Oscar Lange

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Libertarian Economics

 

Economics is contextual. At its inception this context was the struggle for power as entrepreneurial and landowner citizens tried to wriggle free of the impress of ages old monarchical rule. As political freedoms steadily grew and different societies obtained an ability to critique their rulers and as they managed to change the institutional set up in which their economies were embedded the study of economics became a coherent field of enquiry.

This early economics was almost invariably an attempt to demonstrate why it was that monarchs ought to interfere less in the workings of the economy. Such interference was seen as arbitrary and inefficient, whereas the operation of the entrepreneurs and landowners was seen as obeying ‘natural laws’ that would, inevitably, produce better outcomes than those obtaining under state rule.

The market versus state conflict was thus built into classical economic thought from the beginning. Indeed much of the original impetus for economic theorizing was precisely to ‘prove’ the efficacy of markets.

Thus economics has within it a deep tradition of articulating one side of an argument. It is a tradition that resonates strongly today. That one side of the argument is easily detected in the views of libertarian economists – there are very many – who seem to begin their work with an end in mind. That end being a proof of market efficacy.

This is why classical economics and its modern variants are willing to adopt a variety of assumptions that appear to drive towards only one conclusion. It is why so many economists find it difficult to find a role for government in their models. It is certainly why in recent decades the old Keynesian governmental role is so commonly ridiculed.

In many ways modern economics has a predictable air to it: the outcome that markets are so efficacious is based not on empirical work, but on a careful choice of starting assumptions designed to allow that outcome to emerge ‘naturally’. Friedman was hinting at this when he argued that nonsensical assumptions were of no consequence as long as the outcome was ‘correct’.

Modern microeconomics is an example: it is carefully prepared and cleverly constructed to ensure that market outcomes – when markets are left to their own devices – arrive at social outcomes that cannot be bettered. That in order to do this economists have had to resort to adopting a model of human behavior not found in the real world is little mentioned. And when awkward realities do intrude they are usually ignored – as, for instance, with the celebrated questions asked by Ronald Coase and the existence of the firm.

This bias in economics reached its apogee with the notion that modern macroeconomics ought to be constructed atop micro foundations. This would thus assure the market solution would flow through to models of entire economies and thus squeeze the state out. This was necessary in order to undo the work of Keynes who had the temerity to see a permanent role for government and who thus was an apostate in the eyes of the libertarians.

The libertarian worldview thus infects economics thoroughly. And it also means that much of economics is not scientific in the sense that it tries to understand aspects of reality, but is rather ideological in that it tries to advocate a particular way of organizing society.

So libertarian economics is idealistic. It posits a world as it ought to be. It argues a great deal of ‘if only the markets were free’ and has no interest in opening up space for other institutions to play mediatory roles. It is an analog to Marxist thought which has its own teleological drive and idealistic outcomes. Neither are studies of reality. They are critiques. Both are stories with happy endings if only we all submit to their rules.

A critical missing context in both libertarian and Marxist economics is the emergence subsequent to their origins of modern democracy. The modern state that libertarians so decry is a parallel expression of the very ‘agents’ that they model as being so tirelessly self-interested and rational in their economic lives. Yet when these ‘agents’ change coats and become ‘citizens’ they make fools of themselves and vote for all sorts of state activity the libertarians detest.

How can this be?

How can people-as-agents contradict people-as-citizens? Especially when both sets of people are identical.

The problem is, I argue, that libertarians live in the past. They imagine a wonderland of simple production, simple relationships, and simple rules. Causes and effects are easily connected in such a world. They can be easily modeled. Tracing an efficacious curve in such a world is relatively easy. And, yes, the libertarian vision fits quite well with it.

But it is not a modern world. Modes of production have changed. Logistics are different. Distances have collapsed due to better communication. The division of labor has separated us all from our more self-sustaining past. And we are now self-governing. The state, to paraphrase Louis XIV, is us. So the libertarian world is outdated and it is especially not a democratic world where people have two ways to mediate economic outcomes: one through their transacting relationships, another through the ballot box.

Keynes, in his confrontation with Hayek in the 1930’s, recognized this. His response was to attempt to build a theory that accommodated democratic wishes: you cannot have extreme adjustments and massive unemployment without threatening political unrest. So, in order to protect the market driven engine of growth we have to mitigate its apparent occasional extreme outcomes. Our best option for such mitigation is through then state. The mass of the people in their democratic role will demand this mitigation. After all few will benefit from the extreme rewards on offer in a free market, but many can, and do, suffer the extreme penalties from those occasional breakdowns that history tells us markets go through periodically.

Hayek, in contrast was so beset with fears of repressive state interference – his childhood had been spent watching the decline of the Hapsburg lineage and the emergence of fascism – that he found himself forced to argue that even well intentioned state intervention was less efficacious than the most extreme market outcome.

Hayek’s classic work on the role of knowledge in the economy is his attempt to demonstrate this latter point. Since knowledge is so dispersed, and since it is only revealed locally, no central player can accumulate sufficient knowledge to out perform the outcomes generated by a decentralized marketplace. Lange’s counterargument that this exact same set of conditions can be used to justify a socialist economy has, unfortunately, been lost or ignored in the decades since.

My point here is simply this: economics began its life as either a defense or a critique of the emerging industrial economy. It was adjusted in the 1930’s to account for democracy. But this adjustment was rejected by libertarians whose worldview was offended by any economic outcome being subjected to political input. As the libertarian view regained dominance in economics it implied that the profession drifted away from democracy too. It is this latter drift that has made it so difficult for many economists to embrace inequality as a topic worthy of study. It is also this drift that makes many economists so tone deaf to the real world social outcomes of unfettered markets. Creative destruction is still destruction. The system may re-emerge healthier, but the human cost along the way is also real. Accounting for it sits outside the libertarian agenda. Besides our modern economy is not much like that being observed by the founders of economics. It isn’t even much like that of the 1930’s.

Are we sure economics ought to be invariant even while the economy itself evolves so radically?

This libertarian drift is also the reason that we see so many economist give attribution to the market for all sorts of social and political changes. In their narrow and binary world where the only agency is situated either in a market or in a state, they are forced to go to extremes. They give themselves no choice. They have to suggest that progress can only come from free market activity. After all, in their eyes, the state can only be negative.

Even if the state embodies the wishes of ‘we the people’.

 

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Information Matters?

Sorry I have been absent here lately: I am in the middle of several projects that take priority.

Nonetheless in the course of one of those projects I have found myself immersed in the many faces of economic theory with respect to the role of government in an economy. That role appears to lurch from one extreme to the other, which leaves the impressionable outsider having to resort to their political predisposition in order to seek an answer. Economics, you see, has many answers. Some of which flatly contradict others.

So much for science.

The problem begins at the beginning. The beginning, that is, of economics itself. The early pioneers of the discipline were captivated by the apparent order they saw around them, and especially by the seeming ability of goods and services to turn up and satisfy demand without being ‘planned’ into being. This led them, naturally, to build into the subject a bias towards a market-centric explanation of everything. For it was the mystery of the market that they attributed this seeming order to.

Well one thing led to another and we ended up with an almost comical attachment to ‘the market’, very often with no real description of what that actually was. The market is shrouded in its own mystery, with its super-human powers flowing very much from that mystery. Strip the mystery away and the market becomes a whole lot more prosaic. Plus the elegant math used to describe its machinations begins to look very contrived.

It is one thing to marvel at what you think of as a great mystery needing explication, it is another entirely to become so fanatical that you tolerate not a single hint that the mystery might be slightly less than magical.

Yet that’s where we are.

In order to protect the object of their desire from the rude realities of its earthly manifestation, economists made a series of transitions in thought, with each adding layers of complicated theory in order to cover up or atone for what were perceived as prior weaknesses.

Towards the end of the 1800’s one such transition was so radical that it implied that all previous theory was not about economics at all. In  an effort to put economics on a more ‘scientific’ standing its subject matter was progressively narrowed. No longer were the big issues of where wealth and growth came from of any concern, what mattered now was exploring and describing the logic of the magic. Note that there was no doubt about the existence of the magic, that was presumed, all that economics was now to be concerned with was its inner workings.

In the 1930’s this led to an explosion of economic enquiry and argument.

At one extreme Oskar Lange could argue, quite plausibly, that if all the conditions of the magic obtain in a real economy, then socialist organization is not just a possibility, it is guaranteed to work. This set capitalist-leaning economists aflutter. They had to counter attack. One result was that Friedrich Hayek, whose libertarian politics could brook no morsel of socialism entering contemporary political reality, began to argue that the economy was actually a learning device and that, since knowledge was so unevenly distributed in any economy, and was thus well beyond the ken of any government, a decentralized marketplace was the best possible solution to the problem of coordination.

Note that the big problem of economics was now firmly coordination and not those older issues of wealth and growth. Although people like Hayek conflated the two traditions: the libertarians argued that market coordination was also the best longer term guarantor of ‘sustainable’ growth. By sustainable they did not – and still do not – mean sustainable in an ecological sense. What they mean is that growth can be sustained on a robust long term path, albeit with periodic interruptions due to the ups and downs of the business cycle.

Also notice that Hayek, in order to fend off Lange and his evil socialism, had to introduce a decidedly uneven vision of knowledge. In the Hayekian world knowledge was a very local and lumpy affair. Individuals were therefore likely to be much more attuned to it, whilst the government would inevitably be defeated in any attempts it made at gathering, assembling, and analyzing for policy purposes that self-same knowledge base. Such local knowledge is forever inscrutable to the central planner.

The problem with this vision is not its lack of reality. Indeed the Hayekian view on knowledge is a very realistic one. It’s that it seems to fly flat in the face of the parallel efforts being made at the same time to establish the concept of ‘general equilibrium’ as a central fact in economics. Since the days of Walras, economists obsessed with the apparent order of the economy had made attempts to describe the coordination problem in terms of all markets simultaneously. That is to say they sought to describe a world in which all markets, however diverse and seemingly disparate, would magically fall into place together at the same time. This requires prodigious calculation, but market magic was assumed to be up to the task. It was only after making a series of ever increasingly absurd assumptions that economists were able to arrive at a suitable description of such a general equilibrium. Only the very honest amongst them then stepped back and admitted the effort was worthless since those assumptions were so heroically other-worldly as to render the entire effort barren of practical use.

Amidst all those assumptions are one or two that imply information is both freely and widely available to all the players in the economy.

On the face of it this isn’t exactly what Hayek had in mind when he argued knowledge was fragmented and local. After all, how can knowledge be freely and widely available and yet fragmented and local at the same time?

On the one hand we have a theory that, in order to describe market magic as being, well, magical, has to allow us all to have equal access to all the relevant information we need in order to undertake our transacting calculations. And on the other we have a theory that depends upon that same information being impossibly divided and split apart such that no one can assemble it, least of all to undertake transacting calculations.

You might think this dichotomy would be an issue.

On one side the libertarians argue that the government has no role in the economy because it could never gather enough relevant information. The economy, they argue, is just too complicated for anyone to understand, so we ought leave it be. And others argue that the government has no role in the economy because everyone knows exactly what’s going on and can therefore both predict and defeat even the most well intentioned actions of the government. The economy they argue is perfectly understandable as long as everyone thinks and acts like economists theorize they do.

Either way the government doesn’t have a role to play.

If this sounds a tad ideological to you so be it. We are told this is all science.

Meanwhile it sounds to me as if information matters. It really matters. But as of now economists cannot quite agree on how.

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Its Official! The Recession’s Over … Yawn.

Hang out the flags. Set off the fireworks. The recession is officially over. Whoopee. The National Bureau of Economic Research says so. In fact, by their count, the recession ended in June 2009.

There, don’t you all feel better?

Not really.

The “Great Recession” was officially 18 months long, making it a full 2 months longer than the slumps of 1973/1975 and 1981/1982. Those two recessions were doozies and unemployment surged in both. Banks shuddered. Businesses lost money. Shops were closed. But neither felt like this last one. The reason being that both were followed by decent recoveries. Obviously I have a personal gripe about the 1973/1975 slide since its aftermath was sufficiently meandering to set the stage for the Reagan takeover and all the deterioration in our economy that his slippery illusion has implied.

Still, here we are, on the other side of what history will record as the worst slump since World War II. We are edging slowly away from the abyss. So slowly that many of us cannot tell the difference between being in recession and being in recovery. But let’s not be churlish: we should acknowledge that we are afloat and not sinking. At least those of us still gainfully employed. As for those other folks …

If you are someone who believes in market magic, let’s say you were schooled in textbook economics, then the slump has failed to clear out the dead wood sufficiently for the recovery to be robust. In particular you are really annoyed that wages have not dropped low enough to make it attractive for businesses to hire workers in droves. For you magic lovers the lunacy of government intervention has prevented the market from solving our ills. This slow growth is a direct result of that persistent and foolhardy intervention. If only, you mutter to yourselves, unemployment had reached 20%. Whatever it takes. Maybe 25%, like back in the good old days of depression era economics. Back when workers took their medicine like the undeserving ingrates that they are. Silly things like the minimum wage have stopped the market from “clearing”. Demand for workers is too low only because – you suggest – wages have failed to drop to a market clearing level. Then there’s all those payroll taxes imposed by the silly politicians who seem to think we should set aside cash for workers retirement. Phooey! If workers cannot save for their own retirement they should starve. That’s what the market says. And you believe the market magic myth.

It helps if you are a tenured professor when you articulate this myth. That way the slump never actually gets too close to the comfortable surroundings within which you pursue academic freedom.

But that’s another story.

No one ever said that hypocrisy and academia were not entwined.

Meanwhile those of us who base our economics on reality, and not magic, see it very differently.

We see the entire problem as one of insufficient demand. There are no jobs because businesses are being very sensible. They aren’t hiring until they can expect to make a profit from the labor of those new workers. Until business expectations turn more optimistic unemployment will persist. So the central aim of government is to stoke the economy in order to boost expectations. Once we get the engine rolling it will take off on its own and we can withdraw our support. Since the taxpayers are the ones who benefit from the growth in the economy, they get new jobs, pay raises, and all sorts of other neat stuff, it is not unreasonable for them to chip in up front and pay for the necessary boost to get the engine going. They chip in by taking on the responsibility to pay back the debt the government issues as it primes the pump.

Its a perfect example of “we the people” taking responsibility for our own welfare. Its also reality. It also is an affirmative rejection of the notion that “we the people” have to get hammered before we react to the mess that the bankers made.

We are grown ups. We will fix our own mess thank you. We do not have to wait for the market fairy to awake and wave her magic wand.

I am always astonished at how many good people grow up to reject the idea of Santa Claus or the Tooth Fairy, yet still cling to the Market Magic Myth.

It was always a made up story designed to keep the workers supine. The suffering inflicted by the depressions of the 1800’s and that of the 1930’s was turned into a punishment for the ills of the laboring class. It was converted into a parable about the “natural workings” of an economy. The story telling reached its apogee in the arcane and obscure pages of academic economics. Generations of workers were told that the decentralized mechanisms of the free market produced wealth for all. They would get a share of that wealth if only they obeyed the workings of the mechanism. Sometimes that meant hunkering down and starving as the market sought to work its magic and locate a new wage level. That new level seemed always to be lower than the old. But hey, there were new jobs in new places if only you all were willing to take that new wage.

This was the essence of the myth that became modern economic theory. In the hands of people like Schumpeter – he of the “gales of creative destruction” – and then the postwar wave of right wing theorists like Friedman and Lucas, economics became an apologia for naked capitalism. It gave up the pretense of being a science. Instead it contented itself with a justification of a particular form of economic activity.

Nowhere, and I mean nowhere, is there a scientific argument that free markets work to the benefit of society. Nowhere is there a body of scientific proof that central planning is worse than decentralized planning. On the contrary. You may be shocked to hear that during the 1930’s a great debate raged within economics between those who argued central planning was at least as efficient as capitalistic decentralized planning. The argument became known as the “Socialist Debates”, and engaged some of the most famous thinkers of that time. Oscar Lange defended socialism, while Hayek and von Mises defended capitalism. You might be even more surprised to hear that it was generally agreed that the socialists won the debate. There is no proof to support the contention that markets are better at anything. There never was. There was simply assertion and assumption. The victory was hollow. Poor Lange lost on points because of the horror of authoritarianism in Nazi Germany and then in the Soviet Union. That horror so tainted the discussion that postwar economics in the West became single mindedly pro-market, even in the absence of proof.

Back in the 1930’s it was Keynes who acted as the bulwark. He provided the realist view that saved capitalism from its own doings. He saw that the magic was a myth, and argued for a realist intervention in order to prevent the carnage that an imploding market can inflict on the workforce. By mitigating those effects he realized that he could stabilize democracy and allow the middle class to flourish.

This is, of course, nothing new to you. I bring it up because the Great Depression acted as an inflection point. The great debates back then were left incomplete and the proofs were never provided. Keynesian economics prevailed for three decades. It was only when the 1973/1975 recession seemed to disprove Keynes that market magic theorists like Friedman were able to get back into the discussion. With voters disillusioned by the oil shock and the falling away from the heady postwar growth rates of the 1950’s and 1960’s, it was easy to turn their heads back to the capitalist side of the 1930’s debate. Only this time, the Cold War ensured that there was no socialist or centralized side in the discussion. The debate was entirely one sided.

I think, perhaps, that our Great Recession is another inflection point. It is time to redress the one sided nature of the debate and ask simple questions of the magic believers. Questions like: where’s your proof?

I think of the last thirty years as a great experiment. The economy has been managed, by Republicans and Democrats alike, along free market lines. Regulations have been limited and reduced. Taxes have been cut. Welfare has been gutted. The minimum wage has been held down. Laws protecting trade unions have been eliminated or neutered. The list goes on. It may shock you to learn that it took a personal call from Milton Friedman to the SEC in order to persuade that body to allow the establishment of options trading. Up until his call the SEC saw options trading as a form of gambling. Friedman’s reputation was sufficient for them to open up trading. The derivatives melt down of 2007/2008 was thus a direct heir to his theorizing. It was his set of ideas that underpinned the financial collapse. To Friedman and magic believers derivatives are a way markets mitigate risks. Realists see them as gambling.

The experiment failed.

We now have the proof.

Then again, we always did. Ask any CEO whether they believe in free markets and they will respond with a resounding “yes”. Just as long as we retain patent laws; copyrights; restrictions on unions; import quotas where “necessary”; subsidies for agriculture; price supports etc. And just so long as they can establish centralized strategic plans to guide their businesses.

In other words not one CEO truly believes in market magic. Not one. They all run their businesses along centralized planning lines. General Motors is not a free market. Nor is General Electric. Apple. Microsoft. None. They are centrally planned mini economies.

In fact more economic activity in America goes on within the safe harbor of corporately constructed centrally planned economies than takes place in supposedly free markets. Even the OECD, hardly a socialist haven, supports that observation.

Now I am not going to support socialist economics. I find it fails too. But we must be more realistic about the economy in which we operate. We need to recognize that the free market experiment failed. It was always going to fail. It was based on ideas that were incomplete or highly tailored to the 1930’s. In the hands of ideologues masquerading as economists it became twisted. Economics was conflated with politics. It became the American state religion to argue that unfettered capitalism was the only economic system to believed. And like all state religions it turned from being believed, to being revered, to being enforced without thought.

We forgot why the debates of the 1930’s took place. And we forgot that neither of the two sides was correct. Keynes was. And he was in the middle.

I hope we can forget the extremism of the free market magic myth, and return to practical realistic economics. There are jobs depending upon it. Indeed, our respective futures do.