Download 1 The Insufficiency of Economics Dan Hammond

The Insufficiency of Economics Dan Hammond George Mason University November 17, 2016 This essay is a prospectus for a project that I plan to develop over the next couple years. The project is an outgrowth of my historical/biographical work on the career of Milton Friedman and Chicago economics. It also comes from my personal intellectual migration from economics and history of economics to “philosophy, politics, and economics.” In a nutshell, the argument that I will develop is that economics needs to be in “philosophy, politics, and economics.” Economics has been deracinated as a stand‐alone discipline. For that matter, so have other disciplines. But my concern is with economics. Some of the students in the George Mason Philosophy, Politics, and Economics program are coupling PPE with Economics; some with Philosophy; and others with Government and International Politics. So you are probably on board already with my concerns about economics, or politics, or philosophy as stand‐alone disciplines. And you are doing something about it. Perhaps, though, I can contribute to your inquiries through my insights, if that’s what they are, into the insufficiency, and indeed deficiencies, of economics. This past September Professor Boettke was elected President of the Mont Pelerin Society. Congratulations! I will get to the MPS in the course of this essay. But let’s begin with contemporary economics, in which I see two problems (at least). Then we will take a look at Chicago and MIT economics, and conclude with a look at the early days of the Mont Pelerin Society. The first problem with contemporary economics is that for the most part economists do not know the history of economic ideas and see no reason to. The second problem is the dominance of mathematics and econometrics, both of which make it too easy to think you are doing good economics. I see this as the primary cause of 1 economics being deracinated. Despite the demands of mathematical and statistical rigor, the knowledge bar for economic scholarship is set too low! First the lack of intellectual history. An anecdote from the past two weeks may illustrate this. I was soliciting referees for a paper that has been submitted to the journal History of Economic Ideas. As you can tell from its name, this is a “history of economics journal” rather than an “economics journal.” The title of the paper is “Wicksell, Secular Stagnation and the Negative Natural Rate of interest.” The paper is intellectual history – thirteen of Wicksell’s works are referenced, with dates from 1893 to 1919. There are also references to historical figures such as Bohm‐Bawerk (1891); Gustav Cassel (1903 and 1904); Irving Fisher (1896, 1930, 1933); Keynes (1936 and 1937); Alvin Hansen (1939 to 1951); D. H. Robertson (1922 & 1957‐59); Pigou (1943 and 1947); Henry Simons (1942); and Frank Knight (1944). But there are also references to contemporary economics literature (if late 20th century counts as contemporary) – Paul Krugman (1998 & 1999); Robert Barro (1995); a 2014 NBER Working Paper. Finally, and significantly, there are references to four recent papers by Lawrence Summers (2014‐16) and Michael Woodford’s 2003 book on the foundations of the theory of monetary policy. The author of the paper develops a connection between analysis of sluggish growth since the 2007‐09 recession and the history of economic ideas as follows: Knut Wicksell’s concept of the natural (or neutral) rate of interest, introduced between the end of the 19th and beginning of the 20th centuries, has played an important role in modern monetary macroeconomics, especially after the development of inflation targeting policy in the 1990s. More recently, the revival of Alvin Hansen’s 1939 secular stagnation hypothesis by Lawrence Summers and others has brought to the fore the notion of a negative natural rate of interest, in the sense that there is no positive rate of interest able to equilibrate saving and investment at full‐employment income. The present paper investigates whether the negative natural rate of interest may be found in Wicksell. It also examines in what extent the idea of secular stagnation is compatible with his original theoretical framework. 2 The author quotes Summers ‐‐ “following the Swedish economist Knut Wicksell, it is common to refer to the real interest rate that balances saving and investment at full employment as the ‘natural’ or ‘neutral’ real interest rate. Secular stagnation occurs when neutral real interest rates are sufficiently low that they cannot be achieved through conventional central‐bank policies.” Usually when I solicit referees for an HEI submission I go to fellow historians of economics. But with the context of this paper set in current economic issues and analysis, I decided to send it to a macroeconomist. Not only that, I chose an economist who has written on the anemic recovery and has a recent publication with “Pigou cycles” in the title. This economist wrote back to me– “Sorry, but history of economic thought really isn't my field.” If named concepts with histories such as “secular stagnation” and “natural rate of interest,” or “Pigou cycles” are being used today, and names of economists from the past are being invoked in analysis of current economic problems, I would think that economists would want to be careful about using the names of concepts and the economists who created them correctly. They would certainly want to get their mathematics and econometrics correct. No economist would want to say with regard to the mathematics of their analysis that they are using a Cobb‐Douglas production function or using a Hamiltonian unless they actually are. Similarly, they would not want to say they are using the Neyman‐Pearson setup or testing for a unit root in their econometrics unless they actually are. But they are not equally fastidious about the accuracy of their invocation of people and concepts from history. Why this asymmetry? Why is an economist comfortable saying ‐‐ “Sorry, but history of economic thought really isn't my field,” but not comfortable saying ‐‐ “Sorry, but mathematics really isn't my field” or “Sorry, but econometrics really isn't my field.” This attitude reflects, I think, a whiggish presumption that economics is a progressive discipline. If the cutting edge of a discipline is in fact slicing through the tangle of its subject matter to make new discoveries and make the obscure clear, then perhaps there is little reason to look back at the past. Keep your eye on the road ahead. Maybe the history of economics is a history of ignorance dispelled and 3 mistakes corrected. Maybe, but it’s not at all clear that economics is this type of discipline. Furthermore whiggish economists who do not know history of their discipline have no grounds for their whiggish presumption that economics is progressive. You cannot claim progress unless you actually know from where you’ve come.1 Consider economists’ knowledge of business cycles. Have progress in availability of data and in computing power over the past half century been matched by progress in understanding business cycles? I think not. How many economists foresaw the December 2007‐ June 2009 recession? The quip is that only those economists who always predict recession. From Business Week, Dec. 25, 2006 – We put four key economic questions to 58 experts for a sneak preview of the year to come (2007). a. On average the experts see growth cooling to 2.6% by end of 2007, a notch below the 2006 rate of 3.1% b. The unemployment rate will drift up, but not by much, from 4.5% to 4.8% c. … Question: Will the housing recession sink the economy? – Answer: Not likely Question: Will the profit boom turn to bust? ‐‐ Answer: Profits will decline to single digits, but don’t expect a crash. From the Wall Street Journal, Dec. 14, 2006 New home construction is plummeting. Car sales are weakening. Investors have driven long‐term interest rates well below short‐term rates set by the Federal Reserve. All these factors are present today, and all have been precursors of past recessions. But the U.S. central bank and much of Wall Street are now betting that the old rules don’t apply, and that a recession next year, while possible, is unlikely. The Journal quoted Ed Leamer, head of the forecasting center at the UCLA Anderson School of Management, “This time will be different … This time the problems in housing will stay in housing.” 1
See Peter J. Boettke, Christopher J. Coyne, and Peter T., Leeson, “Earw(h)ig: I can’t hear You Because Your Ideas are Old,” Cambridge Journal of Economics 38 (3:2013): 531‐44. 4 The Federal Reserve Open Market Committee presumably has access to the best business cycle analysis available. How did they do in foreseeing the recession? At their December 2006 meeting the FOMC voted to hold the federal funds rate steady at 5.25%. The committee’s statement read: Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market. Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters. Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. …The Committee judges that some inflation risks remain. (http://www.federalreserve.gov/newsevents/press/monetary/20061212a.htm). So twelve months before the recession began the FOMC was more concerned with inflation than recession. The sole dissenter at the December 2006 meeting preferred an increase to 5.50% (indicating that he regarded inflation more of a threat than his colleagues did). Economists do not predict the future very well. What about the present? The minutes of the FOMC meeting December 11, 2007, as the recession was beginning, are suggestive of how little economists know of the present. The committee’s policy directive suggests a growing awareness of weakness in the economy, but falls short of seeing the recession that was in fact under way: The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4‐1/4 percent. Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time. Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. 5 As had been the case in the meeting a year earlier, there was one dissenter. This time the dissenter thought the economy was weaker than his colleagues considered it and that a more aggressive policy adjustment was warranted. Apparently Eric Rosengren, President of the Federal Reserve Bank of Boston, saw the present somewhat more clearly than his nine colleagues. Among these nine were Ben Bernanke and Timothy Geithner (then President of the Federal Reserve Bank of New York). I suspect that the presumption of knowledge that one does not actually have – Hayek’s fatal conceit – is in part the result of another twentieth century development in economics – the primacy of analytical technique. Another anecdote – A few years ago I was having lunch with a young macroeconomist who was visiting Wake Forest. This was at a time when I was writing about Milton Friedman and Anna Schwartz’s work on business cycles. I asked this economist what we (macroeconomists like himself) know about business cycles that was not known a quarter century or a half century ago. His response was to tell me of a new econometric technique. So I asked the question again, with emphasis on “know about the business cycle.” He replied once again by telling me of an analytical technique. The conclusion I drew was that while Milton Friedman and Anna Schwartz used analytical technique as a means to study and learn about the business cycle, this macroeconomist used the business cycle as a means to apply analytical technique. Milton Friedman and Anna J. Schwartz began their research program on monetary factors in business cycles in 1948 at the behest of Arthur F. Burns, Director of Research at the NBER. This work was a continuation of a NBER research program going back to Wesley J. Mitchell’s Business Cycles, published in 1913, seven years before the National Bureau was established. They began not by reading monetary theory or macroeconomic theory, but by building data and reading banking history. This was to beome a hallmark of their approach to monetary economics; the work was empirical and historical. After a decade of research Friedman was still referring to their results as “provisional.” When did you last 6 witness an economist describing the result of a decade’s work as provisional? This is what I meant by saying that mathematics and econometric technique make economic research too easy. The distinctiveness of Friedman and Schwartz’s painstaking development and analysis of data, both numerical and institutional, bears comparison with Paul Samuelson and Robert Solow’s work on the Phillips Curve.2 In “Money and Business Cycles” Friedman and Schwartz used thirty‐two pages to present and analyze extensive data records of money and business cycle turning points, with data covering the period from 1867 to 1960. 3 They observed first that the money stock tended to rise rather than fall through most business cycle contractions. They removed the positive trend from the series by taking logarithmic first differences and examined patterns in rates of change in the money stock over deep and mild contractions. Then they presented the data both in charts and in numerical tables to uncover the cyclical timing and amplitude of money growth through NBER reference cycles. In their analysis everything is out on the table. Friedman and Schwartz made interpretive judgments about patterns in their data but they presented all the information readers would need to make their own judgments. Their conclusions for major business cycles were that: 1. There is a one‐to‐one relation between money changes and changes in money income and prices, … 2. The changes in the stock of money cannot consistently be explained by the contemporary changes in money income and prices (Friedman and Schwartz 1963, p. 50). By this they meant that although causation goes both ways between money and nominal income, money has an active role in the business cycle. There seems to us, accordingly, to be an extraordinarily strong case for the proposition that (1) appreciable changes in the rate of growth of the stock of money are a necessary and sufficient condition for appreciable changes in the rate of growth of money income; and that, (2) this is true both for long secular changes and also for changes over periods roughly the length of business cycles. To go beyond the evidence and discussion thus far presented: our survey of experiences leads us to conjecture that the longer‐period changes in money income produced by a changed secular rate of growth of the money 2
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“Analytical Aspects of Anti‐inflation Policy,” American Economic Review 50 (2): 177‐94. Review of Economics and Statistics 45 (February 1963): 32‐64. 7 stock are reflected mainly in different price behavior rather than in different rates of growth of output; whereas the shorter period changes in the rate of growth of the money stock are capable of exerting a sizable influence on the rate of growth of output as well (Friedman and Schwartz 1963, p. 53). Friedman and Schwartz were well aware that their explanation of business cycles was in competition with others, such as the Keynesian theory that investment was the prime cause. It is perhaps worth emphasizing and repeating that any alternative interpretation must meet two tests: it must explain why the major movements in income occurred when they did, and also it must explain why such major movements should have been uniformly accompanied by corresponding movements in the rate of growth of the money stock. The monetary interpretation explains both at the same time. … We have emphasized the difficulty of meeting the second test. But even the first alone is hard to meet except by an explanation which asserts that different factors may from time to time produce large movements in income, and that these factors may operate through diverse channels – which is essentially to plead utter ignorance (Friedman 1958, p. 54). At a 1959 AEA session on price level stability Samuelson and Robert Solow devoted more than half of their discussion to impediments to the use of historical data for identification of different types of inflation ‐‐ demand‐pull, cost‐push, and demand shift. They were critical of one‐sided explanations of inflation for these typically ignored the “intricacies involved in the demand for money,” relied on aggregate ex post data and partial equilibrium analysis, and failed to account for the possibility that effects may precede causes. Following their pessimistic rendering of the problems involved in evaluating historical instances of inflation, Samuelson and Solow turned to A.W. Phillips’s “fundamental schedule relating unemployment and wage changes,” the Phillips Curve. From a scatter plot of U.S. data on unemployment rates and increases in hourly earnings, a plot without actual numerical values, they offered suggestions about the Phillips Curve for the U.S. They began by noting deficiencies in the data: The first defect to note is the different coverages represented in the two axes. Duesenberry has argued that postwar wage increases in manufacturing on the one hand and in trade, services, etc., on the other, may have quite different explanations: union power in manufacturing and simple excess demand in the other sectors. It is probably true that if we had an unemployment rate for manufacturing alone, it would be 8 somewhat higher during the post war years than the aggregate figure shown. Even if a qualitative statement like this held true over the whole period, the increasing weight of services in the total might still create a bias. Another defect is our use of annual increments and averages, when a full‐scale study would have to look carefully into the nuances of timing. A first look at the scatter is discouraging; there are points all over the place. But perhaps one can notice some systematic effects (Samuelson and Solow 1960, p. 188). The systematic effects that they inferred from the plot were: 1. 1933 to 1941 are sui generis; if there is a Phillips curve it has a positive slope. The anomaly is the result either of NRA pricing codes or of structural unemployment. 2. The data for the early years of World War II are also atypical, though less so. 3. The remainder of the data “show a consistent [Phillips curve] pattern” 4. The Phillips curve shifted upward “slightly but noticeably” in the 1940s and 1950s. In the earlier period “manufacturing wages seem to stabilize absolutely when 4 or 5 per cent of the labor force is unemployed,” but since 1946 “one would judge now that it would take more like 8 per cent unemployment to keep money wages from rising.” 5. The data may or may not represent an aggregate supply curve. If so, the movements along it indicate demand pull and shifts indicate cost push. But if employers in anticipating full employment give wage increases during slack periods, this makes it problematic to interpret the Phillips curve relationship as an aggregate supply curve. Samuelson and Solow conclude on this pessimistic note: We have concluded that it is not possible on the basis of a priori reasoning to reject either the demand‐pull or cost‐push hypothesis, or the variants of the latter such as demand‐shift. We have also argued that the empirical identifications needed to distinguish between these hypotheses may be quite impossible from the experience of macrodata that is available to us; and that, while use of microdata might throw additional light on the problem, even here identification is fraught with difficulties and ambiguities (Samuelson and Solow 1960, p. 191). Despite their pessimistic acknowledgment of the difficulties, Samuelson and Solow ventured “guesses” portrayed in their figure 2, which is a smooth, non‐linear Phillips curve “roughly estimated” from the most recent twenty‐five years of data. The guesses are that: 1. five to six per cent unemployment is required to have wage increases that match productivity growth, 2. four to five percent inflation is required to keep unemployment at three per cent. 9 They warned that the policy trade‐offs indicated by their Phillips curve were at best short‐term. The trade‐offs could well change in the future. Nonetheless, their diagram and inferences are surprisingly precise in light of the serious difficulties they brought to light about drawing inferences from the data. I have suggested that economists are inclined to hubris. In a 1967 discussion with Arthur Burns, Samuelson described his forecasting technique: I am not now referring to the regressions of the computer but I am speaking now of the regressions of the mind, the intuitive forecasting which I do. The other day a colleague of mine … said to me, “Paul, how long do you think it will take before a computer will replace you?”... I thought for a moment, and as the question seemed to be asked in a mean way, I replied, “Not in a million years.”4 Friedman was more modest about what he knew, less sanguine about what any experts knew, and believing in the power of monetary policy, more wary of the potential for harm from misguided policies. He also was committed to systematic examination of data bearing on the business cycle. In the words of his mentor Arthur Burns, Friedman believed that “there is no reliable shortcut to tested knowledge.” The primacy of technique is born out both in empirical economics, i.e., econometrics, and in theoretical economics, i.e., mathematical economics. Early in his career Milton Friedman saw the dangers of technique replacing markets as the subject of economics. He saw this in part because of his training in National Bureau of Economic Research methods by Arthur F. Burns and Wesley Clair Mitchell at Rutgers, Columbia, and the National Bureau.5 This training, plus the relatively low‐brow applied price theory that he learned from Jacob Viner and Henry Schultz at the University of Chicago kept Friedman anchored in the real‐world economy. The irony is that Friedman’s first intellectual passion was for mathematics rather than economics and his initial professional identification was as a statistician rather than as an economist. 4 Burns, A.F., and P.A. Samuelson. (1967) Full Employment, Guideposts, and Economic Stability. Washington, D.C.: American Enterprise Institute, pp. 92‐3. 5
See Hammond, J.D. “Columbia Roots of the Chicago School: The Case of Milton Friedman,” mimeo, 2000. 10 My interpretation of Milton Friedman’s economic methodology, as seen for example in “The Methodology of Positive Economics,” is that he developed his ideas primarily as a critique of mathematical economics. If his methodology as presented in the famous 1953 essay and elsewhere is an oak tree the acorn from which the oak developed was a short book review that he published in the Journal of Farm Economics.6 The book that occasioned the review was Robert Triffin’s Monopolisitc Competition and General Equilibrium Theory.7 Triffin sought to reorient the theory of monopolistic competition away from the Anglo‐American tradition of Marshallian analysis toward Continental Walrasian analysis. For Triffin this meant dispensing with the concept of industry and moving the orientation simultaneously in two directions, inward toward the single firm and outward toward the “whole economic collectivity.” He wrote: The appearance of monopolistic competition assumptions has been a new step in the historical process of purification and formalization of economic theory. The analysis loses in content, while gaining in generality. … On the other hand, we shall find that an increasing number of situations elude the grip of the traditional weapons of pure economics. This raises the question of whether we should not, reversing the historical process of growing generalization just mentioned, enlarge the present box of assumptions of pure theory so as to enable us to tackle these cases; again, the required assumptions should be chosen on an empirical basis, and a price will have to be paid in the form of a lesser generality for the ensuing analysis (1941, pp. 15‐16). Friedman did not contest Triffin’s assertion that the logic of monopolistic competition implies abandoning Marshallian industries. He agreed with this. But he rejected Triffin’s choice of monopolistic competition over Marshallian industry analysis. And he did so because the practical problems for which 6
Friedman, M. "Review of Monopolistic Competition and General Equilibrium Theory by R. Triffin.” Journal of Farm Economics 23 (February 1941): 389‐90. Other places in which he developed the ideas detail are “Lange on Price Flexibility and Employment: A Methodological Criticism,” “Lerner on the Economics of Control,” and “The Marshallian Demand Curve,” all reprinted in Essays in Positive Economics, Chicago: University of Chicago Press, 1953. 7
Triffin, R. Monopolistic Competition and General Equilibrium Theory. Cambridge: Harvard University Press, 1941. 11 economists want to use theory are at the level of industries, not at the level of firms or of the “whole economic collectivity.” If industries have no place in monopolistic competition, then monopolistic competition must go. Friedman’s critique of the formalization of economics in Triffin’s book became an important component of George Stigler’s critique of the theory of monopolistic competition.8 Stigler sent Friedman a letter he had written to Edward Chamberlin in August 1947 concerning Chamberlin’s criticism of the treatment of monopolistic competition in Stigler’s The Theory of Price. Stigler write to Chamberlin: And I am distressed that my failure to accept the theory of monopolistic competition is a crime, per se. This may be so, but requires proof …I am prepared to argue (1) that your theory is indeterminate, and (2) that it is not useful (often) in realistic analysis. I do not recall a single consistent application of it to a real problem, and this is the ultimate failure of a theory.9 To this and the accompanying draft of his LSE lecture Friedman replied: As you know, of course, I thoroughly agree with you and I think you have done a good job of bringing out the points at issue. I am enclosing a reprint of a review of mine that you might find of some interesting relevance. The main additional point I would like to make is that you do not really go at all far enough. I have gotten involved for various irrelevant reasons in a number of discussions of scientific methodology related to the kind of thing you are talking about. In the course of these I have been led to go farther than I had before in distinguishing between description and analysis and in discarding comparisons between assumptions in [sic, and] reality as a test of the validity of a hypothesis10. In the final version of his LSE lecture Stigler concluded with methodological principles for which he credited Friedman. These include that “the purpose of the study of 8
Stigler, G.J. (1949). “Monopolistic Competition in Retrospect,” in Five Lectures on Economic Problems. London, New York and Toronto: Longmans, Green and Co. 9
Hammond, J. Daniel, and Claire H. Hammond. 2006. Making Chicago Price Theory: Friedman‐Stigler Correspondence, 1945‐1957. Abingdon, U.K. and New York: U.S. Routledge, pp. 62‐3.
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Ibid, p. 65. 12 economics is to permit us to make predictions about the behavior of economic phenomena under specified conditions. The sole test of the usefulness of an economic theory is the concordance between its predictions and the observable course of events.”11 In a review of Oscar Lange’s Price Flexibility and Employment, Friedman pointed out that economists using mathematical forms of theories without reference to concrete institutions and market phenomena gained the appearance but not the substance of generality.12 They were prone to causal empiricism because they invariably wished to say something about the real world. We have seen this in Samuelson and Solow’s analysis of the Phillips Curve. We can likewise see it in Samuelson’s work on the theory of public goods. Samuelson and Richard Musgrave are generally recognized as the fathers of the theory of public goods.13 Samuelson intended “The Pure Theory of Public Goods” to be demonstration of the superiority of mathematics over English prose as the language of economics. Early critics of Samuelson’s two articles on the theory of public goods challenged his failure to address the fact that much of what was done through government did not fit the definition of a public good. Stephen Enke used Samuelson’s 1954 article as an example of the sterility of pure theory.14 One aspect of Samuelson’s article in particular that Enke found deficient was that it dealt with polar cases only; all goods in the model are either private consumption goods or collective consumption goods (public goods). Most goods and 11
Stigler, Five Lectures on Economic Problems (1949), p. 23. “Lange on Price Flexibility and Employment: A Methodological Criticism,” in Capitalism and Freedom (1953). 13
Samuelson, Paul A. (1954) “The Pure Theory of Public Expenditure,” Review of Economics and Statistics 36 (4), pp. 387‐89, and (1955) “Diagrammatic Exposition of a Theory of Public Expenditure,” Review of Economics and Statistics 37 (4), pp. 350‐56. Musgrave, Richard (1959). The Theory of Public Finance: A Study in Public Economy. (New York: McGraw‐Hill). 12
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Enke, Stephen (1955) “More on the Misuse of Mathematics in Economics: A Rejoinder,” Review of Economics and Statistics 37 (2), pp. 131‐33. 13 services that governments actually provide do not fit Samuelson’s definition of collective consumption goods. Now a great many government‐provided goods, perhaps most, do not fit this definition, if consumption means enjoyment. Examples are highways, public hospitals and libraries, police and fire protection, and defense against air attack; in each case, for a given public expenditure, I can have better service or more consumption enjoyment if other people will not exercise their rights to those benefits or compete with me for their favorable deployment. Samuelson’s collective consumption goods comprise a small class at the opposite extreme from his more numerous private consumption goods (Enke, 1955, p. 132). Enke challenged Samuelson to show that his theory could handle the intermediate cases of non‐pure private and collective consumption goods. He also raised the question of whether the model could distinguish between the roles of different levels of government ‐‐ national, state, and local. His closing comment, intended for theorists by way of Samuelson, was that economists have a moral responsibility to provide policy advice rather than indulging in the selfish pleasure of “elegant manipulation of highly abstract models” (p. 133). Another criticism came from Julius Margolis.15 His concern was Samuelson’s separation of the economic problem from the social welfare function. Margolis suggested that by assuming that Samuelson’s “ethical observer” finds the optimal tax and transfer scheme before the economists’ work is begun, Samuelson had assumed away the crux of the problem of public expenditures. He claimed that there are not separable “socio‐political” and “technical” sectors such that the economist can deal only with the latter. He attributed the separation of the two in Samuelson’s model to his being an economic liberal, who considers a private market economy natural, and public expenditures departures from the natural. For such a liberal, any move away from the natural market to collective production becomes necessary only by virtue of the technical characteristics inherent in certain goods. Margolis also made the same point as Enke, that Samuelson’s normative model was inadequate as a positive model, because many goods provided by government are not collective consumption goods. They are divisible and serve private ends. He gave as examples education, hospitals, highways, and even police and judicial services. In some instances, such as education, government requires consumption of the good; in others consumption is optional but free; and 15
Margolis, Julius (1955) “A Comment on the Pure Theory of Public Expenditure,” Review of Economics and Statistics 37 (4), pp. 347‐49. 14 in others there is a charge for the good. An adequate positive theory of public expenditure would need to penetrate “the murky waters of political sociology” (p. 348). In these waters, according to Margolis, one would find that “existential values” rather than the technical qualities of goods lie behind public expenditure decisions. Samuelson (1955) expressed his desire to “clear myself from Dr. Margolis’ understandable suspicion that I am the type of liberal who would insist that all redistributions take place through tax policies and transfer expenditures: much expenditure on education, hospitals, and so on, can be justified by the feasibility consideration that, even if these are not 100 per cent efficient in avoiding avoidable dead‐weight loss, they may be better than the attainable imperfect tax alternatives” (1955, p. 356). In distancing himself from a particular kind of economic liberalism, Samuelson also moved away from where he began, from a normative model of public expenditure to what appears to be a mixture of positive and normative conclusions arrived at from outside the model. He suggested that people vote for paternalistic policies such as education (presumably public education coupled with the requirement that children be sent to school) because they (the people) “do not consider the results from spontaneous market action as optimal” (1955, p. 356). Governments provide some services in sectors subject to increasing returns, and others in “myriad ‘generalized external economy and diseconomy’ situations, where private pecuniary interest can be expected to deviate from social interests” (1955, p. 356). Samuelson’s back and forth dialogue with critics continued in several papers between 1955 and to 1969. Samuelson must have thought that he had stepped into a “swampland” of English prose, as Julian Margolis had put it. This is because much of the discussion after 1954 concerned what in “the pure theory of public expenditure,” Xn+1, …Xn+m “collective consumption goods” actually were. Samuelson expressed regret that his analysis was in terms of polar cases of pure collective consumption and private consumption goods, for it had become clear that no actual goods are at either pole. He had tried to resolve this problem of relating the pure theory to the world of actual goods and actual public expenditures by suggesting that actual goods fell between the two poles as a mixture of the two types. But this resolution seemed not to lend itself to analysis, so in 1969 he sought to clarify the definition of a 15 public good in a way that provides a better fit between theory and reality. 16 This was that a public good enters two or more people’s utility function. The definition does not require that the good affect everyone’s utility. Therefore virtually every good is a public good. The private good pole has become a “knife edge,” with everything that does not balance on the edge falling into the public good category. The implication Samuelson drew is rather ominous: This does, however, lead to an uncomfortable situation. If experts remain nihilistic about algorithms to allocate public goods, and if all but a knife‐edge of reality falls in that domain, nihilism about most of economics, rather than merely public finance, seems to be implied (1969, p. 109). He made a few suggestions of possible ways to avoid his “nihilist” conclusion, but without evidence of much hope for their prospects. If the person who many consider the premier economic theorist of the twentieth century concludes that a core economic theory of the role of government, a theory that he is credited with developing, is nihilistic ‐‐ it tells us nothing about what is best done through government ‐‐ this suggests that self‐ reflection is in order for economists. Early in his career Milton Friedman recognized the problems inherent in the mathematization of economics. As he put it in an interview when asked about the distinctiveness of the economics that he learned as a student and taught as a professor at Chicago: There’s no doubt that Chicago was distinctive, and has been ever since. The real distinction was not making price theory the focal point of the graduate curriculum. That isn’t the real distinction at all. The fundamental distinction is treating economics as a serious subject versus treating it as a branch of mathematics, and treating it as a scientific subject as opposed to an aesthetic subject, if I might put it that way.17 Friedman was not philosophically inclined, but he had a strong sense that something was awry in economics – that it had become detached from the concrete realities of markets, institutions, and messy realities of policymaking. What do we find if we probe deeper into his concerns? The problems are not in economics alone. Anthony Rizzi has written about the damage that philosophical idealism has done to physics, the 16 Samuelson, Paul A. (1969) “Pure Theory of Public Expenditure and Taxation” pp. 98‐123. In J. Margolis & H. Guitton, Public Economics: An Analysis of Public Production and Consumption and their Relations to the Private Sectors (London: Macmillan). 17
Hammond, J.D. (1992). ‘An Interview with Milton Friedman on Methodology’. Chapter number? in W.J. Samuels and J. Biddle (eds) Was this Samuels and Biddle or just Samuels? Research in the History of Economic Thought and Methodology. Volume 10. Greenwich, CT: JAI Press: p. 110. 16 discipline that twentieth century economists looked to as a model of hard science.18 Rizzi attributes a disjuncture between physics and the world experienced through our senses to scientistic presumptions inherited from David Hume and Immanuel Kant. From Hume scientists learned to avoid resort to non‐
mathematical or experimental concepts, such as causality. Kant reinforced scientific skepticism with his idea that all of reality is in the mind rather than in the world. According to Rizzi, physicists are led away from the physical world through use of modern mathematics, which itself has been separated from the physical world. Modern mathematics consists of symbols and logic, so mathematical physics is symbols and logic. Physics has become what Jacques Maritain called empiriological. Rizzi’s project is to rebuild physics on the basis of philosophical realism.19 To do so he grounding physics in the pre‐modern realist philosophy of St. Thomas Aquinas and Aristotle.20 Thus far my concern has been with developments in the methodology of economics rooted in modern philosophy and mathematics that Milton Friedman recognized and resisted on the methodological if not philosophical level. I will suggest in the concluding portion of this essay that the problems of economics are broader than Friedman acknowledged. As I see it, Friedman is emblematic of this dimension of the problem. Simply put, the problem is that modern economics is the science of social engineering; economists of the left and of the right are trained to be social engineers. Hayek recognized this problem as did the Swiss economist Wilhelm Röpke. Social rationalism, wrote Röpke: Misleads us into imagining that the market economy is no more than an “economic technique” that is applicable to any kind of society and in any kind of spiritual and social climate. … Social rationalism is evident in the attitude of certain contemporary economists who, while not open partisans of socialism and sometimes speaking in the name of the market economy, work out the most elaborate projects for regulating the movements of the circular flow of the economy. They seem to be prepared to transform the economy into an enormous pumping engine with all sorts of ducts and valves and thermostats, and they not only seem confident that it will function according to the instructions for use but they also seem to be unaware of the question of whether such a machine is compatible with the atmosphere of the market, to which freedom is essential.21 18
Anthony Rizzi, The Science Before Science, Baton Rouge, LA: Institute for Advanced Physics. Anthony Rizzi, Physics for Realists, Baton Rouge, LA: Institute for Advanced Physics. 20
Murray Daw is teaching physics at Clemson University with Rizzi’s Physics for Realists. Daw told me that he came to know there was a problem in physics education when his best students reported that they had learned that physical objects, such as tables, are not real. For these students physics was formulae and operations. 21
Wilhelm Röpke, A Humane Economy, 3rd ed. Wilmington, DE: ISI Books, pp. 93‐4. 19
17 Röpke and Milton Friedman were two of the liberals who Hayek called to Mont Pelerin in April 1947, hoping to strengthen commitment to the principles of liberal government and recover their moral and philosophical foundations. Much was accomplished a Mont Pelerin, including the founding of the society of which Prof. Boettke is now the President. But there was less agreement on the nature and purpose of liberalism than Hayek had hoped.22 The program of the Mont Pelerin meeting included five sessions on strictly economic issues such as monetary reform, trade unions, and agricultural policy; two sessions on post‐war Europe; and two on historiography and politics. There was one session on liberalism and Christianity, and four on the purpose and organization of the nascent Mont Pelerin Society. The last five sessions proved to be contentious. In retrospect this is not surprising, as these discussions went to the very nature and purpose of a liberal association such as the MPS and of a liberal political order. A split became apparent at the first meeting between American economists such as Friedman who, in Röpke’s terms, were social rationalists, and Europeans such as Röpke more attuned to the social and moral requisites of market economies. The tension can be seen in two drafts of a statement of aims for the assembly. The first was drafted by a committee and the second by Lionel Robbins. The first draft opened with a statement that the purpose of the assembly was “discuss the foundations for the preservation of a free society.” This was followed by a list of convictions shared by those present. The first ten convictions listed were economic and legal; the last four were moral and philosophical. Robbins’s revision replaced “foundations for the preservation of a free society” with a statement of the “crisis of our times.” It was easier to agree that there was a crisis than to agree on the causes and remedies for the crisis. Robbins moved several of the “shared convictions” to a list of “areas for study.” One session at the conference that proved especially contentious was the one on liberalism and Christianity. Through the early years of the Society’s conferences sessions on economics crowded out those on religion, history, culture and political philosophy. Röpke delivered opening remarks at the 1961 MPS conference in Turin, less than a month after East Berlin was sealed off from the West by the Berlin Wall. He asked, somewhat rhetorically, how Europe could have come to this: It may dawn upon us now that we may live to see once more confirmed a great truth of human history, namely that suicide, not murder is the normal form of death of a cultural 22
See J. Daniel Hammond and Claire H. Hammond, “Religion and the Foundation of Liberalism,” Modern Age 55 (1&2): 35‐51. 18 system. It is not the strength of the barbarians but the weakness, moral and intellectual, of the civilized which is usually their undoing.23 Notice that Röpke spoke of the death of a cultural system rather than an economic system. Reminding his audience that the primary responsibility of the MPS was to combat moral and intellectual confusion and a failure of will in Western democracies, Röpke exhorted those present: Let us get to work, not in the ivory tower of scientific aloofness and relativism, but keeping in mind that we are menaced by an avalanche which would bury also science itself … And let us avoid the mental disease of so many intellectuals who have forgotten another word of wisdom, also due to [Georg Christoph] Lichtenbeg: “One has to believe in certain ultimate values because it would be absurd not to believe in them.”24 Milton Friedman was a tireless defender of freedom – economic, civic, and political – countering democratic socialists’ claims that economic freedom could be abridged without harm the health of the economy or to the other freedoms. But I think his anthropological presumptions were overly optimistic about human nature. The good side of this was that Friedman presumed good intentions, a commitment to the public good on the part of his fellow citizens, policymakers, and critics. He presumed that people were seeking the truth and would change their minds in the face of evidence. Friedman was slower than his friend George Stigler to adopt the public choice perspective that bad policies are not necessarily mistakes. He learned only late in life that private property is not sufficient for a healthy economy.25 Friedman had faith in the invisible hand’s efficacy so long as markets were in place, open, and competitive. I think of Friedman as a liberal social engineer, believing that markets are necessary and maybe even sufficient for economic and social well‐being. I think we can see today that property rights and markets are not sufficient for a prosperous and healthy society. If markets are not sufficient, then neither is economics. Markets require a culture of virtues. As Röpke recognized, ownership carries with it a set of values that are connected with freedom properly understood. These are: self‐discipline, a sense of justice, honesty, fairness, chivalry, moderation, public spirit, respect for human dignity, firm ethical norms – all of these are things which people must possess before they go to market and compete with each other. These are the 23
W. Röpke, "Opening Speech at the Turin Meeting of the Mont Pelerin Society." The Mont Pelerin Quarterly, vol. III, 1962, 8 24
Ibid, 10. 25
See Peter J. Boettke and Olga Nicoara, “What Have we Learned From the Collapse of Communism?” pp. 643‐77 in Boettke and Christopher Coyne, eds., The Oxford Handbook of Austrian Economics (Oxford and New York: Oxford University Press, 2015) 19 indispensable supports which preserve both market and competition from degeneration. Family, church, genuine communities, and tradition are their sources. 26 If Ropke was right, and I believe he was, the grounds of a healthy economy are not only outside the discipline of economics. They are also outside the academy; they are in the home. 26
A Humane Economy, p. 125. 20