Monday, September 8, 2014

"Capital and its Structure" is being translated into Chinese - My preface and introduction.

Preface
It is an honor to be able to write this upon the occasion of the translation into Chinese of Ludwig M. Lachmann’s Capital and its Structure. Ludwig Lachmann was my teacher, the one who introduced me to Austrian Economics, and the inspiration for my work as an economist. Professor Lachmann was a dedicated teacher and an honorable man. And though his academic contributions are, relatively speaking, not very large, he was a scholar of profound insight and prodigious learning. His personal network of scholars from around the world was impressive. 
Lachmann came to capital theory when as a student at the London School of Economics he was able to work with Friedrich Hayek. Hayek himself was actively working on capital theory in order to bring to English speaking readers an appreciation of the Austrian Theory of Capital, which he felt was necessary for an understanding of the shortcomings of the provocative work of John Maynard Keynes. It was from Hayek that Lachmann derived the inspiration for his own capital theory, which took Hayek’s work in a different direction. During the 1930’s and 1940’s, Lachmann published many articles on capital theory and this book is the unification of that work in its most mature form.
Perhaps most notable about Lachmann’s vision is the centrality of expectations. He agreed with Keynes that expectations were important but felt strongly that Keynes had neglected to account for the them sufficiently, particularly in regards to the theory of investment. Keynes and all other theorists tended to gloss over the heterogeneous nature of capital goods and to treat capital as a homogeneous stock rather than a structure of complimentary items, some more substitutable than others. It was primarily around this insight that he built his capital theory.
By the time this book was first published in 1956, the Keynesian revolution was triumphant and interest in capital theory had faded. Lachmann had left England for South Africa. Its early reception was, therefore, disappointing. It was mostly ignored. By the time of the publication of the second edition in 1978 however, the Austrian School’s star was rising again. Hayek had been awarded the Nobel prize in economics and work in Austrian economics was increasing. Since then it has gained momentum until today and is now a vibrant research program across the world. This book is now regarded as a classic within that program.
Ludwig Lachmann would be very pleased to know that a new audience of readers will now be able to read his work. I am equally pleased.

Dallas, TX

September 2014.

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Introduction
Though he could, with justification. be described as an ‘Austrian Economist,’ Ludwig Lachmann was born and educated in Germany, not in Austria. He became acquainted with and enamored of Austrian economics as a young student in his twenties, discovering the work of Ludwig von Mises. (He met Mises for the first time in 1932.) He spent his long professional life working within and fighting to promote and understanding and appreciation of the ‘Austrian School’ (Mittermaier 1992 ; also Grinder 1977b).
In 1933, after his early education, he left Germany (with his future wife Margot) for England. He thus evaded the rise of the Nazi party for whom, being Jewish, he would have been a target for extermination. He was unable to find an academic appointment in England and thus decided to go to the London School of Economics as a student of Friedrich Hayek, even though he already had a doctorate from Berlin (Mittermaier 1992: 9). This placed him at the very center of the vibrant new ‘Hayekian’ school of economics, together with such scholars as Lionel Robbins, John Hicks, Nicolas Kaldor, Abba Lerner, George Shackle and others, and at the very center of the fast developing battle between the Hayekians and the emerging Keynesians. He already had an appreciative interest in Friedrich Hayek’s work on the Austrian theory of capital and the business (trade) cycle.
Thus, Lachmann’s interest in capital theory grew out of these topical preoccupations with the Austrian version of the business cycle, deriving from Mises, and from the Austrian theory of Capital which was a crucial building block for that theory. The Austrian Theory of Capital (ATC), originating with Carl Menger (1871) was the most well-known contribution of the Austrian School at that time, owing mainly to the extensive work of Eugen von Böhm-Bawerk on the subject. Böhm-Bawerk’s work had achieved world-wide recognition (1959, three volumes originally published in the period 1884-1912). In his influential work on the trade cycle (1933, 1935) Hayek had referred to, and made use of, a highly stylized version of the ATC. And much of his work in the 1930’s was dedicated to the attempt to elaborate and make this theory more widely accessible, especially to English speakers. In the process, he was led to a thorough reexamination of the ATC, writing a number of important articles (some of which are collected in Hayek 1939) and culminating in The Pure Theory of Capital (1941). It was this body of work that was the greatest influence on Lachmann, that crucially shaped his own subsequent work on capital theory and also his enduring preoccupation with the topic of expectations so prominent in this book.
Lachmann had for a while been troubled by the influence of people’s expectations on their actions, and felt that in Price and Production (1935) and Monetary Theory and the Trade Cycle (1933) and in his debate with Keynes subsequent to the publication of Keynes’s Treatise on Money (1930), Hayek had neglected to adequately address expectations in the trade cycle story offered as a counter-argument to Keynes’s. Reading Keynes General Theory (1936) upon its publication he was surprised to find Keynes’s extensive treatment of expectations. Lachmann came to the conclusion that the Austrians had given expectations insufficient attention and the implications of subjectivism for expectations became a theme that motivated his work for the rest of his life and is a distinguishing aspect of his work on capital.
His work on capital theory began in the late 1930’s, continued into the 1940’s and developed together with his work on expectations (Lachmann 1937, 1938, 1939, 1941, 1943, 1944, 1945, 1947, 1948). This work begins in the context of the Hayek-Keynes debate and the onset of the Great Depression, with Lachmann exploring the nature of ‘secondary depressions’ but soon develops beyond this. It culminates ultimately in this book Capital and its Structure published much later in 1956 (Lachmann 1978 [1956]) by which time he was far away and interest in capital theory had disappeared with the triumph of the Keynesian revolution.
            Lachmann’s capital theory is clearly Hayekian in spirit. It is, however, also closely connected to the work of Böhm-Bawerk, whose insights Lachmann sought to carefully and critically reconstitute in a form applicable to modern real world production contexts. His approach reflects what he saw to be the inextricable connection between capital, knowledge and expectations, the implications of which he thought needed to be spelled out clearly in order to provide a satisfactory answer to the Keynesian challenge.
In a famous quotation Lachmann explains:
The generic concept of capital without which economists cannot do their work has no measurable counterpart among material objects; it reflects the entrepreneurial appraisal of such objects. Beer barrels and blast furnaces, harbor installations and hotel room furniture are capital not by virtue of their physical properties but by virtue of their economic functions. Something is capital because the market, the consensus of entrepreneurial minds, regards it as capable of yielding an income. . . . [But] the stock of capital used by society does not present a picture of chaos. Its arrangement is not arbitrary. There is some order to it. (Lachmann 1978:xv).
The value of the capital-stock, being dependent on individual expectations and evaluations is not an objectively observable phenomenon. Only in equilibrium, where all individuals’ expectations were consistent one with the other, would such a value have any meaning. He thus offers a theory of the capital-structure rather than the capital-stock and emphasizes the heterogeneity of capital. The fact that capital goods are physically very dissimilar is significant precisely because of the existence of disequilibrium. Physical heterogeneity could be reduced to value homogeneity if the values of the various capital goods could be simply added together. Where disequilibrium means that individuals have different and frequently inconsistent expectations, one cannot simply add together individual valuations. This means that aggregate measures of the capital stock are no coherent and cannot be understood to indicate the objective worth of the economy’s productive capital.
            According to Lachmann, though the capital-stock is heterogeneous, and cannot be meaningfully aggregated, it is not amorphous or meaningless. The various components of the capital-stock stand in a sensible relationship to one another because they perform specific functions together. That is to say, they are used in various capital combinations. If we understand the logic of capital combinations, we give meaning to the capital-structure and, in this way, we are able to design appropriate economic policies or, even more importantly, avoid inappropriate ones.
Understanding capital combinations entails an understanding of the concepts of complementarity and substitutability. These concepts pertain to a world in which perceived prices are actual (disequilibrium) prices, in the sense that they reflect inconsistent expectations and in which changes that occur cause protracted visible adjustments. Capital goods are complements if they contribute together to a given production plan. A production plan is defined by the pursuit of a given set of ends to which the production goods are the means. As long as the plan is being successfully fulfilled, all of the production goods stand in complementary relationship to one another. They are part of the same plan. The complementarity relationships within the plan may be quite intricate and no doubt involve different stages of production and distribution.
Substitution occurs when a production plan fails (in whole or in part). When some element of the plan fails, a contingency adjustment must be sought. Thus some resources must be substituted for others. This is the role, for example, of spare parts or excess inventory. Thus, complementarity and substitutability are properties of different states of the world. The same good can be a complement in one situation and a substitute in another. Substitutability can only be gauged to the extent that a certain set of contingency events can be visualized. There may be some events, such as those caused by significant technological changes, that, not having been predictable, render some production plans valueless. The resources associated with them will have to be incorporated into some other production plan or else scrapped—they will have been rendered unemployable. This is a natural result of economic progress which is driven primarily by the trial-and-error discovery of new and superior outputs and techniques of production. What determines the fate of any capital good in the face of change is the extent to which it can be fitted into any other capital combination without loss in value. Capital goods are regrouped. Those that lose their value completely are scrapped. That is, capital goods, though heterogeneous and diverse, are often capable of performing a number of different economic functions.
Lachmann’s analysis of capital in terms of complementarity and substitutability are linked to the theory of investment (which he points out must contain an implicit theory of capital) and specifically to Keynes’s marginal efficiency concept (which lacks any recognition of such a theory). The effect of an increase in investment on the demand for capital depends, in his account, on the shape of the already existing capital structure and the degree of its complementarity with the new investment.
The relationship of this book to the work on capital theory by his mentor and colleague Friedrich Hayek is of some interest. When asked about his Pure Theory of Capital Hayek once remarked, “I think the most useful conclusions drawn from what I did are really in Lachmann’s book on capital” and he suggests that what Lachmann said is perhaps as much as could be said. Hayek continues: “Like so many things, I am afraid, which I have attempted in economics, this capital-theory work more shows a barrier to how these things I’ve stressed – the complexity of the phenomena in general, the unknown character of the data, and so on- really much more point out limits to our possible knowledge than [are] contributions that make specific predictions possible.” (quoted in Kresge and Wenar 1994:142).
            Lachmann’s capital theory, as expressed in this book, in chapters one through six, is well-known and much admired by scholars working in the Austrian tradition. Chapter seven is something an outlier, however. It contains puzzles in that the policies that Lachmann recommends do not seem to fit well with his view of capital in a dynamic economy. Many have ignored this chapter and a few have tried to explain it. Chinese readers can now add their voices to this discussion.
            The concept of capital is central to an understanding of the “capitalist” economy. Ludwig Lachmann’s Capital and its Structure is a work of striking originality and insight. Its translation into Chinese is to be celebrated.  

References

Böhm-Bawerk, Eugen, von (1959), Capital and Interest (3 vols in 1), South Holland: Libertarian Press.
Grinder, W. E. (1977a), Capital, Expectations and the Market Process, Essays on the Theory of , the Market Economy,  Kansas City: Sheed, Adrews and McMeel
Grinder, W. E. (1977b), ‘In Pursuit of the Subjective Paradigm’ in Walter E. Grinder (ed.) (1977a), 3-24.
Hayek, F.A. (1933), Monetary Theory and the Trade Cycle, London: Jonathan Cape.
Hayek, F.A. (1935), Prices and Production, London: Routledge and Kegan Paul.
Hayek, F.A.(1939), Profits, Interest and Investment, London: Routledge.
Hayek, F.A.(1941), The Pure Theory of Capital, Chicago: University of Chicago Press.
Keynes, John Maynard (1930), A Treatise on Money, Cambridge, Macmillan
Keynes, John Maynard (1936), The General Theory of Employment, Interest and Money, Cambridge, Macmillan
Kresge, S. and Wenar, L. (eds.), (1994) Hayek on Hayek: An Autobiographical Dialogue, Chicago: University of Chicago Press.
Lachmann, L. M. (1937) ‘Uncertainty and Liquidity Preference’ Economica 4 (August) 295-308; reprinted in Lavoie, D. (ed.), (1994) 29-41.
Lachmann, L.M. (1938) ‘Investment and Costs of Production,’ American Economic Review 28, September: 469–481; reprinted in Lavoie, D. (ed.),  (1994)  42–56.
Lachmann, L, M. (1939) ‘On Crisis and Adjustment,’ Review of Economics and Statistics 21 62–68; reprinted in Lavoie, D. (ed.),  (1994) 76–90.
Lachmann, L, M. (1941) ‘On the Measurement of Capital,’ Economica 8, May: 367–377; reprinted in Lavoie, D. (ed.),  (1994), 91–106.
Lachmann, L. M. (1943), ‘The Role of Expectations in Economics as a Social Science’ Economica 10; reprinted in Grinder, W. E. (ed.),  (1977), 65-80.
Lachmann, L, M. (1944) ‘Finance Capitalism,’ Economica 11, November: 64–73; reprinted in Lavoie, D. (ed.)  (ed.), (1994), 107–123.
Lachmann, L. M. (1945) ‘A Note on the Elasticity of Expectations’ Economica 8 (November) 248 -253; reprinted in Lavoie, D. (ed.), (1994), 124-130.
Lachmann, L, M. (1947) ‘Complementarity and Substitution in the Theory of Capital,’ Economica 14, 108–119.
Lachmann, L. M. (1948) ‘Investment Repercussions,’ Quarterly Journal of Economics 63, November: 697–713; reprinted in Lavoie, D. (ed.), (1994) 131–146.
Lachmann, L. M.(1978) [1956] Capital and its Structure, Kansas City: Sheed, Andrews and McMeel. [Chinese edition, 201-].
Lavoie, D. (ed.)  (1994), Expectations and the Meaning of Institutions: Essays in Economics by Ludwig Lachmann, New York: New York University Press.
Menger C. (1871), Principles of Economics. Translated by James Dingwall and Bert F. Hoselitz. New York: New York University Press, (1976).
Mittermaier, K. H. M. (1992), ‘Ludwig Lachmann (1906–1990) A biographical sketch’, South African Journal of Economics, 60  (1), 7-25.

Saturday, August 23, 2014

Two recent posts from my Facebook timeline

Breaking News! The PA and Hamas issued the following joint statement this morning, 10 am in Ramallah. 

We state clearly that we recognize the right of Israel to exist as a Jewish state and to live in peace in this region. We commit ourselves to peaceful coexistence conditional upon the withdrawal of Israeli troops from the West Bank, the removal of checkpoints and the establishment of normal cross-border relationships that encourage trade and cultural exchange. This is further conditional on the satisfactory settlement of the harm caused by the settlement of Israelis in the West Bank and the cessation of all settlement activity. In return we offer the following guarantees of our peaceful intent.[whereupon followed a list of specific proposals for joint monitoring of military and terrorist activities and reporting and redress procedures].

Just kidding


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This awful event [the videotaped beheading of an American journalist] prompts me to agonize over something that is in my mind 24/7 these days.

Given the undeniably escalating threat of Islamist terrorism - ISIS, Boco Haram, Hamas, and I am sure many others whose names I do not know, the question arises as to what the best response politically, militarily, economically, is. Libertarianism inclines strongly towards total non-engagement on a state level - though I imagine it would defend the right of private individuals in defending victims who are attacked, murdered, raped, etc. Libertarians and others will also argue, correctly in my view, that in many (most, all?) cases, the gain in power of these barbarians is a direct and/or indirect result of our and our allies' past cumulative military adventures - the horrible unintended consequences of war, even "defensive" war - the most obvious example being the rise of ISIS as a result of the disastrous invasion of Iraq, which has left the country inestimably worse off than under Saddam Hussein.


Be that as it may, how can we know how things would have been in the absence of such intervention. I recall when asking this question before some responses pointing toward situations suggesting that it was only when and after such intervention that the terrorists gained any traction. Not decisive, but suggestive. Still, there remain many who absolutely deny that the power of the Islamists depends on the misdeeds of the west. I confess to being at a loss on this. I just don't know and I don't know know how anyone can know. And related to this, I don't know what "we" ought to do regardless of the the "why" - given where we are now, is it preferable (at the level of the government) to ignore the threats or to somehow react to them. No doubt we have a huge public choice problem - incentive and knowledge problems - the belligerent personalities tend to take things over and mess them up big time. A real dilemma.


About one thing I feel sure. These are barbarians who have taken terror and violence to a new level - their utility functions include pleasure from the suffering of others - they are unmitigated sadists - worse even than the industrialized killers of the Nazi state. They need to be taken at their word and not underestimated. 




Tuesday, May 13, 2014

Good can and often does emerge from actions not intending it. Bad can and often does emerge from actions intending to do good

The idea that good can and often and does emerge from actions not intending it, and, that bad can and often and does emerge from actions intending to do good, is amazingly unfamiliar to many, perhaps most, thinking people today - and this is true not only of young people, though they are the ones I would like to target with this post. 

I write this out of my frustration in encountering a tremendous resistance to the idea by young people known to me, some of them very close to me. They dismiss it when I say it, thinking it is some kind of apologetics coming from me, a certifiably extreme "conservative" thinker [though of course I am neither extreme nor conservative]. How to pierce the barrier of knee-jerk disbelief to provoke real thought is something I have yet to figure out. In the meantime, for the choir or for those who might be willing to give it a chance, here is what I believe. 

Prosperity is not the result of intending to do good, but stagnation through the welfare state is the result of so intending to do good. The road to stagnation, corruption, deprivation, and poverty is paved with good intentions.

Doing well pretty much trumps doing good when it comes to doing good. Intentions are (or should be considered) irrelevant in evaluating the outcome. Doing well does much more good than intentionally doing good. And, at the individual level, the obvious good done by the Bill and Melinda Gatefoundation pales compared to the good Microsoft has done by transforming average people's lives while pursuing profits.

There is nothing particularly worthy about doing good altruistically as compared to doing good by making profits when you understand the greater good that the latter does. But the prevailing conventional wisdom has deprived the business person of the ability to benefit from this understanding, because most people not only simply do not understand it, but, in addition, what they think they know about it is exactly the opposite, namely, that in order to do good one must intend to do so directly and not by pursuing profits – pursuing profits according to this conventional wisdom results in exploitation and inequality, not general wealth-creation, and besides is selfish and unworthy. Businessmen out for profits are want to "trick" consumers into buying their products. The public discourse has thus demonized profit-seeking, but doing good by doing well is admirable and should be praised. And businessmen should be made to feel proud and motivated by it.

It is not acceptable to condemn successful business people for not doing enough for charity. What the successful businessman has done is incredibly admirable (though he personally may not be so admirable) and will do more good indirectly and in the long run than any charitable contributions he would have made. I am happy to praise charitable contributions. But I am not going to exaggerate their good or diminish the greater good done by simply doing business - by providing people more valuable options that they can afford and give them the ability to elevate their lives. We put hard-working entrepreneurs in the position of thinking they have to apologize for the profits they make and cover their rears by ensuring that they make some token charitable contributions. It is obnoxious in the extreme and if not remedied will bring the end of our profit-driven wealth-creating economy.

See Dwight Lee and J.R. Clark on “Markets and Morality” here.  

Sunday, May 4, 2014

Gary Becker (1930-2014): A Personal Appreciation

Professor Gary Becker died yesterday at the age of 83. At the time of his death, he was arguably the most highly respected living economics scholar.

The blogosphere will soon be flooded with obituaries, appreciations  and evaluations of his work by people better placed than I to offer them. Given, however, that I was privileged to have been able to study with him for a short period of time as a graduate student at the University of Chicago, and that he acted as the chairman of my Ph.D. dissertation committee, I would like on the occasion of his passing to  offer a few words of personal appreciation.

Becker will be remembered mostly for his work on human capital and the economics of the family. It is hard to overstate the influence of his contributions to these fields. Indeed, he pretty much created them – though one must not minimize the contributions of others early scholars like T. W. Shultz, Simon Polacheck, and especially the independent and complementary work of Jacob Mincer.

By his own account, Becker came to these subjects through the influence of his mentor Milton Friedman whose approach led him to see economics as the study of people “in the ordinary business of life” (as Alfred Marshall would have it). But his first foray beyond the traditional borders of the subject was not in those subjects (human capital or the economics of the family) but rather in the economics of discrimination, a very volatile subject at the time. He literally wrote the book on The Economics of Discrimination (see also here). It seemed to him at the time that the conversation on civil rights and segregation was hopelessly confused by the lack of an understanding of the social processes at work, an understanding that was accessible using the eternal principles of economics to investigate how people act on their preferences, whatever they are and whatever we may think of them. So he quite controversially investigated the likely results of economic processes in which people had given (race or gender) preferences and showed quite simply that, as long as people were free to act in open markets as employers, workers, or consumers, the act of discrimination would carry a price. For example, discriminator-employers who indulged their preferences would be outcompeted by those who hired the most qualified person for the job, and, in this way, open competition would tend to erode discriminatory outcomes (if not discriminatory attitudes).

When I came to the University of Chicago I knew nothing of any of this. My exposure to Chicago was confined to Friedman’s monetary work. I did not even know what a great price theorist Friedman was. But I soon became aware of Becker, the young prince of the department, and I took as many courses from him as I could – two in price theory and at least one on topics in family economics as I recall. And I became aware also of his work on discrimination. I read the book with great excitement, but also some disappointment. I left South Africa for Chicago in September 1972. This was, in retrospect, the peak in the power of the Apartheid regime. South Africa epitomized racial discrimination and it was very ugly. I had seen it first-hand every day. And here was a book on the underlying principles of discrimination. So I thought it would provide answers for me about South Africa – what was Apartheid really about, what was its future?

While I found the book fascinating, I did not find the answers to the questions I started with. Of course, this was an absolute blessing for me. It became the opportunity for my dissertation on the economics of Apartheid. The reason the answers were not there was that Becker had excluded the case of state-enforced discrimination by assumption. But his work did provide the answers by implication. If state power is used to prevent the competitive process from eroding the effects of discrimination then discrimination may endure and even flourish. (I subsequently found the analysis I was looking for in the works of Anne Krueger and William Hutt). Becker’s models provide the necessary window into what would happen once the apparatus of state discrimination were abolished. It was vitally relevant at the time, and it remains so to this day as we consider the current regulatory environment of affirmative action and racial preferences.

I used Becker’s theories again in my work on capital. I came to Chicago after studying capital theory with Ludwig Lachmann. The two scholars were different in every way. It was as if they spoke different languages, not even the common language of economics. It left me quite confused. But when I started to study Becker on human capital I made my own “translations” and began to see very interesting things. Crazy to imagine combining a radical Austrian with a Chicago equilibrium-empiricist. But that is what I ultimately did, and I think it worked. Becker adopted the language of scientism, the denigration of any work that did not feature confronting the data with some very abstract model to yield satisfactory t-statistics. But I did not find this persuasive or helpful. Rather it was Becker’s penchant for imaginative theoretical insights, using what Chicago thought of as “the equilibrium-method,” that fascinated me.  The equilibrium method consists in understanding equilibrium to mean individual constrained-maximization, which really means purposeful action. The economic models take basic economic situations and manipulate logical (mathematical) symbols, representing aspects of those situations, like attitudes, costs, benefits, etc., to wring-out hard-to come by, but important, economic intuitions that often explain observed phenomena in new and insightful ways. That was the genius of this productive period in the history of the Chicago School that is Becker’s legacy. One has to look past the method, which is both a way of thinking and a way of gaining “scientific” respectability, to see the richness of the insights. This richness is a result of the “Chicago-method” of applying basic Marshallian price theory in a flexible and innovative way. For example, the economics of the family, the economics of discrimination,  crime and punishment, human capital, public choice, religion and, most recently, the economics of addiction and similar subjects.

Clearly Gary Becker’s contributions transformed economics. His work spurned massive changes in approach and widened the scope of its endeavors. When he wrote his book on Human Capital he faced substantial opposition to the very use of the term. His daring to apply economic tools to an analysis of choice to have children provoked the vehement condemnation of the sociologists. But Becker was always unfazed by these obstacles. He harbored no grudges and he affected no airs. As a teacher he was tough but incredibly open-minded and accepting of the thoughts of others. He encouraged critical thinking and the expression of ideas. I never saw him angry with students or colleagues. He was a true gentleman.


He was busy, always busy, and I had a hard time getting to talk to him. And I was always awed by him. I wish I had been able to have had more of him, but I am honored to have been able to have known him in the way I did. 

Tuesday, April 29, 2014

Thoughts upon trying to fall asleep - famous economists in my life (in case it may be of interest).

My limited dealings with Milton Friedman (as a student at U of C and various chance meetings) did not endear him to me. I found him a rather unsympathetic personality. But, as a scholar, from his writing, I learned a great deal. I refer to his writing on policy and political economy. He was always clear and logical and tried to anticipate all possible counterarguments. He did not engage in hyperbole or gratuitous denigration. He was perhaps the most effective popularizer of the ideas of classical liberalism of the twentieth century. There was a lot he did behind the scenes that may emerge over time. He advised many governments, including those of Israel, India, Chile, China and the U.S. Who knows how many millions of people benefited from his advice in the journey from poverty to middle class.
I found his scholarly work frustrating in his concessions to the prevailing methodology. He was a strategic writer. He adopted the medium best suited to get the attention of those who disagreed with him most. As a result, for example, he adopted the Keynesian macro-model and much of his work on money comes to us through that. Its hard to know how much he actually approved of the models he used. But he was a master in dressing up appropriately. His Theory of the Consumption Function is more than that though. In that work he went to the center of the conventional wisdom in econometrics and exposed it for a fraud - there were fatal conceptual errors in the main variables. I believe it is hard to overstate the influence of this work on the economics profession and on Friedman's career. After this they absolutely had to take him seriously. He played the game better than they did.

Friedman was forever a "pragmatist" looking for the practical rule to live by. Perhaps the most valuable simple rule for policy that he offered was that the composition of government spending matters much less than the sheer size of government. To do something simple to advance the cause of freedom and prosperity downsize the government dramatically.

In terms of his relationship to the Austrians, I don't know much from my own personal experience. I speculate that the story about the first Mont Pelerin meeting in which Friedman, Stigler and other American 'liberals' found themselves together with Mises, Hayek and a bunch of old-world gentleman, was typical of cultural dynamics that characterized the relationships more generally (just speculation). Maybe Friedman saw in Mises a stuffy, dogmatic old foreigner without much practical relevance. He represented the past and could not speak to the future in an effective way. Mises probably saw Friedman and company as brash, superficial, compromisers who were part of the problem rather than the solution.
Concerning Hayek, who later spent considerable time at Chicago, Friedman clearly owed him a great debt and was much influenced by him in his political economic writings. Friedman acknowledges this debt but is sadly dismissive of Hayek's work as an economist. I wonder still whether Friedman was really so narrowly superficial in his understanding of scientific inquiry or if this was just a strategic decision. (He shared with Hayek a fundamental distrust of convoluted mathematical and/or statistical modelling devoid of economics). Either way - not good.
I met Hayek on very few occasions and got to ask him only one question. I was a budding U of C PhD and was young and an idiot. I asked him what he thought of Friedman's monetary rule. He seemed irritated. He gave the now-familiar answer about how such a rule would never be adhered to in a real crisis (something Friedman seems to have to believe himself in the end), but then he said that, in any case, Friedman had misunderstood the role of statistics in economics and social science. I did not have the faintest idea what he meant. Now I know. At the time Hayek was in the middle of his turn to the examination of complex phenomena and he would have seen Friedman's pedestrian data-crunching as rather pathetically naive. Perhaps he was also bothered by Friedman's appropriation of the ideas of Hayek's friend and colleague Karl Popper to characterize what he (Friedman) was doing - "hypothesis refutation."
Friedman's position toward Hayek pretty much mirrored that of the rest of the mainstream profession - condescending dismissal. And the rest is history.

Thursday, April 10, 2014

Passover Food for Thought

Matzah: A symbol of both slavery and freedom? 
Of all the many religious holidays in the Jewish calendar Passover (Pesach) is perhaps the mostly widely and persistently celebrated worldwide. One may speculate on the reasons. Perhaps it is because of its  association with freedom. I don’t know. For my family it is a time of get-together to reflect on things and eat a lot of food, some of it good. So here are my reflections for this year – emanating from my rather esoteric interest in capital theory.
Matzah is a central symbol and prop of the celebration. I like it and end up eating too much of it. But what does it represent? It is “the bread of affliction” in two ways. First, it is what the Children of Israel ate in Egypt while they were slaves. Not for them the rich, plump, bread of their oppressors. They had to make do with the harsh flat bread we call matzah. Second, when finally Pharaoh agrees to let them go, to exit slavery for freedom, they must hurry before he changes his mind again. So they do not have time to bake normal bread, they must take the shorter route of baking matzah, which requires less time because it does not require yeast to rise.
In each of these ways “time” is important. It points to the universal, the essential, relationship between time and value in production. And what could be more basic, more essential, than the production of bread? The value of bread, like the value of anything, is a reflection of our preferences. In general we prefer bread to matzah. But it is more difficult to produce bread than matzah. It takes more “time.” And time is something that slaves do not have. They serve every minute at the behest of their masters. They do not have the luxury of the time to prepare the dough for bread and to set it aside to rise over time. To be enslaved is fundamentally not to be in control of one’s time.
But the lesson is broader and more subtle than this. For it is not time, in itself, that is valuable. It is what we do with it. The passage of time by itself produces no value. The symbol of dough rising is an apt one. The dough must be correctly prepared if the passage of time is to result in the output of delicious bread. It takes time for the dough to rise – pure time. And it takes time – labor-knowledge-time - to prepare the dough correctly. In fact, the passage of pure time is seldom the important part. Rather it is the value of the input-time, valuable because of its potential to produce what we value, that is the key.
Thus, modern complex economies are economies that fundamentally embody fortunes of valuable “production time” – vast and intricate networks of indirect production processes stretching back into antiquity and forward to eternity. We can see this graphically in the modern production of matzah. This happens now mostly in matzah factories. And, in a literal sense, the production of a piece of matzah is almost instantaneous. It happens very quickly as the matzah dough is laid on the matzah machine and baked in less than 18 minutes. But, if one considers the time taken to produce the matzah machines, to acquire the knowledge necessary to operate the machines, to build the buildings in which the factory resides, etc., etc., we see that it is a very long and involved process indeed, one that is only possible in a society of free people who have been able to create this intricate network over a long period of time.
Considered in this way, we may say (ironically and paradoxically) that the matzah we eat today is at once a symbol both of time-deprived slavery and of time-rich freedom! The fact that we can choose to eat matzah made in a complex sophisticated factory is a result (symbol?) of our freedom. We have the time and freedom to make it so that it is easy to bake it in a short time – we take time to make it less time-consuming. A nice paradox. 
Chag sameach Pesach. May the holiday serve to enhance our appreciation of what it means to be free and our resolve to defend freedom wherever we can. 

Saturday, December 21, 2013

The Common Sense Appraisal of Regulation

The way I see it there are only two possible justifications for regulation (aka interfering in other people's private decisions).

1. people are too stupid and/or uninformed to make their own decisions
2. peoples actions have effects (good or bad) on others (third parties) which they do not take into account in their decisions.

When I say "justifications" I do not mean that if they were true then interventions connected with them would be justified. In fact, particularly with 1. I do not see it as a justification at all. But, most people who support regulation fall back (when you boil it down) on either or both of these and nothing else. So it is worth examining them a bit more closely.

Let's consider 1. Is it true? Maybe in part, but not to the extent that most interventionists think. I think most people are more inclined and able to be informed if they are encouraged ("incentivized") to be so. But let's assume it’s true. So what? As most people reading this already know, there is no reason to presume that the regulators know any more than the people they are regulating do, or that, if they do, they can be trusted to do the right thing - the well-known knowledge and incentive problems. Further, there are strong reasons to believe that when acting in their own interests people will do better than regulators acting for them - because they know more about their own preferences and circumstances and because, in acting in their own interests (which includes the interests of those they care about), they have a greater incentive to get it right. The reward for doing so, and the cost of not doing so, is greater for them than for some disconnected regulator. I conclude that this is a bad justification after all - it is an elitist position better served to satisfy the ego and conscience of the elites than of the people they purport to help. 

Let's consider 2. The tired "externality/market failure" argument. Logically this is more resilient to criticism. If it is understood as essentially a question of the lack of property rights, and if it is not a simple matter to establish clear and enforceable property rights, (for example automobile emissions, global warming, protection from foreign invasion) then it might be persuasive to say that some kind of regulation is worth considering. But to be decisive a few questions have to answered affirmatively first. Is the external cost or benefit proven? Can the magnitude be estimated? And, most importantly, can it be decisively shown that regulation to deal with it will work and will be worth the cost in resources and loss of freedom? Every economist knows that to justify regulation it is not sufficient to identify an externality - though it may be considered necessary. In addition it has to be shown that the external effects of the intervention itself is justifiable. Those who support individual freedom and autonomy and distrust big-government initiatives, no matter how well-intentioned, will require a hefty burden of proof, one that can be seldom overcome. The knowledge and incentive problems apply just as much to this justification as to the previous one. 

The public sphere and the private sphere are not neatly compartmentalized spheres of action in which human's act wisely and benevolently in the former and not in the latter. Fallible human beings occupy both spheres. The reason the private sector is so much more successful than the public (government) sector is because it does not rely on the good judgment and good intentions of central administrators, but rather on the simple exercise of self-interest by simple people.

Saturday, September 14, 2013

Reflections on Yom Kippur - 2013


We associate the day mostly with sin and repentance, but it is in equal measure about death and how we understand and cope with it.

In its origins it seems to me these two themes were clearly connected because transgressing - לחטוא - (sinning - it does not mean quite the same thing in the English translation) was seen to be something that offended God and for which one could be punished - accumulating to a shortened life.

[Squaring the circle with the view that God foresees and knows everything and, moreover, is the cause of everything, is the irresolvable contradiction of all such world views.]

But, in the way it has evolved down the ages until today, with the myth of the supernatural less powerful, and the imperatives of community coming to the forefront, these two parts (repentance and death) seem less connected - but no less poignant We still have to deal with death. "Though I walk through the valley of the shadow of death, I shall fear no evil" - be comforted.

When hearing the names of the long list of congregants who have died this last year, I had these thoughts. Reminding ourselves of the inevitability of death is like teaching economics - one cannot avoid the (budget) constraints. But, there is comfort in the knowledge that though each of us is  destined to die alone, we need never live alone, but may choose, until our dying second, to live connected to those we care about. Yom Kippur is about living connected lives.

Saturday, July 13, 2013

More on the Power of the Tribe

Further to my recent post on this issue (see here): Consider the position of a research anthropologist embedded in the tribe he is researching. I have read books about such people who go, sometimes for years, to faraway places, and, after a period of introduction and initiation, become an accepted member of the tribe. In order to fully understand their laws, customs, mores, rituals, values, etc. the researcher participates as a fully-fledged member of the tribe in all of its life-cycle and day-to-day events. 

The researcher has a reason different from the other tribal members for participating in its religious observances, even carefully adhering to the letter of the law. For him it is not a matter of a shared belief in the religious significance of these practices, these injunctions, prohibitions, prayers, religious actions (like prostrations or sacrifices, the intonation of blessings), etc. all involving the supernatural in some way. For the researcher these are a matter simply of tribal practices, having scientific interest. But in order to gain maximum insight, he  considers it necessary to fully immerse himself in the setting, to see what  they see, to feel what they feel, as best he can.  And, often, in the  process, being empathetic in temperament, he comes to value these practices almost as they do, seeing it as they do, but also, simultaneously, seeing them more detachedly as part of the valuable social-capital of the tribe. He sings with them, he celebrates with them, he mourns with them, and by the time he  leaves, he is sad to say goodbye to his close friends. But he does leave and then he writes his book about his experiences and becomes famous and revered in that other world from which he came.

His position is not much different from that of someone born into and growing up in a strictly religious community, who, on the road to adulthood, no longer shares the belief in the supernatural and the associated practices. He still identifies with his family, friends and other members of the community who retain their beliefs. And, moreover, he has an inside understanding of what the traditional religious practices really mean to those who do still believe. He may see these practices as valuable, or aesthetically pleasing and evocative of pleasant childhood memories. And he may still elect to participate in some of them, even though they do not have the same significance to him as they used to.

I grew up surrounded by religious practice. As a young adult I stopped believing the party line. I went through a brief period of rebellion when I distanced myself from all religious practice – or as much as I could. But then I decided this was silly and I  started to participate in whatever felt good to me – for my own reasons, which were mainly to be with those that I loved, enjoying what we had always enjoyed together, appreciating the music, the poetry, going with the flow. I am not alone. Many of my coreligionist community friends are tribal first and religious second, if at all.

A recent example prompted this blog. I continue to participate in the ritual of the priestly blessing at weddings, and, being of the priestly tribe of Cohanim, if I am asked I to give the bridal couple the traditional blessing, as part of the ceremony under the wedding  canopy, I will do so gladly – and did so recently. I see it as tapping into a beautiful age-old practice. I am under no illusions. I don’t believe I have any special power to bestow God’s blessing, nor do many (most) of those who attend these weddings. What others believe is their business, not mine.

Some of my friends didn't understand this and questioned me about it. They see in it an inconsistency between conviction and practice, a kind of hypocrisy. I don’t agree, and I think they are applying an inappropriate standard of “rationality” to my actions. For me, as I have explained before very clearly (see here) it is part of the aesthetic. I am like the anthropologist in my simultaneous identification and detachment.

Just because a particular practice was born of a particular set of beliefs sometime in the past, does not mean that we cannot transcend its original significance and yet continue to use it, for other reasons. This happens all the time, in very complex ways. Some individual components of the social capital continue to evolve and morph into new combinations of meanings and actions, even while some others get discarded. As Friederich Hayek might have said, our current practices embody more wisdom than we can consciously know. As long as no compulsion is involved, why is this even an issue?

Saturday, July 6, 2013

The Importance of Secularization - and the first amendment.


I believe the founders knew something important when they came up with the first amendment. They understood that all totalitarian movements resemble a kind of religion, and that when an established religion is supported by the coercive power of the state, it invariably becomes intolerably oppressive.  Without the power to compel, religion becomes an individual life-style choice, one that offers great support and comfort to some. In the absence of state-power religious leaders must compete for adherents who, being unable to compel the observance of the population, must make the tenets of the religion palatable and attractive if they are to survive. The power to choose, the power to exit, is what makes religion civil; and the absence of this is what makes religion toxic.

This is what I understand to be the enormous benefit of what we call “secularization.” It is the distinguishing element between toxic and civil religion. In other words, it is not so much the elements of the religious teachings themselves, as the context in which they occur, that is pivotal. Consider the three Abrahamic religions, Judaism, Christianity and Islam (in order of their founding). Of the three, Christianity is on paper the least intrusive (which may explain its rapid explosion after its inception). In terms of actions, observances, diet, etc. it requires much less than the other two religions. Faith rather than action is emphasized. Yet, when it became the religion of state we got the puritans, the inquisition, colonial plunder, the crusades, etc. The claim to be the “one true religion” provided license for all manner of coercion and brutality once empowered by the formidable state apparatus. It then became an all-pervasive (hence totalitarian) force reaching into the most intimate cervices of private life. Absent this power, Christianity, though its adherents can sometimes be obnoxious and annoying in their dogmatism, is associated most prominently with universal love rather than universal oppression.

Islam and Judaism are both incredibly intrusive in their teachings. They both preach all manner of severe rituals and observances. They dictate behavior in the workplace, the kitchen, the dining room, the bedroom and even the bathroom. They offer complete instructions for every aspect of life, no matter how seemingly small and detailed. As such, some people (like me) find them unacceptably intrusive taken as a whole. Yet, in civil societies, secularized societies, one is free to take them or leave them; or to take part of them and leave the rest. Pluralism is protected. I often wonder how Judaism might have turned out in practice had it ever gained a foothold as a state religion (we see some of this in the excessive, though muted, power of the religious parties in Israel, the restrictions they have obtained and the others they desire). Many biblical prescriptions are incredibly harsh (even violent). Yet these play absolutely no role whatsoever in modern Jewish religious teachings in civil societies. The rabbis have no coercive power. Over the generations, lacking state power, the rabbis tweaked biblical injunctions and prescriptions to make them more palatable to people who have a choice. Persuasion rather than coercion drove the evolution of the religion. It may also help to explain why Judaism became an inward-looking religion and foreswore evangelism.

So, I can’t help wondering whether this is an element in explaining the absence of a Reformation in Islam. Sharia law is problematic primarily because it claims the power to compel. It is this rather than the fact that it is so comprehensively intrusive, which is at worst obnoxious to those who do not choose it, that makes it so threatening and dangerous. (It is this desire for the power to compel that makes the Muslim Brotherhood unacceptable as a ruling party). If this is true, then the war for hearts and minds to achieve civil society should focus on selling the importance of something like the first amendment.   

Saturday, June 22, 2013

The Power of the Tribe

I have been thinking about “tribal identity.” It is everywhere in a myriad of manifestations. It still flourishes in most of the world that is not yet “modern,” where it is probably the most powerful of social bonding forces, trumping even national identity, often to the chagrin of the world’s lofty politicians. And it exists in the world’s advanced societies in interesting transformations – often overlapping with religious choices, but, subtly, not exactly the same thing. Universalist intellectuals (many libertarians among them) don’t like it one bit. They intellectualize about how dysfunctional such irrational affiliations are. Their ideal society would have only individuals, their families and friends – no tribes with their atavistic rites and prejudices.

But anyone who has read Ayaan Hirsi Ali’s infidel  can see the enormous power of “the tribe” as a social organizing entity, a vital form of social capital, an emergent institution, not so easily banished, and certainly not without dangerous unintended consequences as a result of trying. Anyone who knows anything about social-network theory will recognize the many different forms of tribal affiliation and sentiment as strong bonding ties (as opposed to weak ties) very much akin to “family ties.” It seems to me they can be understood as “extended” family ties, weaker than immediate family ties, but nevertheless, very powerful. They have evolved and morphed from old, sometimes forgotten, practices that now manifest in the form of “traditions.”

From the perspective of social analysis in the service of individual freedom, these tribal ties can be seen as variously destructive and dangerous, neutral, and immensely helpful, depending on the details. As extended, sometimes world-wide, coordinating devices, they are remarkable; allowing individuals to navigate in otherwise strange societies with the indispensable help of their fellow tribal members with whom they share “meanings.” As informal mutual-aid societies (sometimes providing just emotional support and companionship), they are unsurpassed. They provide echoes of familiar sounds (language, music), smells and tastes (foods), and practices (rituals for life-cycle events like births, deaths, weddings).  And they continue to do this long after they have lost their connections with ancient founding myths. Like elements of physical capital, they get spontaneously reformed into unintended combinations to suit the times. They embody ancient wisdoms that form part of the tacit knowledge of our present social life. (I realize that Hayek said something similar about religion).

Of course, some very destructive “wisdoms” can and do linger – like those that rest on the racial superiority of the tribe – the hangovers of the zero-sum societies in which they originally emerged and flourished – societies in which predatory power was necessary for survival and in which pluralism was unknown. At times these impulses have surfaced in the religions of modern societies, as with Christianity during its predatory, inquisition phase. And, of course, Islam, has a very complicated tribal aspect to its makeup, much of it potentially violent and destructive, totally inimical to the tenets of civil societies based on individual rights and freedoms. In many cases, disparate tribal impulses within Islam are vying for legitimacy – the strong ties of mutual-aid that could form the launchpad for success in modern complex societies pitted against the anguished impulse to totally reject and work for the destruction of everything that the “poisonous, corrupting” modern secular societies stand for.

This “war” will never be won by military conquest or suppression. Nor will it be won by denying the force of tribal ties and attempting to “educate” them out of society. It will only be won if tribal members who embrace the creative elements of their extended network ultimately win out over those who embrace the destructive ones. Foreign and domestic policies should be fashioned with this in mind.

Saturday, June 1, 2013

Complexity and Economic Policy


I am reading a fascinating book by Alan Kirman, titled Complex Economics: Individual and collective rationality Routledge: 2011 – being The Graz Schumpeter Lectures of 2007 (which interestingly had the different and more engaging title: The Economy as a Complex Interactive System: Theory, Empirical Evidence, and Experiments. I know of Kirman’s work over the last thirty years exploring the inadequacies of the “representative agent” in economics; his critique of the lack of connection between the individual agent, who interacts directly with other agents, and the macro outcomes that result. The book is something of a summary of much of the work he has done over the years on this issue and the main chapters are case-studies – of fish markets, financial markets, public goods and segregation in real estate markets (a la Schelling) respectively. His analysis uses mathematical modeling and other ideas from various disciplines that have investigated complex interactive phenomena.

This is a theme that will be familiar to Austrian economists. The Austrians, after all, ever since Menger, have wondered about these questions, and certainly Hayek has been credited with anticipating many of the insights that have emerged. Yet, it is not until his summary concluding chapter that Kirman even mentions the Austrians; but he does so in a very interesting and challenging way. Here is the relevant text (page 214ff).

My idea and aim has been to suggest that we should re-center economics on different themes than the traditional ones of efficiency and equilibrium and that we should place interaction and coordination at the center of our interests. In particular, we should focus on interaction and its consequences for aggregate behavior. … We should accept that individuals are suspended in a web of relations and linked directly and indirectly to others. … one is faced with a system which is in evolution with no special reason as to why it might converge to some stationary state.

This sort of idea as I have said before, is far from new, and it has strong echoes of the Austrian School, which fell from favor because of its ‘lack of rigor’ and also because of its ideological associations. Yet reading Schumpeter on ‘creative destruction’ and von (sic) Hayek on ‘self-organization’ one is struck by the insights which preceded, by far, the appearance of what we are pleased to call complexity theory. The Austrians were not too preoccupied with efficiency or the progress towards efficiency as are modern economists; indeed von Mises argued that it is impossible to determine and meaningless to suggest that the real economy is closer to the final state of rest and therefore manifests a superior coordination of plans and greater allocative efficiency, at one instant of time than it was at a previous instant (Mises, Human Action 245-6). He had a vision of a market in continuous restless movement drifting back towards a state of rest but constantly perturbed by the arrival of fresh information or by the discovery of opportunities by the actors.

Thus von Mises has the idea that individuals look for opportunities but often do not have the information necessary to be able to profit from them. He does not view individuals as optimizing but rather, as opportunistic. Individuals never possess the information necessary to fully optimize but this does not prevent them from trying to seize opportunities as they arise. Out of this constant search and adjustment some sort of consistency of actions arises. This is what von Hayek argued, since he had the view that markets self-organize but, in so doing, make internal adjustments as their participants learn new modes of behavior or simply how to get around the existing rules. Once again, as I have said, learning is important but individuals may be attempting to learn about moving targets, in particular other individuals who are themselves learning. There is no good reason to believe that such a process will converge, as we have seen [from the models he presents].

And here comes the kicker:

But once we recognize this we can put paid to a standard myth. The idea that markets do self-organize has been used to justify the injunction to leave them to their work. The less interference there is the better. Yet since the self-organization may not be stable, such a view is not justified. While there is a constant restructuring of the economy and the relations within it, there is always the possibility that this process will lead to a sudden and possibly catastrophic change at the aggregate level. In the simplified models of financial markets that I presented we saw how the fact that people herd on successful strategies can generate bubbles and crashes. This does not preclude the existence of long periods of apparent stability.

… [our model suggests that] a stock market crash is not the result of short-term exogenous events, but rather involves a long-term endogenous build-up, with exogenous events acting merely as triggers.

He references the work of Hyman Minsky on the ‘disruptive internal processes’ in the economy. He also refers later to the importance of the structures of interrelations between individuals to the networks (qua institutions) these interactions create. And, though he shies away from policy recommendations, he has a few remarks that suggest he rejects government responsibility for the crisis and affirms a particular type of sophisticated intervention based on the informed understanding he is providing.

I found this work to be a fascinating window into the world of a conventionally trained, turned heterodox, but not Austrian, economist – one oriented toward the use of formal quantitative reasoning. It seemed to me a good-news-bad-news story. Here are some reactions.

1.       What I found most surprising (though perhaps I should not have) is how surprising he seemed to think the importance of individual interaction was and would be for the mainstream. I mean how many decades does it take before people wake up? Maybe a lot.

2.       His appreciation of the Austrians is nice, but he doesn’t seem to appreciate the importance of subjectivism consistently applied. Most important, he does not examine the government as part of the society, as part of the social nexus (cf. Richard Wagner). If one cannot go simply from the behavior of individuals in the market to the aggregate outcomes, would not the same apply in those social organizations we group within the sphere of government? Are not the individuals acting within these networks subject to the same complex interactions that render the outcomes unpredictable, sometimes perverse? It seems like such a natural extension.

3.     That being the case, one may wonder about the problems of ideological bias that he sees in the work of the Austrians – their faith in the stability of the market process – and turn to his inability to see instability in the government process. Is this a mental block occasioned by an ideological commitment to the idea of government palliation?

4.      Nevertheless, he does make one important point for Austrians – not a new one, but one that continues to be a challenge. Austrians from Menger to Lavoie affirm that the market process is a complex one that defies reductionist understanding. And they are happy to extend this to the government process. Yet they claim that the market process is stable, more stable than the government process; and that goal-oriented government intervention is likely to fail because of this overall complexity (the knowledge and incentive problems that manifest). This strong policy conclusion is hard to “prove.” (Obviously or else the battle would already be won.)

5.    My own view is that it is possible to make this argument and not simply rely on particular interpretations of historical events – though the latter will of course be the decisive arbiters in the end. One starts with the asymmetry of incentives between market and government (situations in which outputs are sold in markets and those where they are not), and one proceeds to an analysis of the type of interactions that characterize many of the networks we regard as helpful institutions, like the market, the common law, language, conventions, standards, etc. to show how positive feedback produces convergence. By contrast, in situations like central-bank financed government expenditure to counteract recessions the feedback mechanisms from individual interactions between agents of the government, central bank, and large banks are such as to amplify divergence, etc. Network effects deserve more widespread application.  

Sunday, May 12, 2013

Why don’t we learn from history?

If life were a seemingly random sequence of unrelated events, it would not be life as we know it, and many of the blessings we now enjoy would be impossible. We see patterns and we categorize. We follow routines day to day. Even over long periods, spanning generations, we are often struck by what we see as situations bearing similarity to what came before. We talk metaphorically of “history repeating itself.” 

For me, as for many of my like-minded friends and colleagues, this Great Recession from which we are struggling to recover, came as no surprise. Nor did the fact that it has been so deep and lingered so long. We see it as a repetition of an old and avoidable folly. We see it as the predictable result of irresponsible monetary and fiscal policies, very reminiscent of the 1920’s, and to some extent also of the 1970’s (see here or here). So the question “why don’t we learn from history?”

I have an answer, a theory [theories are cheap to produce, you will have to decide its market value.]  There are three reasons: Social situations do not provide controlled experiments; memory is very imperfectly transmitted across people and especially across generations; the study of history is neglected.

1.   Social science does not proceed on the basis of controlled experiments that yield unambiguous answers. History does not speak with one voice. This is no surprise. Everyone thinks he is an historian. Multiple interpretations of events and episodes abound. We can neither dispense with, nor feel completely confident in our interpretations. We are dealing with very complex, multiple cause, multiple effect, multiple-multi-layered-multi-directional interactions. Still, when we live through something we get a sense of it – not always accurate, but sometimes (occasionally) the “evidence” is compelling enough to produce a narrowing of interpretations. Such an episode occurred in the 1970’s and 1980’s, leading to the election and reelection of Ronald Reagan (and Margaret Thatcher in Britain). Widespread disillusionment with the preceding decades of Keynesian economics emerged from the experience of “stagflation” – inflation and unemployment simultaneously  – as predicted by the likes of Milton Friedman and before him Friederich Hayek.  I lived through that, and I never imagined that Keynesian economics could ever again gain traction in academe or in policy circles. This is where memory comes in.

2.     Those who were not "there” – indeed were removed from it by a generation or more – did not feel the same sense of conviction that I did. How could they? They learned about it, if at all, from books, or from their parents, or from their grandparents. No matter how much one tries – and probably not many tried very hard – one cannot communicate the sense of what it was like to actually “be there.” In any case, the young tend to discount whatever their parents tell them. It is part of the declaration of independence that accompanies the transition from youth to adulthood. By 2007, not many people actually remembered the excesses of the 1970’s and the stagflation that occurred. We are doomed to have to relearn the lessons of our parents and grandparents by our own experience.

3.     Finally, as unreliable as history (and memory) may be, it is still valuable. The study of history used to be a highly valued component of what was regarded as a well-rounded education, indispensable for good citizenship. It was a proving-ground for critical thinking, for a sense of perspective about the world in which we live. Sadly, the study of history has been devalued at all levels of education, not least, and most significantly, at the college level. [And at the graduate level too – my first year in the Ph.D. program at Chicago they abolished the economic history requirement.] Today’s high school and college graduates are illiterate in historical knowledge. No wonder they are doomed to repeat the mistakes of history.

And being ignorant of our ignorance makes it ever so much more difficult to regain what we have lost. Against the odds, however, with faith in the abiding curiosity of human beings, I remain hopeful.