how any anticapitalist revolution could preserve what needs to be preserved in capitalism: rights, “a truly free market,” and a sense of fraternity.
In socio-political terms and in terms of economic management we can discern three markedly distinct kinds of “capitalism.” In common usage “capitalism” refers to corporate state capitalism, large monopoly businesses, in working alliances with the state. A second distinct level, under monopoly capitalism, is the “market economy,” small or medium-sized business which avoids state subsidies and thrives on competition and innovation. A third, or basement, tier (amounting to 30–40% of activity in industrial economies) is the “underground economy.” Outside the legal market and the control of the state, this underground economy consists of “evasion, smuggling, barter for goods and services, moonlighting ‘off the books,’ and above all work performed at home.” All three levels of “capitalism” interact. The top tier of corporate state capitalism needs the smaller, more competitive units of the real “market economy” to survive. During severe economic crises the market economy my provides a “safety net” and innovation for monopoly capitalism.
Adam Smith: Economic Utilitarian
“The Utilitarianism of Adam Smith's Policy Advice.” Journal of the History of Ideas 42(January-March 1981):73–92.
Was Adam Smith (1723–1790) a utilitarian? In his practical attitudes, his major writings, and his policy recommendations, Smith must be viewed as “a practicing and contemplative utilitarian.” Although he avoided discussing possible conflicts between justice and utility in justifying and applying trade restraints, it was the criterion of utility (the greatest happiness of the greatest number) that preoccupied him. General utility rather than justice or rights was decisive in his taxing and anti-smuggling actions as a Commissioner of Customs and in his advice to the British government on such topics as the American war for Independence.
Smith may be regarded as a rule-utilitarian by his recourse to the criterion of utility in his evaluations of social, political, or economic systems. When Smith refers to justice, he insists on the utility of justice. Smith's “whole approach to social philosophy is summed up in the thesis that practices whose origins and supports lie in unreflective human sentiments, molded and harmonized by the socializing effects of life in a community, are admirable well adapted to the divinely planned end of human welfare.” Unintended utilitarian consequences flowed from nonutilitarian motivations.
To determine whether Smith's moral criterion was in fact utilitarian, the authors study events from Smith's biography that involve Smith's making value judgments on key moral and political issues. They conclude that Smith's policy advice was utilitarian from considering Smith's evaluations and advice on the following topics: the Union of 1707 of Scotland and England, the secession of the American colonies from Britain, the monopolistic tendencies in trade and in some professions, and, finally, Smith's attitude toward smuggling.
It was on utilitarian grounds of the long-range benefits to both countries rather than on the grounds of Scottish rights that Smith approved of the forcible incorporation and union of Scotland and England in 1707.
On the issue of American secession from Britain, Smith gave consistently utilitarian advice in his correspondence, in the Wealth of Nations (1776), and in his famous 1778 memorandum. His gloomy view of British military intervention was not so much that it was unjust to America but that it was badly mismanaged and likely to fail. In February 1778, Smith wrote a memorandum to Lord North's government on the American question. In discussing four possible options to resolve the conflict, Smith never raises the question of rights or justice in the rebellion but does emphasize utilitarian considerations. In his Wealth of Nations the crux of Smith's argument over retaining or giving up the American colonies is that monopoly control of retaining the colonies benefits only the merchants rather than general utility.
Likewise Smith's defense of economic liberalism was utilitarian and not in favor of liberty for its own sake. He admitted restrictions of economic liberty for legitimate purposes of government or for the national interest.
In 1778, Smith, the apostle of free trade, accepted the lucrative post of Commissioner of Customs. As a customs officer he was zealous in administering the laws against smuggling. Smith's inconsistency in accepting the post that violated economic freedom is mitigated by the fact that he was never a total advocate of laissez faire which he considered a utopian dream. He supported trade barriers which could raise revenues for government and so opposed smuggling for utilitarian reasons. When he discovered that he owned items prohibited by the custom laws, he burnt them to set a utilitarian example or respect for law. In effect he balanced two utilitarian considerations: the economic consequences of customs law and “the serious long term disutility of lack of respect for the law itself.”
Roepke: Laissez faire and Social Order
“Wilhelm Roepke and the Problems of Contemporary International Political Economy.” World Affairs 14(Spring 1979):307–312.
Since the end of World War II, we have seen a flood of proposals for avoiding another depression. Postwar federalists, functionalists, “neo-functionalists,” and other theorists of integration and interdependence have propounded views concerning the most feasible paths to world order.
Recent critics have pointed out the deficiencies of these schools of thought. Their utilitarian tendencies, mechanistic dynamics, naive optimism, and idealistic predelictions have been exposed in numerous studies—some produced by disillusioned exponents of the former optimism. Stressing the consumerist “need-gratification” of atomistic individuals, much early postwar thought predicted the rise of more rational forms of political organization in the wake of the nation-state's inability to solve urgent economic problems, problems which had already led to chaotic depression and world war.
Diametrically opposed contemporary trends have revived the term “international political economy.” The phrase emphasizes the importance of the political framework of trading relationships in a more harmonious world order. Wilhelm Roepke has made a key contribution to the effort to rediscover the extra-economic bases of international and national order. He has sought to defend laissez-faire liberal ideals, but, in so doing, he has emphasized the holistic, social factors without which, he claims, the market economy could not survive.
Laissez-faire capitalism, Roepke writes, “implies the existence of a society in which certain fundamentals are respected and color the whole network of social relationships: Individual effort and responsibility, absolute norms and values, independence based on ownership, prudence and daring, responsibility for planning one's own life, proper coherence with the community, family feeling, a sense of tradition and the succession of generations combined with an open-minded view of the present and future ....”
Roepke thus rejects a “social rationalism” which views the market economy as a mechanical technique of an invisible hand, transferable into any spiritual or social setting. It might in fact work harm in an unsuitable context. “Individuals who compete on the market and there pursue their own advantage stand all the more in need of the social and moral bonds of community without which competition degenerates most grievously.”
With his holistic conceptions of political order and social adhesion, Roepke's thought along with that of other conservative thinkers offers a potentially rich source of speculation on the processes of global integration. Besides many standard classics (Polanyi, Pirenne, Rostovtzeff, Roepke), Prof. O'Leary cites a growing literature (Gilpin, Tucker, Keohane and Nye, Calleo, Kindleberger) that discusses whether a truly liberal and harmonious world economy is attainable. Nevertheless, Wilhelm Roepke most clearly articulates the paradoxical tenet that a basically free world economy requires a prior framework of agreed and enforceable codes.
Government-Induced Boom & Bust
“Boom and Bust: The Political Economy of Economic Disorder.” The Journal of Libertarian Studies, Vol. 4, No. 1 (Winter 1980):1–37.
Keynesian economics maintains that governmental macro-economic management is required for prosperity. It assumes that unemployment in market economies is due to insufficient levels of total spending and that appropriate public policies can and will both eliminate the unemployment, and promote economic stability. Both of these assumptions obscure the actual relations between economic conditions and government policy.
Using a holistic approach to focus either on unemployment or price levels in the aggregate obscures the actual sources of prosperity and depression. In addition, the belief that public policy can and will work to promote stability ignores political realities. Politicians, desiring to stay in office, see government expenditure programs as ways of securing votes and they tend to promote programs financed by borrowing rather than taxation. Consequently, an incumbent government will attempt to use deficit finance to serve its political purposes.
If government borrows from private citizens to finance expenditures in excess of revenues it may raise market rates of interest and “crowd-out” borrowing for private investment purposes. This foments political opposition. It becomes possible to avoid this consequence through creating new money in the amount that government wishes to borrow. This is possible since government has effectively nationalized money and credit. Debt instruments are issued by the Treasury and monetized by the Federal Reserve. It then becomes possible for politicians “...to buy the support of a favored clientele, who benefit from the money expansion, without having to impose vote-losing taxes in the process stat or crowd-out private investment.”
Deficit-financed expenditure programs favored by politicians are intentionally discriminatory since they attempt to alter the distribution of incomes by changing the structure of relative market prices. The same is also true of tax reduction and money expansion programs. In addition, the actual results of such programs can only be understood by focussing on the changes in income distribution and in the structure of relative prices brought about by such political action.
In spending newly created fiat money, a politically favored group obtains control over resources, while at the same time altering the structure of relative prices. As the new money is diffused throughout the economy in additional transactions, one by-product is a rise in the absolute price level—which effectively reduces the control of resources by those more distant in the chain of transactions from the favored group. More importantly, the change in the structure of relative prices becomes a source of economic disorder.
Additional government-caused distortions insue. Deficit spending financed by monetizing treasury debt allows the amount of public and private borrowing to exceed the amount of private saving. The market interest rate is thus pushed below the rate of interest that would ordinarily clear financial markets—the “natural” interest rate. This artificially cheapens private real investment and encourages the expansion of more time- or capital-intensive production processes. Capital goods industries expand at the expense of consumer goods industries.
“With the production of consumer goods decreasing relative to that of producer goods, in conjunction with no greater desire of consumers to save, prices of consumer goods will start to rise in response to shortages of these goods. A self-reversal will set in motion: the capital goods boom will turn into a capital goods bust. The process of expansion that is set in motion by the money creation will reverse itself automatically, unless the inflation accelerates. Without this acceleration of inflation, much of this increased investment will turn out to be unprofitable. As these investments are scrapped or put to different uses, economic contraction will result. Excess capacity will arise as capital becomes unemployed. But labor will become unemployed as well. Both types of unemployment result from the previous inflation.”
Inflation and unemployment are thus directly related to a sequence of cause and effect, and “stagflation” is a direct consequence of government political activities. The cure is an end to the government policies that created the inflation. An inevitable result will be a recession until the economy's structure of production accurately reflects the underlying real data of wants, resources, and knowledge. Recession is an inherent part of the recovery process from politically induced economic instability.
The state monopoly over money is not intended to contribute to economic instability, rather the contrary. Nevertheless, the pursuit of political gain in a setting including that monopoly has that result. “By taking a variety of steps to remove money from the category of a nationalized industry, the ability of the ordinary vicissitudes of politics to promote economic disorder would be lessened.”
Austrian vs. Neoclassical Methodology
“The Neoclassicalists vs. the Austrians: A Partial Reconciliation of Competing Worldviews.” Southern Economic Journal (Summer 1980):1–12.
Although the economists of the neoclassical-Chicago and the Austrian schools share a commitment to market economics and individual freedom, they differ on a number of theoretical issues. The Austrians, such as Nobel laureate Friedrich Hayek, believe that the neoclassicalists have ignored Austrian policy and methodological insights that would have prevented the current inflationary crisis that savages western economies. To advance this debate, Prof. McKenzie explores the representative positions of the two schools, pinpoints the major issues of controversy, and offers some ways to reconcile their differences. His analysis concentrates on these theoretical issues separating the two schools: (1) the nature of economics as a discipline, (2) the predictability of human action, and (3) the nature and purpose of theory.
In regard to the nature of economics as a discipline, neoclassical economists endorse “Robbinsian” maximizing behavior which presupposes an objective external world existing independently of the subjective values of maximizing individuals. They see the task of economics as the study of how the individual pursues his subjectively determined interests by objective, external, scarce means. Neoclassicalists believe they can objectively measure, predict, and empirically test the behavior of economic man maximizing the use of given scarce means to reach ends. Whereas neoclassicalists downplay the subjective and nonmeasureable, the Austrians place in the center of their theory the subjective, nonmeasureable, and nonpredictable evaluations of individual actors. Smith and Jones may consume apples but they are not the “same” objective goods in each's evaluator's eye. For Austrians it is impossible to measure a country's capital stock since human actor's evaluations possess no constants that remain fixed over time. Austrian economics limits itself to “praxeology,” or the logic of choice in human purposive action. This subjectivist or individualist emphasis leads Austrians to seek a free social framework (e.g. Hayek's “Constitution of Liberty”) permitting individuals to solve their own problems. Neoclassicalists, on the other hand, are pragmatists and seek to deal with maximizing problems within a given social structure.
It follows that Austrians reject the neoclassicalists' central conviction that human behavior is predictable. Neoclassical economists test their hypotheses by the empirical accuracy of predictions. Accordingly, for neoclassicalists, what government (as opposed to the market) should do is an open question to be solved by an empirical cost-benefit analysis. By contrast, Austrians reject quantifiable empirical tests and predictibility because, as noted, they see no constants to measure in the subjective evaluations of individual actors. Since individuals learn, change their values, and develop a complex “spontaneous order” past regularities of human action cannot be the same in the future.
What are the two schools' respective positions on the nature and purpose of theory? As pragmatists, neoclassicalists are not interested in the correspondence of theory to reality. They consider theory as a convenient mental fiction or “tool” to make accurate predictions that can be tested on future behavior.
Austrians, by contrast, use theory not so much to tell what will happen as to explain the process by which human action occurs. Austrian theory aims not at prediction but at real “explanation” that makes sense of the world. Austrians limit their patterns to general “patterns of outcome.” Methodologically, Austrians believe that social sciences of human action deal with phenomena so complex that they cannot be observed in their entirety even if they could be measured.
Professor Friedman's Instrumentalism
“A Critique of Friedman's Instrumentalism.” Southern Economic Journal 47(October 1980):366–374.
Lawrence Boland has recently identified Milton Friedman's “positive economics” methodology as a variant of instrumentalism and has asserted that instrumentalism has never been either criticized or refuted. Prof. Boland implies a vindication of Friedman's position.
Prof. Friedman was actually unaware that his position was instrumentalist but accepts Boland's characterization. Unfortunately, Boland's characterization of instrumentalism is incomplete—isolating only the methodological implications while ignoring the ontological questions. Thus, Friedman should actually be viewed as a “methodological instrumentalist.” The core of Friedman's methodological instrumentalism are the beliefs that: (1) the goal of science is to discover hypotheses that predict well, and (2) the “realism” of assumptions does not matter.
In contrast to Boland's assertion concerning the criticism of instrumentalism, post-1940s philosophers of science unanimously reject the notion that the only goal of science is prediction; they favor the the alternative claim that the goal of science is explanation. If explanation is taken as the goal of science, then methodological instrumentalism fails for it is concerned with predictive adequacy, not explanation.
“Perhaps the most damaging claim against Friedman's own particular brand of instrumentalism is not that it is incorrect, or even implausible, but that it must be viewed, in the light of the more recent work, as anachronistic.”
Milton Friedman's Critics
“A Critique of Friedman's Critics.” Journal of Economic Literature 17(June 1979):503–522.
Milton Friedman's essay, “Methodology of Positive Economics” (1953), enjoys authoritative status among textbook writers; however, virtually all journal articles written about this methodological essay have been highly critical. Why, Prof. Boland asks, do honest textbook writers ignore the critics? He argues that the reason for this paradox is quite clear. Every critic of Friedman's essay has been wrong. They have not recognized that his methodological position is both logically sound and unambiguously based on a coherent philosophy of science, namely instrumentalism.
Boland reviews the underlying logical principles of Friedman's methodology: modus ponens vs. modus tollens, notions of necessity and sufficiency, conjunctive and disjunctive arguments. He emphasizes that logic itself provides little help in determining the truth of assumptions or conclusions. Logic can only ‘pass along’ known truths. This limitation of traditional logic leads to a discussion of the so-called problem of induction. Unfortunately, no logician has ever solved this problem of how one argues from the truth of particulars to general truths.
Instrumentalists such as Friedman concern themselves only with the usefulness of conclusions drawn from assumptions or general theories. They may allow that theories or assumptions can be true, but they argue that truth or falsity does not matter in so far as the utility of the conclusions is concerned.
As a result, Friedman rejects the “testing” of hypotheses in the sense of verification of the truth of propositions. For him successful testing is merely confirmation that assumptions have yielded conclusions allowing accurate prediction of future events. Thus, Friedman's view assumes an “as if” theory of explanation. Even false assumptions may be treated as if they were true, as long as observed phenomena follow from them.
Prof. Boland finally analyzes the objections to Friedman's essay raised by prominent economists (Koopmans, Rotwein, Bear, Orr, Melitz, De Alessi, and Samuelson). Their critiques, he judges, uniformly arise from misunderstanding Friedman's instrumentalist methodology. Friedman himself is partly to blame for this confusion by seeming to be concerned with the verifiability or refutability of true scientific theories. What Friedman actually presents is an alternative to that kind of methodological discussion. Unfortunately, most critics miss this point.
Entrepreneurship and Justice
“Entrepreneurship, Entitlement, and Economic Justice.” In Perception, Opportunity, and Profit (Chicago: University of Chicago Press, 1979):200–229.
Professor Kirzner seeks to supplement or reformulate Nozick's Entitlement theory of justice and argues that Nozick does not solve all the questions concerning the justice of market processes. He suggests that his version of the “finders-keepers” ethic answers these questions and, moreover, accords with the moral intuition of defenders of the market.
Kirzner reminds us that Nozick's defense of market entitlements is predicated on justice both in acquisition and in transfer. Though he points out that Nozick never specifies the details of justice in transfer, Kirzner suggests that justice results if and only if transactions are voluntary. The voluntariness of market transactions is viewed as sufficient to prove their justice only if “serious” error is not an essential part of the transaction. Fraud is theft and hence excluded by definition from the class of voluntary market transactions. Kirzner wishes to highlight, however, another type of error, one endemic to market transactions and one which render them unjust.
Building on his theory of entrepreneurship, Kirzner notes that markets are always in disequilibrium and thus always offer profit opportunities. Entrepreneurial profit-seeking is the driving force of the market process and this competitive process of profit-seeking would seem to depend on error or a kind of deception. Entrepreneurs buy low from sellers who would not sell if they knew that they could sell at a higher price; in turn, entrepreneurs sell to buyers who would not buy if they knew that they could buy at a lower price. Entrepreneurial activity thus depends on ignorance and error on the part of sellers and buyers. Entrepreneurs trade on this ignorance.
Kirzner notes the relation of this critique of entrepreneurs to the doctrine of the just price. He also observes that modern scholars recognize that the Scholastics concluded that whatever the market price settles at is the just price. Nonetheless he is concerned that modern critics might develop a new critique along the lines that he suggests; he is further convinced that Nozick's theory offers no answer to such a critique.
Kirzner's solution is as follows. A hitherto unknown use for a good in effect does not exist as far as market participants are concerned. Entrepreneurs who discover these uses are creating value. He argues that creators of value are entitled to receive that value. This defense rests crucially on the assumption that all others are free to seek profits (i.e., hitherto unknown uses for resources) and thus equally free to create appropriate value.
It is not entirely clear that the relationship of Kirzner's theory is to Nozick's. Kirzner accepts that already known resources can be acquired justly from nature only along the lines suggested by Nozick. He even describes Nozick's theory as “a crucial framework” for his own. To the extent that Kirzner's theory differs from Nozick's, questions arise. For one, subjectivist economics concludes that value is created by the evaluating agent, i.e., the consumer. It is not clear in what sense the entrepreneur can be said to have created value. Heretofore, Kirzner has only credited the entrepreneur with discovery of unnoticed opportunities. If discovery equals creation, then the consumer's importance in subjectivist economics is vastly diminished.
Externalities & Government Intervention
“The Problem of Externality.” The Journal of Law and Economics 23(April 1979):141–162.
The concept of an “externality” has gained increased prominence as modern technology produces an ever-lengthening catalog of unwanted side effects. Dahlman's essay deals with the theoretical analysis of the sources and remedies for externalities. When an externality is present, there are interactions among individuals that ought to be taken into account, but are not. Since it is believed that market forces cannot cope with these interactions, it is supposed that such situations justify government intervention. Dahlman critically examines the underpinnings for the standard analyses of externalities and questions this justification for government action.
Externalities exist because it is too costly for interacting parties to transact on the market. Benefits cannot be fully captured in the market place nor harm fully compensated. Dahlman patiently leads the reader through a typology of transactions costs. He concludes that all transactions costs ultimately are costs due to incomplete information. Those who assert that markets fail to take account of externalities are implicitly asserting that they know better than markets what to do. They are postulating rather than proving that a “better way” of organizing economic activities exists. Although government is typically alleged to be that better way, this conviction is not a scientific conclusion but a normative judgment.
Standard general equilibrium theory cannot demonstrate that externalities, which should be eliminated, in fact exist. Standard economic analysis can only show that people do the best that they can, given their information. “Whatever is, is optimal.”
Dahlman argues that Ronald Codge's alternative tradition to that of general equilibrium economics would allow possible changes in institutional arrangements that would lower transaction costs and make market transactions easier. Such changes might also involve government intervention.
STATEMENT OF OWNERSHIP, MANAGEMENT, AND CIRCULATION