Say? McCloskey

Getting back from a break is always tough. In our current economic climate I am finding it even more difficult than usual. Nothing much changes. Growth is so-so – I found last week’s headlines hilarious when first quarter GDP was revised down. Some in the press screamed  about things being much weaker than originally estimated. The downward revision was from 2.5% to 2.4%. If you squint you can make out the difference. And since both figures are estimates notoriously subject to revision I think we can safely ignore anyone who argues that the latter number being smaller means anything at all.

But, politics being economics and vice versa, every statistic is grist for the political mill.

One of the advantages of taking a break is that you can put down books you’re having a hard time with in good conscience. That’s what I did with Deirdre McCloskey’s “Bourgeois Dignity”. Deirdre has a habit of saying in 400 pages what can best be said in 50, and her tone can sometimes border on the patronizing, but her topic is important and I respect her opinions. So on I wade. And wade.

The topic is one I stumble over, and, according to McCloskey, is one that economics in its various standard forms, fails utterly to explain. The problem is this: the modern world is a veritable cornucopia compared with that of 250 years ago, and most modern accounts of how we got from here to there fall lamentably short of providing a full explanation. Let me give an example: geography. It cannot be that having a terrific location is sufficient explanation for the acceleration in growth of the past three centuries. The reason is simple: it hasn’t changed. Britain, where the acceleration first became noticeable, hasn’t moved. It was always a peripheral and not too well endowed island hanging off the edge of Europe, which in turn is a bump on the side of the great Eurasian landmass that extends all the way to China. With the latter being the locus of far earlier and more extensive invention.

Practically any statistic traced back to around 1750 shows a similar near exponential trend line. By any stretch of the imagination, and in most if not every category, we have more stuff and are vastly better off than our ancestors were.

Why?

McCloskey, steeped as she is in Chicago style economic thinking, presses our noses to the libertarian glass and claims that it all is a result – a natural result to boot – of a change in the tone of social conversation. Somehow, sometime, and somewhere it became okay to make a buck by being inventive. With a flip of the libertarian switch we went from being stuck in an ecclesiastical authoritarian monarchical tyranny, where most people were mired in abject and predictable poverty, and where change was glacial if it existed at all, to our modern iPod in every pocket, fast paced, and much healthier world.

It was, to paraphrase Kirzner, the entrepreneurs what done it.

How?

They managed to identify opportunities to make abnormal profits from being innovative. ‘Abnormal’ profits being those that accrue from being smarter than the rest, not simply taking what the market allows, which is ‘normal’ profit. The rest, according to McCloskey, is history. Once it became socially acceptable for someone to express their desire to be rich by exploiting their practical knowledge the pace picked up. And, boy, did it ever pick up.

Most of McCloskey’s book is series of put-downs of other ideas – with geography, as I mentioned above, being one.

The problem I have is that this emphasis on the entrepreneur and the acceptance of the private enterprise narrative that provides the context for abnormal profit making, is that it falls precisely into the very trap McCloskey accuses others of being unable to avoid. It relies on a single thread. Were it not for this single shift in the social conversation and the consequent acceptance of profit making, we would not, McCloskey would have us believe, be surrounded in goodies and good health. The best we could have hoped for was a nice but not breakthrough shift in our standard of living.

This makes light of all sorts of other factors that seem to be important, not least the self-same geography belittled above. It would, I imagine, be a fat load of good getting the entrepreneurial bug slap in the middle of the Sahara. It surely helped being in the Midlands of England.

Then there’s the sly way in which McCloskey slips her libertarian economics in as settled theory. For entrepreneurial innovation and the rise of ‘bourgeois’ values to launch the economy into warp speed there has to be a transmission mechanism to spread the wealth. This is crucial otherwise we would be talking about the rise of a few mega-rich folks and not about the enormous increase in wealth of even the poorest tranche of the population. There has to be something that generalizes the gains.

We find clues on page 208:

“Supply, when so guided by prices, creates its own demand through the expenditure of the income earned, and the prices adjust to clear the market.”

So, entrepreneurs chase after abnormal profits by innovating. This means they turn into producers. They hire people in order to produce. Those hired folks get paid a wage. And those wages provide the means for the stuff the entrepreneurs are making in their factories to be bought. How neat. How circular.

How terribly old fashioned.

There is nothing new in this. For those of you who haven’t had the pleasure of an economics education, the circular reasoning in the quote above is known – in its various forms – as Say’s Law. It is the stuff of right wing classical economics. Strip it down to this: ‘supply creates its own demand’.

This may look uncontroversial, and McCloskey slides it by us as if that were true, but it is hugely controversial. Indeed Keynesian economics owes much to the notion that Say’s law is simply wrong. Hidden within Say’s Law is the origin of supply side thought. Hence its appeal to libertarians who want to elevate rugged individualism to Olympian status. What McCloskey and others of her ilk want us to believe is that the adventurous spirit of entrepreneurs provides the energy that kicks the economy into high gear. Moreover, that energy sets in motion a self-fulfilling spiral of ever increasing wealth. By providing employment, entrepreneurs flood the economy with wages sufficient to guarantee that whatever they make will be bought. Read that again. They guarantee that whatever they make will be bought. This is iconic right wing thinking. The implication is that there can never be insufficient demand. Those wages being paid, as long as prices adjust smoothly, will pump exactly enough money out there to mean everything supplied gets bought. There can never be a shortfall in demand. Never. Ever.  All we ever have to do is to encourage entrepreneurs to take risks and build supply. We need to get out of their way because they will pay wages and hence ensure growth. Ayn Rand rules.

The Keynesian interpretation of the Great Depression and our recent mini-depression stands in stark contrast. Which is probably why McCloskey dismisses Keynesians as leftist and misguided. Keynes, you see, put priority on other things, not on supply, and certainly not solely on entrepreneurial pursuit of abnormal profits. Indeed he, much to McCloskey’s chagrin, focused more on demand, and argued that it could, in fact, fall short. Which is why he suggested bolstering demand when needed through government action. Such government action being what we nowadays call ‘stimulus’.

This is horror for McCloskey. Her entrepreneurial heroes are rendered mere mortals. Worse, her transmission mechanism is tossed aside and the purchase of bourgeois values diminished. Worse still, it is the government who arrives to save the day. Yet it works. It really does. This is an ugly prospect for a libertarian to say the least. With the supply-creates-its-own-demand circle broken the McCloskey thesis shrinks back to just one more partial explanation alongside all those she dismisses.

Still, I agree with McCloskey. Something big happened over the last two to three hundred years, and standard economic theory cannot explain it. That lack of an explanation in contemporary standard theory is why McCloskey drifted away from her Chicago School roots. The shame is that she drifter rightward and not leftward to where a plausible alternative exists. The rise of modern capitalism – a word she eschews because of its ethical load – was one factor in the change we need to explain. An important one. It was one  among a whole complex of factors. She has an important point to make, but stating controversial economics as if it were settled theory is not the way to make that point.

Read her book though. Although I must warn you: set aside plenty of time.