Friday, November 28, 2014

The Logic of the Free Market in China

I sometimes encounter a particular version of “cultural relativism” which asserts that the benefits of free markets are culturally specific. For example, I am told that cultures that are more collectivist in nature do not react well to the kind of American individualism that we are used to, and that different cultures need to develop their own kind of open-market society, some that are necessarily more “community oriented” than ours; and that such constraints will not limit their economic growth and development.

About to be published in January 2015 is the second edition of the English translation of an amazing book by the Chinese economist Weiying Zhang that gives the lie to this perspective. It is aptly entitled The Logicof the Market and its English version subtitle is An Insider’s View of Chinese Economic Reform. The message is simple - the logic of the market is universal. Yes, it has its particular expression in different cultures, but, its basic logic is the same for all people always and everywhere.

Zhang’s exposition is, in a word, “beautiful”. His simple but elegant style comes through in the translation as he weaves simple, intuitive truths together with profound insights into the miraculous working of the market process, drawing equally and effortlessly form the likes of Adam Smith and Confucius. The book is full of examples from contemporary and historical Chinese thought and experience. Its potential audience is thus enormous, including readers all over the world. For someone like me, teaching economics to Chinese students studying business in America, it is an invaluable resource. I am going to recommend to them that they buy both the English and Chinese versions, and thereby improve both their English and their economics.  

The content is wide in scope. After an expansive introduction (added to this edition and worth reading by itself if that is the only part of the book you have time to read), the book is divided into four parts. Part one, “the nature of the market” is a comprehensive statement of the workings of the market process – the explanation behind the astounding economic developments of the last 200 years in the West and the last 30 years in China. Zhang tackles head-on the relationship between market and morality. He makes no apologies. The market is simply the most efficient and the most moral of social systems, the most compassionate and democratic. The market is a property-based system. China’s predominant historical experience has been with position-based systems. Position-based systems are inefficient and privilege those with social status to the detriment of the rest of society. China’s state-based system is a class-based system. He warns against the ominous anti-market sentiment that has lately developed in China. By way of numerous illustrations Zhang covers labor markets, housing markets, anti-trust, and much more.

In part two “the logic of China’s reform” Zhang examines in more detail the nuances of the transition that China has experienced in the last generation and emphasizes the need to maintain the momentum towards greater freedom. Part three looks at “the origins of the financial crisis” in which he examines the logic and illogic of much of macroeconomic thinking and the dangers of China’s Keynesian response to the crisis.  Part four ends the book with “the prospect of China’s future”.

Zhang is clearly worried, if not pessimistic. Given the prominence of China in the world economy today, his concerns should be our concerns. Somewhat controversially perhaps, he believes that the role of economists everywhere is to understand and safeguard the market economy. And with this book he has certainly made it a lot easier for those who wish to adopt this mission.

Sunday, October 26, 2014

Israel is still very socialist - Friedberg Economics Institute Fellows Seminar - Fall 2014

My trip to Israel was sponsored by The Friedberg Economics Institute (HT: Bob Borens). I was participating in the second fellows seminar. Simply stated the Institute, like the partner organization the Jerusalem Institute for Market Studies (HT: Corrine Sauer and Robert Sauer), is dedicated to promoting an appreciation of the importance of economic freedoms and the market process in the hope that such an appreciation may lead to movement toward greater economic freedom in Israel. Here is the official statement.

The Friedberg Economics Institute was founded in Israel in 2014 as a non-profit organization with a mission to advance, in Israel, appreciation for the principles of economic freedom and the potential for improving growth and prosperity through application of these principles.

The Friedberg Economics Institute sponsors seminars, bringing the world’s best economists and economic policy makers to Israel to teach ideas of free-market oriented economic thinking and principles of economic freedom.

The Institute’s initial target audience is Israeli university students. Over time we hope to broaden our audience to include thought leaders in government, business, and the press.

My two lectures were concentrated on describing what might be called ‘an alternative economics’ – alternative to the standard technical fare that is taught in all but a few economics departments and business schools around the world. I pitched my content at both economics students and intelligent non-economists (of which there were a few). The first was specifically on the “closing of the economist’s mind” starting with Ricardo, but more especially since WWII as economics became more “scientific” aka scientistic. The vision of Adam Smith inquiring into the nature and causes of the wealth of nations was lost. Why and what are the consequences?

In my second lecture I talked about methodology, epistemology, ethics and political economy. More specifically I focused on how popular presumptions and mindsets determine where the burden of proof is put in any policy action.  I used Hayek’s views on knowledge and complex phenomena to explore a few themes relating to policy design and implementation that I have been working on.

There was also a discussion panel with the four lecturers, Deepak Lal, Leszek Balcerowicz, Michael Sarel, and me, as well as lots and lots of informal discussions.

I think my remarks were well received although they were regarded as very controversial and provocative in the extreme. This did not surprise me much. It is well-known that the fundamental principles underlying popular perceptions of society and how it works and ought to work are socialist in nature. Israel was born out of a blending of Eastern European socialist ideology with Jewish national aspirations. These principles run deep and span all classes of society. Even where they are opposed, as from the religious right, there is no well-articulated alternative. But, what I was surprised to find, was the extent to which formal economics teaching in all of the universities – as far as I could tell – reinforces this. Economics teachers have abandoned any attempt to foster an appreciation of that system of natural liberty to which Adam Smith referred. Hayek is never mentioned and disequilibrium is banished with a wave of the hand. Not much either about public-choice. It is standard technical fare. It seems that anyone not hewing to the party-line would not be able to get tenure or last very long in any institution of higher learning. The objective is to produce quantitative virtuosos. Any resemblance between the economics of the class room and real-world economies is purely coincidental.

I found this quite alarming. While the Israeli economy has moved significantly away from its all-pervasive socialist structure (though not nearly far enough as these still permeate most of it) to become a highly innovative, high-growth economy, the mindset has hardly changed at all. In truth, the entrepreneurial sector encompasses a minority of the population and for the rest it is socialist business as usual. The aim is to get Israelis to begin preaching what their most successful entrepreneurs practice. Perhaps with this seminar we made a small beginning and more will be done with similar events in the future.  See also here.

Saturday, October 25, 2014

Jerusalem 2014

Touchdown Tel Aviv. It’s always a bit emotional for me. So many memories from important periods and events in my life. So much recent misplaced vitriol and the frustration of not knowing how to deal with it.

While I was growing up and into my early adulthood, Israel was the darling of the world’s intellectuals across the political spectrum. This beleaguered nation built by ghetto refugees of Eastern Europe, further propelled by survivors out of the ashes of the holocaust, defying the odds to become a viable democracy and home for Jews from every corner of the globe, including 800,000 from North Africa who had been expelled from their homes. It was a heroic, romantic story of hope and achievement in the post WWII period when people were looking for a brighter future.

All this changed after the 1967 war. Suddenly, Israel’s very success in defending itself, and every success thereafter, became a cause for condemnation and vilification – not to mention wholesale historical revisionism.

I arrive soon after the latest military confrontation with Hamas – a polarizing media and maven event, but, one in which at least Israel’s public persona was clear, unapologetic and persuasive to many, though clearly not to all or even perhaps most. The disproportionate media attention, the misconceptions, the distortions, and the motivationally suspect have left a bad smell with me. What will I find this time – how will I feel?

On my second day I go on an unusual tour of Jerusalem, a tour seen from the position, first, of the security – the lives – of the people living there, and, second, from the point of view of the accurate history of the city. The tour is organized by a highly partisan  organization and the tour guide (an ex-South African who hails from my childhood city of Johannesburg) glosses over some uncomfortable details about the 1949 war and violence against the Arab population in various places. Though much of this history is still highly disputed, there seems to be little doubt that the Israeli forces were guilty of bad things. Both sides were. So he distorts this by saying that all of the Arab refugees of that period left in response to exhortations from Arab state leaders. Many did, but many were brutally driven out. That is disappointing, to say the least.

But, overall the picture he presents is undeniable and highly relevant to the debate over Jerusalem. The world media has quite simply been duped into thinking that Jerusalem was once an Arab city, important to Islam, that the Israelis appropriated, and that the moral thing to do would be to return it to its rightful owners. Not only is this false on the national level (something which Libertarians would find irrelevant and obnoxious even to say) but it is false on the individual level as well. There simply was no large Arab population that was displaced from Jerusalem. And, importantly, Arab and Israeli neighborhoods are so intricately intertwined now that it would be impossible to separate the city into Arab and Jewish sections. Here are some important facts:

Jews have been living in Jerusalem continuously for nearly two millennia. They have constituted the largest single group of inhabitants there since the 1840's. Today, the total population of Jerusalem is approximately 800,000. 

It is a popular misconception that East Jerusalem has historically been populated only by Arabs. In the mid- 1800's, the entire population of Jerusalem lived behind the Old City walls (what today would be considered part of the eastern part of the city). Later, the city began to expand beyond the walls because of population growth, and both Jews and Arabs began to build in new areas of the city. By the time of partition, a thriving Jewish community was living in the eastern part of Jerusalem, an area that included the Jewish Quarter of the Old City. This area of the city also contains many sites of importance to the Jewish religion, including the City of David, the Temple Mount and the Western Wall. In addition, major institutions such as Hebrew University and the original Hadassah Hospital are on Mount Scopus — in eastern Jerusalem. 

The only time that the eastern part of Jerusalem was exclusively Arab was between 1949 and 1967, and that was because Jordan occupied the area and forcibly expelled all the Jews.

So, to treat Jerusalem as part of the so-called “settlements” is just wrong in so many ways. The city is a modern city with a vibrant Arab and Jewish population, and some Christians, including a successful high-tech area. The attempt to make Jerusalem part of any overall settlement is a strategic ploy designed as a first step in the dismantling of the state of Israel. It is the “heart” of Israel. Destroy Jerusalem and you destroy Israel. “East Jerusalem” is not east Jerusalem – it is a ring of territory surrounding what used to be the city within the city wall. As both Arab and Jewish populations have grown the supply of housing has become an increasingly binding constraint to the point that rental prices now rival those of Manhattan.  Achieving some sort of normality in the housing market – with transparent titles and security – would lead naturally to an ordered expansion available to both Arabs and Jews – but the absence of a unifying legal structure – and some places with no structure – has meant that the situation is highly precarious and dysfunctional. The interests of the Palestinian Authority quite clearly do not match the interests of the Arabs who live in Jerusalem – Israeli citizens and, increasingly, non-citizen residents. They come to Jerusalem in large numbers for a better life under Israeli authority and they would opt to live under Israel if given the choice. Many have for generations now.

This tour saddens me but adds to my previous impressions. I try to remain optimistic and to marvel at the beauty and resilience of the city – to the seamless mixing ancient and modern in an open and vibrant market system. I am here to try to explain to Israelis the importance of economic freedom, a topic I will turn to in my next blog. 

Friday, October 24, 2014

From the Friedberg Economics Institute Fellows Program, 2014 - 2

Peter Lewin
October 20 at 5:31am
Today I had the pleasure and privilege of hearing Leszek Balcerowicz talk about economic freedom, both as a concept and as a strategic objective in real-world situations. He is a rare individual who combines theoretical knowledge and knowledge and vision of how to implement the theory's implications. He is a passionate and optimistic believer in freedom.
Leszek Balcerowicz is a Professor of Economics and Head of the Department of International Comparative Studies at the Warsaw School of Economics. He is considered the architect of Poland's economic reforms initiated in 1989 - he designed and executed the radical stabilization and transformation of Polish economy since the fall of communism in Poland. In September 1989 Leszek Balcerowicz was appointed Deputy Prime Minister of Poland and Minister of Finance in the first non-communist government in Poland after the Second World War. He retained his positions in the government until December 1991. From April 1995 to December 2000 he was the President of the Freedom Union, a free market - oriented party and from October 1997 to June 2000 he was Deputy Prime Minister, Minister of Finance In 2001-2007 he was the governor of the Central Bank of Poland.
A recipient of numerous awards and honors, including the 2014 Milton Friedman Prize for Advancing Liberty and Poland's highest decoration - Order of the White Eagle - for his contribution to the systemic transformation, he is active, as a Chairman and Founder, with the Civil Development Forum Foundation, a think tank based in Warsaw.

From the Friedberg Economics Institute Fellows Program, 2014 - 1

Peter Lewin at Neve Ilan Hotel
October 19 at 1:54pm ·
Michael Eisenberg, seen here at tonight's gala dinner, gave the keynote to kick off the event. Guess what he talked about? The SHARING ECONOMY. Look at his bio below. He is an investor in Airbnb among other companies. His rushed away to catch a flight to NY where he will be for two days.
In his talk he unintentionally channeled my thinking about the significance of the sharing economy, except perhaps more articulately and emphatically. I said in
a post and elsewhere that I thought it was the most significant development towards free markets in a hundred years. He thinks it is the basis of a revolution that is just getting started that is as big as the Industrial Revolution. No need to quibble about who is right, it is an important transformative phenomenon.
He then went on to explain, as I have, the tremendous resistance to it and how it could be derailed through expanding government regulation protecting vested interests - the taxis, hotels, freight shippers, etc. But he added significantly that, since this is a global phenomenon, it cannot be blocked worldwide and those economies that do not make their peace with it will be left behind and will pay a higher ultimate price for the transition.
He believes that the transition will come and will be painful - that the sharing economy revolution will leave no industry untouched and that many people will be rendered economically obsolete - many more than the expanding companies can absorb. He called for corporate philanthropy and individual outreach to promote retraining, etc.
This is where I would venture to disagree. There is no way he can know this - though his hyperactive, charismatic, personality might make him think he should and does. My own suspicion is that, with minimal intrusion, the market process would adjust much more quickly and rapidly than we might expect. I intend to address this in my two lectures, touching on Hayek, spontaneous order and the propensity to innovate in crises.
One of his conclusions I do believe we cannot escape - all change is painful for some and large changes are painful, sometimes devastating, for many. There will be pain. The only question is when and how much - if we try to regulate it away it will come later and it will be more.
This is what makes the case for free markets in the face of this phenomenon so difficult to sell. That is why I am here.
Michael Eisenberg is a Partner at Aleph, a $140MM early stage venture capital fund, which he co-founded with Eden Shochat in 2013. Michael joined Benchmark Capital as a general partner in July 2005 and continues as the partner responsible for Benchmark’s Israeli portfolio. Michael joined Benchmark from Israel Seed Partners where he was a general partner from 1997. Eisenberg began his career at Jerusalem Global where he started and led the firm’s successful investment banking group and partnership with Montgomery Securities. Michael has focused on Internet investments since 1995 and has invested in and sat on the board of Israel’s leading companies and start ups, such as (Nasdaq SHOP, acquired by EBAY), Conduit, SeekingAlpha, Gigya, WeWork, Wix, (Nasdaq ANSW), Tradeum (acquired: VERT), and Picturevison (acquired: EK).

Sunday, October 5, 2014

Free markets are difficult to sell

First, distinguish between correct and salable. Free market economics may be (is) correct but may not be salable. Put another way, free market economists as a group, or on average, get paid less than interventionist economists - who, maybe because of this are in the large majority. In a nutshell scientism leads to statism (HT: Pete Boettke). The kind of quantitative closed end economics that most economists do feeds nicely into the aspirations of politicians who have promised their constituents utopia. Free market economics is definitely a harder sell. 

The absolutely crucial point to make here is that it is precisely because free markets do not rely on the good intentions of individuals to achieve social benefits that they are superior to government policies designed to do what markets do automatically, and that, government policy being, by definition coercive, the presumption should be against them. The natural inclination of most people is to think that since free markets are peopled with individuals who intend only their own good, the government is needed as a corrective to these bad or indifferent intentions. But, this is to misunderstand in two ways 1. for free markets the right intentions are neither necessary nor sufficient to produce the "right" results - quite the contrary, acting in a self-interested manner most often produces socially beneficial results when the underlying institutional conditions are right - it is not from the benevolence of the butcher that we get our meat. and 2. for government policy good intentions are absolutely necessary but absolutely not sufficient. With the best intentions in the world governments, being basically limited human beings acting in a complex world, are very likely to fail. And most often they do NOT have the right intentions, because they predictably, even excusably' act in their own interest - Adam Smith pointed out individuals never spend other people's money as carefully as they spend their own, they have an incentive to inflate their budgets not economize on them - and to fake results to claim spurious successes - and there is no market feedback to check them. 

Saturday, October 4, 2014

Rituals and Beliefs

Last night a student asked me off the record what my personal religious beliefs were. I said that although I was a convinced agnostic, I did very much appreciate the beauty and function of many of the traditions in which I was raised and live. These rituals, I suggested, enabled us, among other things, to celebrate together and to grieve together. We are not at a loss about what to do, what to say, etc. because it is all scripted for us and the meaning and significance is understood by us all. These ritual events nudge us to take time out from the every day forest to take a look at the beauty and wonder and sometimes sadness of the trees. Rosh Hashanah to Yom Kippur starting next Wednesday night are traditionally known as the days of awe - days of appreciation, of self-reflection, when we are urged to ask those whom we may have offended to forgive us (only they can, not even God can).

These are beautiful traditions, that require action not belief. And they certainly do no harm.

Anti-Zionsim and Anti-Semitism

The fallout from the Israel-Hamas conflict makes me realize that there is a lot of misunderstanding as to what Antisemitism is. A lot of people think it is simply another kind of racism - a sort of irrational prejudice based on color or religion. It is that, but it is more - there is a history in which "the Jew" as an object of fear and aversion was a vital necessity for the viability of both Christianity and Islam and this has spilled over into the secular descendants of those cultures. Hence, in the story below, Jews, not Israelis, are banned from the university campus, and many Palestinians make no distinction.

Yom Kippur 2014

A custom among many Jewish families on the night preceding Yom Kippur - the holiest, most reflective night of the year - parents invoke the blessing of the high priests as found in the bible and "give" it to their children.
For me it says 'I love you and I hope with all my heart for a happy and prosperous year for you. I just want you to know that.'
In the synagogue service when the high priests say this they raise their hands, put their thumbs together and separate the first and second fingers from the third and fourth - five points for the five books of Moses.
The most important application of this is the blessing invoked by Mr. Spock in Star Trek, who raises one hand in this way (with the V separation) and intones 'live long and prosper.' Leonard Nimoy, Spock's alter ego, is Jewish and introduced this into the series as an adaptation of the priestly blessing. Maybe you did not know that.
Here is the blessing. It is also part of many Christian liturgies.
Then God spoke to Moses and said, Tell Aaron and his sons,
דבר אל אהרן ואל בניו
This is how you are to bless the children of Israel. Say to them:
May God bless you, and keep you;
May God shine his face on you,
And be gracious to you;
May God look at you,
And give you peace.
So they shall invoke my name on the children of Israel, and I shall bless them.
(Numbers 6:22-27)

Monday, September 8, 2014

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

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.

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.  


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

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.