The Online Library of Liberty

A project of Liberty Fund, Inc.

• Introduction
• Part 1: Economics and Ethics
• Chapter 1: Are Economists Basically Immoral? *
• Chapter 2: Economics and Ethics: the Problem of Dialogue *
• Chapter 3: Income and Ethics In the Market System *
• Part 2: Economics and Theology
• Chapter 4: Can Homo Economicus Be Christian? *
• Chapter 5: Economic Scientists and Skeptical Theologians *
• Chapter 6: Christian Theological Perspectives On the Economy *
• Chapter 7: Controlling Stories: On the Mutual Influence of Religious Narratives and Economic Explanations *
• Part 3: Economics, Theology, and Justice
• Chapter 8: Justice, Natural Law, and Reformation Theology *
• Chapter 9: The Concept of Economic Justice In Religious Discussion *
• Chapter 10: The U.s. Catholic Bishops and the Pursuit of Justice *
• Part 4: Economics and History
• Chapter 12: Christian Social Thought and the Origination of the Economic Order *
• Chapter 13: Clerical Laissez-faire: a Case Study In Theological Ethics *
• Part 5: On Teaching and Learning
• Chapter 14: “the Nature of Man”: What Are We After? *
• Chapter 15: Researchers and Degree Purchasers *
• Part 6: Teaching Economics
• Chapter 16: Economics Is a Way of Thinking *
• Chapter 17: Teaching Introductory Economics *
• Chapter 18: Teaching Economics By Telling Stories *
• Chapter 19: Between Sterility and Dogmatism *
• Part 7: Economic Method
• Chapter 20: Ethics On the Road to Serfdom and Beyond *
• Chapter 21: Measures of Wealth and Assumptions of Right: an Inquiry *
• Chapter 22: The Foundations of Law and Economics: Can the Blind Lead the Blind? *
• Part 8: Policy Commentary
• Chapter 23: What Is the Responsibility of Business Under Democratic Capitalism? *
• Chapter 25: An Economic Perspective On Illegal Drugs *
• Chapter 26: Economics, Ethics, and Ecology *

CHAPTER 19

Between Sterility and Dogmatism*

This paper will try to describe an approach to the teaching of economics that might improve our chances of avoiding both sterility and dogmatism.1 In the course of arguing for the approach, I want to present and defend the heretical claim that economics has a great deal to say about the morality of the market.

Scylla and Charybdis

The sterility with which I am concerned comes from refusing to draw a conclusion until we think we have provided a complete statement of the conditions that must be met for the conclusion to follow rigorously. Economists who behave in this antiseptic fashion give the impression to students that their discipline has nothing of real importance to say about social issues. The opposite danger is dogmatism, which appears when we present conclusions without adequate supporting evidence and argumentation—without just what it takes to produce sterility.

If this account is roughly correct, there may be no channel through which to steer between the rock of dogmatism and the whirlpool of sterility. In that case we would be in urgent need of an alternative route. Sterility and dogmatism, in case they don’t stand self-condemned, are serious impediments to the generation and maintenance of student interest. Interest is essential to learning, because people learn nothing in which they have not first become interested. Threats such as low grades can sometimes stir interest—they induced me to learn the multiplication tables. But threats are far less effective and reliable in nurturing interest than is the belief that valuable insight or understanding lies ahead.

The core of my recommendation is simply that economics be taught with far more attention to social processes. We spend too much time, I believe, on the formal relationships among static variables. We neglect the more interesting and significant issues: What processes created and now maintain these relationships? What subsequent processes can we anticipate as a result of these relationships or the introduction of new factors?

Formal Analysis

Suppose you’re teaching the orthodox “theory of the firm” (or what we oddly call “the theory of the firm” even when the actors are not firms but net-revenue-maximizing black boxes). You show your students when and why marginal revenue lies below demand for a particular seller, and what will happen when marginal revenue and marginal cost are less than price. You derive and display the familiar triangle between the demand curve and the marginal cost curve that results from the seller’s decision to restrict sales to the quantity at which marginal revenue equals marginal cost. What do you do next?

What can be extracted from this set of formal relationships among static variables: demand, price, marginal cost, marginal revenue, quantity? Can we demonstrate waste, inefficiency, non-optimality?

Many of us try. We go through contortions that numb the minds of our students in a largely vain effort to derive some significant conclusion from the analysis without violating our canons of scientific procedure. We would like to demonstrate—rigorously, of course—that an expansion of output to reduce the size of the triangle is a Pareto-superior move. But we need to make some assumptions in order to get to this conclusion, assumptions that are very hard even to state clearly. Zero transaction costs is a favorite. What is there about zero transaction costs or perfect information that makes economists think it will justify policy conclusions? Why don’t we allow zero transportation costs to perform a similar function in our analysis? One can defend any policy conclusion at all if allowed to abstract from everything that would defeat the policy. I believe I could “solve” all the social problems of the world if allowed to assume zero transaction costs. Is it not the case that distinctively social problems are always the result of positive transaction costs, and would disappear if transaction costs were zero?2 What in the world are we doing when we introduce such assumptions in order to draw conclusions? The truth of transaction costs is that they exist, in a multitude of surprising and unexpected forms. They are part of the processes of social interaction. There are all sorts of very real and important costs associated with social transactions that we had tended to overlook before Ronald Coase, or Frank Knight before him, taught us to see why the social world so often fails to meet our expectations.3

Substantive Analysis

The beginning of substantive as distinct from purely formal economic analysis is dissatisfaction. We begin by observing an unsatisfactory state of affairs, or what we suspect to be an unsatisfactory state of affairs, or what someone else says is an unsatisfactory state of affairs. Our formal analysis, with cost curves and demand curves, is a preliminary exercise, an aid to thinking that acquires meaning only when it is put to work on some real, or at least recognizable, social transactions: the marketing of airline tickets, for example, or of restaurant meals, prescription drugs, hardcover and paper-cover books, new textbooks and used textbooks, bachelor’s degrees, foreign automobiles, crude petroleum, long-distance telephone service, or any other price-cost relationship troubling enough to prompt the question: Is this what we want?

Our tools are put to interesting and important uses when we employ them to construct plausible accounts of social processes in response to some kind of dissatisfaction with an observed state of affairs. These accounts can look backward or forward in time. We can try to explain how the observed situation came about; or we can try to predict what will happen if some new factor is introduced, such as a change in the law. This, I submit, is the knowledge we’re after whenever we are trying to evaluate a situation.

Criticism and Inquiry

Suppose, for example, that a student complains about the difference between what the bookstore pays when it buys back used books and what it charges when it resells them. Does the student have a legitimate complaint? We are regularly told that economic analysis cannot answer such questions; but that is a half-truth at best. If economic analysis cannot tell us what ought to be, it can often tell us a good bit of how matters might have come to be. What is the social process through which the gap between buying price and selling price is established and maintained? That is basically what we must know in order to judge whether or not the bookstore is behaving in an unfair or otherwise unacceptable way. And that is precisely the sort of knowledge economics can help us acquire. It is true that no finite account of the process can be guaranteed in advance to settle the question of fairness to any particular person’s satisfaction. But that implies no more than that any inquiry might have to be extended. In what direction? In whatever direction the continuing questions of the dissatisfied inquirer may point us.

A situation cannot be judged satisfactory or unsatisfactory, of course, until it has been compared with alternatives. Economics provides the same kind of assistance here. If our indignant student judges the bookstore’s used-textbook practices unacceptable, the question of an alternative system immediately arises. “What changes would he recommend?” When the recommendation for reform is presented, economic analysis can attempt to anticipate its consequences. Once again the consequences will be a process, and not simply a clearly-defined state of affairs at some future date. The proposed reform can then be evaluated in the light of the flow of consequences anticipated from its introduction. There is again no guarantee that the asserted consequences will convince any particular person that the proposed reform is either desirable or unacceptable. Anyone may want to push the inquiry further. While refusing to decide is in practice itself a decision, in principle economic analysis can continue indefinitely.

Positive-Normative or Simple-Complex?

The claim that economic analysis can never settle normative questions is demonstrably false, since it often does exactly that. It is quite true that economic analysis by itself can never settle normative questions, but economic analysis never exists “by itself.” The knowledge anyone acquires through economic analysis always exists in conjunction with a lot of other knowledge, beliefs, values, assumptions, working principles, and matters taken for granted. Economic analysis presents arguments, and no argument, not even the most respectably rigorous one, will necessarily convince anyone, much less everyone. That’s just as true, however, of so-called positive economics as it is of normative economics.4

Certain kinds of questions are indeed easier to answer than others. Clearly-formulated questions, simple questions, and questions resting upon a broad or deep consensus are easier to answer than carelessly-formulated questions, complex questions, or questions that beg questions. The gulf that so many economists believe they see between positive and normative questions reflects, I think, a misinterpretation. The questions we call “positive” are the ones on which we think we know how to achieve agreement: the clear, simple questions that arise within a well-understood and accepted framework of thought. We label a question “normative” not because it is categorically different from “positive” questions but because we don’t (yet) know exactly how to go about agreeing upon an acceptable answer.

More Misleading Distinctions

Perhaps economists pay so little attention to processes and so much attention to static outcomes at well-defined points in time and space because we find it so much harder to pose questions we can answer definitively when we inquire about processes. That is probably also why we disavow any knowledge of equity but claim expertise on efficiency. We may know less about efficiency than we suppose, however, and more than we realize about equity. Every measure of efficiency is a ratio of values; there is no such thing as technological or objective efficiency. It follows that every measure of efficiency presupposes the appropriateness of particular evaluations, which means, to make a long story short, that every measure of efficiency presupposes the acceptability of some set of entitlements or property rights. Who has the right to value, or to have their valuations counted? An authoritative statement about efficiency rests upon an implicit judgment about equity.

The means-ends distinction is another device we commonly use to confine the questions we ask within manageable bounds. That dichotomy, too, tends to steer us away from the study of social processes into the examination of static conditions: the formal conditions entailing the most effective allocation of given means for the achievement of given ends. In reality, however, neither means nor ends are ever given. We have no ends, but only provisional goals which are going to be means toward the achievement of further goals if we reach them; and those further goals will also be provisional and also really means. We don’t know what we’re after, even though we are highly purposive creatures. We largely find out what we want in the process of trying to get it. And one thing we want is to discover more about the means at our disposal. Our goals change as we approach them. There are no “final goods,” no benefits at the end to be totted up and compared with all the costs in some grand benefit-cost analysis, because benefits often turn into costs and costs into benefits before we get to the end—except that there is no end, unless it’s death, whereupon it’s too late for benefit-cost analysis to serve any purpose. The means-ends dichotomy is a useful simplification. When invoked as a dogma, however, it distorts our perceptions and obscures the important truth that purposive behavior, especially among a society of cooperating persons, is a process and not a problem in pure logic.5

I do not want to be misunderstood. I am prescribing, not proscribing. Economists should and will continue to engage in static analysis, because it stimulates their interest, advances their careers, and also sharpens the tools we use to analyze social processes. My concern is that the prestige and satisfactions of static analysis not deter economists, especially teachers of economic principles, from also using their tools to construct plausible accounts of social processes in response to problematic situations.

Moral Judgments and Social Processes

I want to conclude with the altogether heretical argument that we are seriously underestimating the power of our analytical tool kit and the relevance of our discipline to public policy when we contend that economics has nothing to say about justice or other ethical issues. By making this self-denying claim, we surrender the right to discuss the morality of the market to those who don’t understand how markets work. If economics is practiced exclusively in the formal-static mode, it will indeed have little to say about justice, because justice in large societies characterized by market interactions is far more a matter of process than of outcomes or states. Whether a situation is or is not unjust will depend on the processes that produced it. There is no such thing as an unjust pattern of income distribution; or, if there is, I have yet to encounter a clear and coherent explanation of how it could be recognized. There are, however, unjust actions that distribute income in particular ways. When economists discuss the social processes through which income is allocated, they are, whether they wish to or not, illuminating the morality of those processes.

It is not the outcome but the process itself that enables us to approve or condemn the functioning of the market in particular cases. Outcomes such as poverty, unemployment, or inequality are only relevant as clues or guides to inquiry. I am not merely arguing that this is how we ought to assess the morality of the market; I am contending that this is in fact how we do it, even when we describe what we are doing quite differently. I am thus making an empirical claim, a claim that can be tested by examining the processes of moral reflection and moral discourse in which we regularly engage. Someone who asserts, for example, that great wealth amid grinding poverty is an unjust state is, I believe, putting forward the hypothesis that any such combinations that we observe will be found to have emerged from unjust processes.

To Be Continued

But what constitutes an unjust process? While that isn’t an easy question to answer, neither is it the altogether empty question that so many economists seem to suppose. What processes do we in fact condemn as unjust? What do our actual processes of moral reflection and moral discourse reveal? There is no ultimate answer, of course. There never is, at least not to any human question. Those who practice economics as a humane science, rather than a branch of human engineering, must learn how to be content with less than ultimate answers and with suggestions that are merely plausible.

PART 7

Economic Method

[* ] Reprinted from Journal of Private Enterprise (Fall 1986): 14-19, by permission of the publisher.

[1. ] The approach is hardly novel. F. A. Hayek is its most eminent contemporary practitioner, but Adam Smith was working this way in the eighteenth century. I presented an earlier version of these recommendations in March 1986 to students and faculty at Whitman College in Walla Walla, Washington. They might not even recognize the present version, but their questions and comments made a significant contribution to my reformulation of the argument.

[2. ] If all members of every society had “perfect information,” including correct information about what everyone else wanted and how much each would sacrifice to obtain (or avoid losing) what was valued, what kind of social problems could possibly arise? There would be no wars, for example, because with the outcome of any conflict known in advance, the parties would simply settle on the terms that conflict would impose. The price system on which economists lavish so much study (properly, in my view) would be unnecessary in a world of perfect information costlessly acquired by all.

[3. ] The classic reference is to R. H. Coase, “The problem of social cost,” Journal of Law and Economics (October 1960). Knight’s discussion of methods for meeting uncertainty was a much earlier exploration of these themes. Frank H. Knight, Risk, Uncertainty and Profit (New York: Harper and Row, 1965; originally published in 1921), especially part III.

[4. ] Donald N. McCloskey has done much to make this position more acceptable, or at least familiar, in the economics profession. See especially McCloskey, “The Rhetoric of Economics,” Journal of Economic Literature (June 1983).

[5. ] No one has argued more cogently for the position taken in the two preceding paragraphs than Frank Knight. See especially the first two essays in Frank H. Knight, The Ethics of Competition and Other Essays (Chicago: University of Chicago Press, 1976). One of Knight’s most distinguished students, James Buchanan, maintains that Knight himself failed fully to appreciate the limitations that his own arguments place upon the conception of economic activity as essentially maximizing activity.