Front Page Titles (by Subject) I: Economic Theory - Literature of Liberty, Summer 1982, vol. 5, No. 2
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I: Economic Theory - Leonard P. Liggio, Literature of Liberty, Summer 1982, vol. 5, No. 2 
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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Elsewhere in this issue (“Law, Politics, and Freedom) the reader will find summarized Prof. Norman Barry's “A Defence of Liberalism against Politics,” in which our bibliographical essayist posits economic spontaneous order as a vital defining characteristic of liberalism: “that a natural economic order would emerge if individuals were left to pursue their private purposes. . . .” It is appropriate that this issue featuring Prof. Barry's essay on “The Tradition of Spontaneous Order” should open its summary section with Don Lavoie's paper on the related topic of the market as an ‘invisible hand’ mechanism for conveying inarticulate knowledge—an idea indebted in no small measure to the late Michael Polanyi's notion of “the tacit dimension” or “personal knowledge.”
Polanyi (1891–1976) was one of the pioneering investigators of how “spontaneous order,” involving “polycentric mutual adjustment”—any system's ecological self-regulation through ‘feedback’—was a vital precondition of health and progress not only in economics but also in science, art, and society. All these dimensions of human life require individual freedom to innovate and respond; hence freedom is a precondition of the spontaneous order, and as Polanyi noted, the free market is the exemplar of such an ‘invisible hand’ coordination:
The other ordering principle is much more elusive. So elusive, that Adam Smith who first made clear its operations in respect to commercial activities has called it an ‘invisible hand.’ The difficulty of appreciating its functions has been a constant menace to the maintenance of a free society; it has lent plausibility to the aspirations for directing industrial production centrally without the use of the market and also to the closely allied demands for the central direction of all scientific research.
(“Pure and Applied Science and Their Appropriate Forms of Organization.”)
Several of the other summaries in “Economic Theory” repeat the theme of spontaneous order in either major or minor key. See particularly Littlechild-Owen, Ekelund-Hebert, and Bornemann.
Those interested in pursuing other developments of the spontaneous order tradition may consult Prof. Barry's Bibliography, especially Polanyi's “The Determinants of Social Action” and “Pure and Applied Science. . . ” together with the Langford-Poteat volume Intellect and Hope: Essays in the Thought of Michael Polanyi. Other informative sources for spontaneous order mentioned in the Bibliography include: Bertalanffy, Koestler, Koestler-Smythies, Bronowski, and Bateson.
The Market & Inarticulate Knowledge
“The Market as a Procedure for the Discovery and Conveyance of Inarticulate Knowledge.” Paper Presented at the Liberty Fund Conference on Thomas Sowell's Knowledge and Decisions. Savannah, Georgia; April, 1982.
The author elaborates on the spontaneous order argument of Friedrich Hayek (with the aid of Michael Polanyi's concept of inarticulate knowledge in Personal Knowledge) that the market is a procedure for discovering and conveying the dispersed knowledge of market participants. With the notable exception of Thomas Sowell's study, Knowledge and Decisions (1980), contemporary economic literature has not appreciated the inarticulate nature of the knowledge which the market communicates.
Professor Sowell's appreciation of Hayek's insight into the function of the competitive market system as a knowledge-dispersal mechanism derived from his reading of Hayek's 1945 seminal essay, “The Use of Knowledge in Society.” That essay, in turn, developed out of Hayek's attempt to answer such “market socialists” as Fred Taylor and Oskar Lange in the socialist “Calculation Debate” in the 1930s. The market socialists claimed that a socialist Central Planning Board (CPB) could achieve the allocative efficiency and beneficial results of competitive capitalist markets without relying on the private property rights institutions and free market price system that underlie free exchange. The market-socialist model, built as it is on the assumption of complete and articulate knowledge available to central planners, is an excellent foil for the market model of communicating inarticulate knowledge through the price mechanism.
Market-socialist theory and models claim to have overcome Hayek's critique of the Lange-type market-socialist models of the 1930s. But even if the central planners had the use of a super-computer capable of co-ordinating the myriads of quantities and prices available, they could not duplicate the efficiency of the free market since the relevant market knowledge is inarticulate. “The producers know more than they can explicitly communicate to others. While the market marshalls this dispersed knowledge without requiring its articulation, all these market-socialist models necessarily require the full articulation of the localized knowledge to the CPB during the ‘dialogue.’”
Lavoie discusses the philosophy of knowledge implied in saying that “We know more than we can articulate.” He gives a critique of the ‘objectivist’ epistemological belief that denies any legitimacy to knowledge that is not fully articulated. The thought of Whitehead, Sowell, Hayek, Polanyi, and Gödel's mathematical response to the Entscheidungsproblem is surveyed to show that no fully formalized system can possibly be ‘complete’, and that the ‘certitude’ and ‘rigor’ of any such system have to be established from outside the formal framework itself. Polanyi and Hayek (both modern exponents of the related idea of a spontaneous order which evolves without articulate, conscious purpose by invisible hand processess) have shown from such examples as the child's ability to speak that inarticulate knowledge (such as the “unconscious” rules of grammar and syntax) underlies all articulated knowledge.
Lavoie concludes by outlining the particular role which inarticulate knowledge plays in the market process. In effect, the price system is a telecommunications device for conveying knowledge which market participants would be unable to articulate.
An Austrian Model of Price Adjustment
“An Austrian Model of the Entrepreneurial Market Process.” Journal of Economic Theory 23 (1980): 361–379.
Mainstream neoclassical economics gives a central role to the concept of equilibrium, but neglects the process by which such equilibrium is reached, and so lacks an adequate theory of price adjustment. By contrast, the Austrian school of economics—Mises, Hayek, and Kirzner—subsumes an adequate theory of price adjustment under the theory of the market process, which plays a more important role than the concept of equilibrium.
The Austrians also differ from the neoclassicals on the nature of disequilibrium. In the standard Walrasian view, disequilibrium is overcome by a single uniform price throughout the market when supply equals demand. By contrast, the Austrians stress that, because market participants are not fully aware of each other's activities, a homogeneous good may trade at different prices at different parts of the market. The Austrian approach to the price adjustment process next examines how entrepreneurial alertness on the part of market participants leads to a uniform price which is the equilibrium price.
This challenging Austrian approach is not widely known among economic theorists because Austrian models have not yet been represented in mathematical terms. The authors seek to fill this vacuum and develop a simple mathematical model of the market process and prove two theorems on the convergence of market prices. The model embodies two distinctive features of the Austrian approach: (1) it assumes a dispersed “division of knowledge” among market participants in society; and (2) over time entrepreneurial alertness allows people to learn new knowledge or discover opportunities and thus create price adjustments. The Austrian model is developed with a discussion of the arbitrage process, the discovery mechanism, and the nature of the market process.
Subjective Value: Plato, Bentham, & Smith
“The Roots of Hedonism: An Ancient Analysis of Quantity and Time.” History of Political Economy 13 (Winter 1981): 812–823.
Benthamite utilitarianism championed the “spirit of quantitative rationality and subjective individualism” as a touchstone for developing 19th-century classical economic theory. The later marginal utility revolution pursued this same spirit. It is wrong to assume, however, that the “hedonic calculus” arose only after observing the growth of commercial activity in the wake of the eighteenth century. Actually, the theory of quantitative subjective value was forged by the ancient Greeks “with little reference to exchange or commercial values.” Plato's dialogue Protagoras presents this early analysis. Lowry discusses the Protagoras' theory and the context in which the Greeks developed this analysis of quantitative subjective value. It seems likely that Adam Smith and Jeremy Bentham were indebted to the Epicurean and Platonic discussions on this and related topics.
Plato's dialogue Protagoras presents a debate between a youthful Socrates and the famous Sophist Protagoras of Abdera, who was instructed by the famous Atomist philosopher Democritus of Abdera. The opening of the dialogue—presenting Protagoras' views on the origins of civil society from the god-given gifts of justice and aidos (fellow-feeling)—anticipates Adam Smith's Theory of Moral Sentiments and its doctrine of sympathy, shame, and conscience as the origins of human society. Near the end of the dialogue, the theme of the teachability of arete (virtue or excellence) leads to an analysis of pleasure and pain. The idea of subjective pleasure and pain as a measure of well-being coincides with the subjective relativism presented in Plato's Theaetetus in which Protagoras' theory of knowledge is discussed. The Protagoras presents, in the framework of a theory of moral choice, the hedonic calculus along utilitarian, consequentialist lines and the subjective evaluation of good. It seems clear that Bentham's Principles of Morals and Legislation derives its principle of the greatest happiness or pleasure of the greatest number from Plato.
Lowry identifies the setting of Protagoras' hedonic analysis as a materialist formulation of the economics of successful weighing of the important choices in Greek life (particularly efficiency in military, political, and agricultural pursuits). Two rival versions of this theory of choice contend for the laurel. Plato promoted the idea that “reason, primarily the reason of an authoritarian sovereign, should acquire the force of moral law”—in the name of efficiency. By contrast, Atomists like Epicurus (and possibly Protagoras) came closer to the democratic notion of arete (which stressed cooperation, compassion, and the feminine). As non-authoritarians they supported democratic principles and the doctrine of sympathy and fellow-feeling as a basis of social cohesion. Thus “the development of a materialist quantitative value formulation of the basis for choices in the pursuit of efficiency and success” had wide and diverse social implications.
The Atomist-Protagoras-Sophist individualist and participatory tradition—in contrast with Platonic author-itarianism—presented its theory of the innate attraction between atoms as the root of natural mutual sympathy and social cohesion.
John Taylor: Labor & Liberty
“The Political Economy of John Taylor of Caroline.” Journal of American Studies 14 (December 1980): 387–406.
John Taylor of Caroline has chiefly been studied onesidedly, either for his oppositional ideology during the 1780s and 1790s, for his negative fear of power, privilege, and corruption, or for his agrarianism. In fact Taylor's thought rested upon twin interacting foundations of “physical” powers (agricultural prossperity) and moral, metaphysical, or political powers (republican liberty). This joint commitment was exemplified in two books: Arator, Being a Series of Agricultural Essays, Practical and Political (1803) and An Inquiry (1814). Both works are complementary: In the defense of republican liberty political action was primary; although in the promotion of agricultural prosperity it was but a means to an end, the end was as dear to Taylor as republican liberty itself. Macleod concentrates on elaborating Taylor's neglected “physical” world, that is, his economics.
Taylor was commited, like the French physiocrats, to agriculture, but he was economically more commited to a labor theory of value. “Physiocrats might wish to free economic endeavour from state direction but they were not anti-statist in their orientation: their analysis derived from the need to generate a more substantial and secure governmental revenue. Taylor, on the other hand, was anti-statist and wished to avoid the generation of a revenue which he considered must inevitably become a fund for corruption extracted from the true producers of wealth.” Wealth, he believed, should be retained by those individuals whose labor produced it: “national prosperity and liberty are safe, endangered or lost, in proportion as individuals retain, or governments acquire, the investiture or disposition of the earnings of industry.”
Although Taylor borrowed from mercantilist ideas (as in his identification of the agricultural interest with the national interest), he fused these and other ideas into his own personal amalgam. He was not a scientific political economist, and his analysis of the labor theory of value was more often normative than analytical. But he came closest of the early Americans to a qualified Ricardianism merged with the ideology of 18th-century whiggery and its notions of natural property won by honest labor, talents, and industry rather than by state coercion and corruption. Taylor's antagonism to state granted monopolies or to a military establishment was a blend of his opposition ideology (from which he defined any “transfer of property by law” as “aristocracy” and privilege) and his strict labor theory of value since government expenditures fell ultimately on the back of honest labor. This is seen from an analysis of tariffs and the public debt. Taylor doubted the benefits of state-promoted commercial growth and used the labor theory as a moral weapon to preserve an old social order.
Competition, Property Rights, & the State
“The Proto-History of Franchise Bidding.” Southern Economic Journal 48 (October 1981): 464–474.
The authors present a provisional historical analysis of franchise bidding (governmental granting to privileged parties of exclusive franchise for providing “public utilities” and “public goods” on the basis of competitive bids) as a way of untangling the distinct meanings of competition and the distinct institutional forms of property that give rise to these different meanings of competition. By clarifying the history of ideas concerning competition in franchise bidding, we will be better able to evaluate Harold Demsetz' and others' advocacy of franchise bidding. They view it as a substitute for a political commission's regulation of public utilities and a more efficient way of providing public goods. The historical analysis suggests, however, that franchise bidding, which is based on ultimate governmental control over what could be private property, merely substitutes one form of regulation for another.
Competition denotes two radically distinct notions of economic rivalry based on different structures of property rights. Private property rights gives rise to competition in Adam Smith's free market sense of allowing every seller an equal right to serve customers and allowing every buyer the freedom to choose goods from the seller he prefers. On the other hand, when the State (rather than private persons) is the lawful owner of the property right it franchises, it allows “competition” only in the sense of a contest among sellers to obtain an exclusive, monopoly right to serve buyers who have no right to choose their sellers.
Historically considered, these two opposed notions of competition were articulated, respectively, by Richard Cantillon and Bernard de Belidor. Cantillon's notion of competition centered on entrepreneurs who competed, in the framework of a free market and private property, to satisfy consumer demand at their own risk. Belidor inaugurated the “French System” of governmentally granted exclusive franchises to maximize state revenues as a form of rent seeking. In 1605, the French economist Vauban influenced Louis XIV and his minister Colbert to favor governmentally sponsored franchise bidding. Geographically the two opposed concepts of competition found their respective homes in England (politically and economically freer and more decentralized) and France.
The authors discuss the normative, philosophical background to the 18th-century differing doctrines of competition. The free market notion of competition posited the “natural identity of interests thesis” which maintained that egoistically motivated market participants harmonize their interest of their own accord through a spontaneous order which fuses individual and general interests. The more interventionist notion of competition denied a natural harmony of egoisms, and sought the involvement of the legislator to bring about “the artificial identification of interests.” Jeremy Bentham and Edwin Chadwick, who sought concentration of ownership and control of property rights in the hands of the central state to achieve harmony of interests, are the intellectual forerunners of Demsetz' espousal of governmentally sponsored franchise bidding.
Nineteenth-century theoretical extensions and refinements in franchise bidding are analyzed in the writings of Bentham, Chadwick, Mill, Sidwick, and Marshall. Finally, the pardoxical transformation of competition as a process (as understood in the Austrian tradition of Carl Menger) into the more recent neoclassical view of competition as a theoretical situation is discussed. Paradoxically, Demsetz casts his analysis of competitive franchise bidding in the static mold of orthodox, neoclassical theory.
Mercantilism: Monopoly Revenues & Regulation
“Mercantilism as a Rent-Seeking Society.” in Mercantilism as a Rent-Seeking Society: Economic Regulation in Historical Perspective. College Station: Texas A & M University Press, 1981, Chapter 1.
The prevailing paradigm about mercantilism (1500–1776) views it as either a web of economic fallacies and statist “central tendencies” or as a very sensible idea for a historical period which sought to consolidate state power. Heckscher's Mercantilism (1934) spans both variants of this paradigm. But a new paradigm is now needed to explain mercantilism in the light of the insights advanced by the Buchanan-Tullock public choice approach and by the “economics of regulation” approach. The older paradigm emphasizes certain regulatory implications flowing from a balance-of-trade and specie-accumulation objective, which, in turn, hastened the objective of creating the nation-state. The newer paradigm challenges this interpretation: The exact reverse is, in fact, the case: “the balance-of-trade objective was nothing more than the by-product of the interplay of numerous self-interested parties who were seeking rents from monopolization in these early nation-states.”
By rent seeking the authors mean seeking revenues by buying and selling monopoly and cartel (guild) privileges. The “supply of and demand for monopoly rights through the machinery of the state is seen as the essence of mercantilism.” The government interest group found that such revenues supplemented its tax revenues. Merchants and others (on the “demand side”) sought such monopoly rights to escape competition and thus earn monopoly “rents.”
The rent-seeking model is more useful in explaining developments in the mercantile economies than the usual specie-accumulation interpretation. The rent-seeking paradigm accounts for the emergence and decline of the social order of mercantilism in England and France in terms of individual behavior motivated by seeking “rent” in the face of varying institutional constraints rather than in terms of the irrationality or error in the social order of mercantilism. Mercantilism is viewed as an inclusive system of economic regulation, which was designed by the give-and-take of interest groups contending within specific institutional frameworks (such constraints as property rights, the degree of competition for political power, and the rule of law) to provide revenues for the nation-state and monopoly rents for successful projectors of monopoly schemes. The varying institutional frameworks (such as the differing structures of property rights, the degree of political competition, and the development of the rule of law) helped determine the incentives which led away from regulation to the free market in England, but not in France.
The precursors of this new “polinomic history”—the paradigm that combines positive economics and politics in its focus—include Adam Smith (with his emphasis on economic motivation and class interests in accounting for human choice), Frederic C. Lane (who investigated organized violence and its effects upon the economic motives and behavior of Renaissance governments in exacting tribute from merchants for protection), and the analysis of public choice and the economics of regulation. A detailed bibliography contains a useful survey of such sources for the new paradigm of rent seeking. The authors are convinced that a cogent explanation of the rise or fall of mercantilism and the origins of a more laissez-faire social order must appreciate the role of institutions in the course of economic history. Centralized political administration and weak private property rights, making for an effective system of rent seeking, may overregulate and retard the emergence of a free market as happened in France in contrast to the more liberal political economy of England.
Romantics vs. Marx on Political Economy
“The Fiends of Commerce: Romantic and Marxist Criticisms of Political Economy.” History of Political Economy 13 (Spring 1981): 80–94.
Marxism and Romanticism stand as essentially alien doctrines, opposed in sensibility and style, scornful of each other's excesses, and insensitive to their common concerns. Recent years, however, have witnessed a renewed interest among social theorists in understanding the ties between these two outlooks. Prof. Ryan's article examines some areas of difference and agreement among Romantics and Marxists within the realm of economic theory. His point of departure is the critique of classical political economy.
George Bernard Shaw made the comment that, compared with the scorn which Ruskin heaped on classical economics and capitalism in general, Marx's criticisms read like the “platitudes of a rural dean.” Like Marx, the Romantic critics perceived that the failings of classical theory lay not merely in its facts and figures, but in its guiding assumptions about human nature and society, the questions it asked, and the type of answers it provided.
Romantics called the whole enterprise of political economy into question by casting doubt on its fundamental conception—the notion of ‘human nature.’ They did so in a variety of ways. First of all, the Romantic emphasis on the uniqueness of each individual and his capacity to construct his own reality, both inward and outward, formed an implicit challenge to any general theory of human nature with its reduction of individual activity to common and invariant passions.
Romantics specifically objected to political economy's view of man—not only because it described him as an asocial, selfish animal—but because it positively promoted antisocial tendencies as the very basis of its theories of politics and morality. The reductionist urge in political economy led theorists to explain all human actions by considerations of profit and loss. This, the Romantics felt, produced an inadequate and perverted picture of the object under study.
Marxist analysis shared the Romantic distrust, if not outright rejection, of the concept of human nature which formed the focal point of classical theory. Marx's attack on this theory is both an internal and external critique. He points to contradictions within the theory itself and then holds the theory up to scientific standards largely external to it.
For Prof. Ryan, Marx's originality as an economist lay in his insight that all economic processes have a political character, since all social life is permeated by force, coercion, and the struggle for power. In failing to appreciate the political character of economic relations, the classical economists, Marx believed, failed to grasp the true nature of their object of inquiry. By regarding economic forms as dictated by the facts of human nature, they took as timeless and “natural” what were actually the expressions of quite specific and changeable social relationships. “Change the social relationships,” Marx wrote, “and you change the ‘essence of man’ along with them.” This rejection of human nature theory was clearly anticipated in the works of Romantic theorists.
Unlike the Romantics, however, Marx seems to champion the scientific approach to economic study as vehemently as any of the classical theorists. For Marx, people living in a capitalist society lay in ignorance of the social forces that affect them. As a result, their individual capacity to choose may be nil in the face of the social influences that batter them. The unfreedom of those living under capitalism makes a predictive science of that society not only possible but necessary.
With the advent of communism, thought Marx, this will all change. In the words of Marx and Engels, the “domination of material conditions over individuals and suppression of individuals by chance” will be replaced by “the domination of individuals over chance and circumstances.” The social conditions which necessitate political economy will thus be dissolved. In the words of G. A. Cohen, political economy “withers away” as a truly free society comes into being.
Academic Economics as Ideology
“Fifty Years of Ideology: A Selective Survey of Academic Economics in the United States, 1930–1980.” Journal of Economic Studies 8, no. 1 (1981): 16–36.
Defining ideology as “a mixture of consciously or unconsciously accepted ideas and beliefs” that “provides the underlying support or rationalisation for fundamental features of thought and action in a society,” the author presents a detailed panorama of the prevalence of ideology and values in the allegedly value-free academic discipline of economics from the Depression to 1980 and the revival of the Austrian School.
The author debunks the notions that academic economics during this period was ideologically value-free in its selection of texts, advocacy of government intervention, hiring practices, mathematical methodology, or changing policy recommendations and ideas with the winds of fashion. Over the past half-century, academic economists have not lived up to their self-image of objective scientists practicing value-free analysis. “The question of whether they had ever been completely faithful to this position in the past lost its significance beginning in the 1930s when the line between science and policy was virtually obliterated.”
The Depression which ushered in the New Deal's unprecedented government intervention beginning in 1933 did not seem catastrophic to the sheltered seclusion of most college campuses. Alfred Marshall's neo-classical paradigm continued as the basis of lectures, discussion, and textbooks throughout the 1930s and into the immediate post-World War II months. Orthodox economists dismissed the insights of the rival institutional economics which looked upon economic behavior as “a complex web of interrelated economic, political, sociological, and psychological influences.”
The war years exposed students to militarist and nationalist propaganda consonant with the official ideology of creating a “war man” and a patriotic “military-industrial complex.” This atmosphere was favorable to the interventionist economic doctrines of John Maynard Keynes' The General Theory of Employment, Interest and Money (1936). “The idea of essentially costless warmaking sustained the political ideology of war” and Keynesianism extended government spending into social outlays. “The Keynesian aggregative macro-approach directed its attention to full employment defined as consisting of essentially homogeneous jobs as such. Large-scale government spending programs unencumbered by the constraints of the gold standard emphasized increasing consumer income to remedy a deficiency of aggregate demand. The accompanying expansion in government direction of the economy was taken for granted. . . .”
The new Keynesian principles gave rise to two types of economists, whom Shakle termed the “mathematicians” and the “conceptualists.” “Academic economics as a profession of technicians engaged in structuralising, controlling, and predicting the behaviour of the economy. . . became possible with the increasing use of quantitative methods and the computer solution of complex models, optimisation objectives, and econometric equations.” The PhD program ideologically emphasized Keynesianism and quantitative methodology; it downplayed the history of economic thought. A communications problem developed when this abstruse formalism was introduced to undergraduates. The classroom saw method triumph over subject matter, and endured the tedium of formalistic lecture without discussion of underlying meaning and significance.
The post-war decades witnessed the Keynesian full employment dogmas installed as the new orthodoxy. Textbooks such as Samuelson's taught Keynesian theory to an entire generation of economists. “The Keynesian paradigm mean while prevailed for several decades. This faith was eventually shaken not by the intellectual evolution of theory but by the unfolding of economic disasters to which Keynesianism's nonchalance over inflation had contributed.”
“As multiplying interest groups pushed their claims on government for part of the national income, the number of economists taking positions on current questions and the politics of full employment was greater than ever before. Theoretical interest meanwhile took the form of discussions of the public interest in terms of initiating, controlling, and allocating costs and benefits.”
The predominant collectivist liberalism supporting the ideology of the mixed economy eventually met with classical liberal or libertarian challenges. Milton Friedman and the Chicago economics department played a major role in articulating a defense of the market economy. A renewed interest in the Austrian School added momentum to the market approach. “Hayek's exposition of the contribution of the individual to the optimum function of an economy as against the inefficiency of centralised bureaucratic management won a degree of attention along with his other contributions. Mises' discussion of the logical impossibility of rational socialist calculation continued to be cited. . . . His general theory, especially Human Action attracted a circle of ardent disciples.”