Sraffa

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More on What’s Missing

I suspect economic theorists are not alone in shunting to the side issues or phenomena that might upset the applecart.  But they appear to do it with a determination that other disciplines mind find somewhat alarming.  This is why I relentlessly and repeatedly mention Cause and his 1937 question about the existence of the firm.  It isn’t because I imagine that theories of the firm began in 1937, or that they are somehow restricted to a peculiar Anglo-Saxon view — Coase would have been an ideal advocate of such a view having spent his career on both sides of the Atlantic — but because he typifies the dilemma he raised.  He cannot quite accept the enormous ramifications of his question, and so he wanders off and tries to invent a reason for firms to exist that can be kluged together with the pre-existing purist view of marketplace superiority.  Firms, in the theoretical tradition born to help Coase out of the box of his own making,  are made out to be exceptions rather than the rule.

Well, when you have theorized utopian markets, how can any other phenomenon be anything other than a sullied alternative?  You’re stuck with trying to make everything else out to be a result of some mysterious “failure”.

Economists have done a wonderful job of hiding from the demons that reality might unleash and the damage such demons might wreak on their pristine imaginings.

A much broader scale of avoidance was suggested by Sraffa in 1926:

“In the tranquil view which the modern theory of value presents us there is one dark spot which disturbs the harmony of the whole. This is represented by the supply curve, based upon the laws of increasing and diminishing returns. That its foundations are less solid than those of the other portions of the structure is generally recognised. That they are actually so weak as to be unable to support the weight imposed upon them is a doubt which slumbers beneath the consciousness of many, but which most succeed in silently suppressing. From time to time someone is unable any longer to resist the pressure of his doubts and expresses them openly; then, in order to prevent the scandal spreading, he is promptly silenced, frequently with some concessions and partial admission of his objections, which, naturally, the theory had implicitly taken into account. And so, with the lapse of time, the qualifications, the restrictions and the exceptions have piled up, and have eaten up, if not all, certainly the greater part of the theory. If their aggregate effect is not at once apparent, this is because they are scattered about in footnotes and articles and carefully segregated from one another.”

Whenever economists trip over an uncomfortable counterpoint to their core ideas they have, throughout the course of their discipline’s development, had a wonderful ability to bury inconveniences like the firm in the footnotes.  Sraffa was, of course, trying to put forward a more sweeping critique, but I get the feeling that most economists do what he is suggesting they do whenever they have to tackle production, innovation, and all the other things that firms do.  They compress it into as small a space as possible and bury it in the footnotes where it can be ignored while they press on chatting about the glories of general equilibrium, set-in-stone preferences and the other paraphernalia of orthodoxy.  And, yes, I am aware that economists are a broad church, so don’t waste your time letting me know I am missing something, but I have that annoying habit of looking at what they teach the kids instead of what they argue about behind closed doors.

Speaking of a broad church, this is from Witt in 2006:

“Evolutionary economics focuses on the processes that transform the economy from within and investigates their implications for firms and industries, production, trade, employment and growth.

These processes emerge from the activities of agents with bounded rationality who learn from their own experience and that of others and who are capable of innovating. The diversity of individual capabilities, learning efforts, and innovative activities results in growing, distributed knowledge in the economy that supports the variety of coexisting technologies, institutions, and commercial enterprises. The variety drives competition and facilitates the discovery of better ways of doing things. The question in evolutionary economics is therefore not how, under varying conditions, economic resources are optimally allocated in equilibrium given the state of individual preferences, technology and institutional conditions. The questions are instead why and how knowledge, preferences, technology, and institutions change in the historical process, and what impact these changes have on the state of the economy at any point in time.”

This makes sense.  Notice the introduction of time.  Notice the emphasis on change occurring within the system rather than being some magical “exogenous” phenomenon.  And notice the implied feedback between the creation of knowledge and the state of the economy. I have mentioned too many times that I am at a loss as how to explain the absence of knowledge from the standard production function that serves to suffice as a description of what a firm is in most economic theory.  The increase in our collective inventory of useful knowledge is one of the most obvious features of our relatively modern acceleration towards universal prosperity.  This accumulation of knowledge is far more important to our current state of wellbeing than, for instance, any accumulation of capital.  After all, what is “capital”?  As an aside: those of you foreseeing the imminent demise of “capitalism” need first to stipulate what you mean by capital.  Personally I think it foolish to predict the end of something that remains ill-defined.  Capital, as in the bricks and mortar, or even of the financial assets, of an economy will surely continue to exist.   So if it’s simply the transference of ownership you are predicting, we have examples from history.  Not very helpful ones if you are imagining a great improvement in outcomes.

Anyway, back to the firm as a problem for economics.  This is from Teece and Pisano in 1994:

“What is it, then, about firms which undergirds competitive advantage?

To answer this, one must first make some fundamental distinctions between markets and internal organization (firms). The essence of the firm, as Coase (1937) pointed out, is that it displaces market organization. It does so in the main because inside the firms one can organize certain types of economic activity in ways one cannot using markets. This is not only because of transaction costs, as Williamson (1975, 1985) has emphasized, but also because there are many types of arrangements where injecting high powered (market-like) incentives might well be quite destructive of the cooperative activity and learning. Indeed, the essence of internal organization is that it is a domain of unleveraged or low-powered incentives. By unleveraged we mean that rewards are determined at the group or organization level, not primarily at the individual level, in an effort to encourage team behavior, not individual behavior, in order to accomplish certain tasks well. Inside an organization, exchange cannot take place in the same manner that it can outside an organization, not just because it might be destructive to provide high powered individual incentives, but because it is difficult if not impossible to tightly calibrate individual contributions to a joint effort. Hence, contrary to Arrow’s (1969) view of firms as quasi markets, and the task of management to inject markets into firms, we recognize the inherent limits and possible counterproductive results of attempting to fashion firms into clusters of internal markets. In particular, learning and internal technology transfer may well be jeopardized.”

I include this in my random set of quotes because it both mentions Coase [yeah!], and get to another aspect of economics that seems to be missing: notably that we live in a collective world where some element of solidarity is essential to the understanding of how value is created.  Orthodox economics builds itself up from a purely individual perspective.  This is because it started out as an exploration of demand more than of production.  It attempted to put consumers in the center of the arena, which was forgivable in an era when industry was primitive and production was of simpler goods and services.  But we have moved way beyond that era.  Production nowadays is complex spatially, informationally, and with respect to the time it consumes.  If it depends on the mobilization of “teams” how, exactly, does the concept of a wage being fixed by a person’s marginal production fit in?  The elegance of the marginal approach is its main attraction — economists swoon over elegance — suit its realism in a modern context is somewhat suspect.

And to double down on my view that knowledge is central to any understanding of economic growth, this is from Soo, Devinney, and Midgley in 2002:

“The notion that knowledge is a source of competitive advantage has been advocated extensively in the management literature over the past decade (i.e., Winter, 1987; Quinn, 1992; Nonaka and Takeuchi, 1995). The value of intangible assets increases as goods and services become more sophisticated in content and production and the foundation of competition becomes intensively knowledge-based. As hypothesized by Teece (1998: 76), “the key sources of wealth creation at the dawn of the new millennium will lie with new enterprise formation; the renewal of incumbents; the exploitation of technological know-how, intellectual property, and brands; and the successful development and commercialization of new products and services”.

I think that stands for itself.  Innovation and knowledge accumulation, as expressed through the vehicle we call a “firm” is a central phenomenon of interest to economics.  The missing middle looms large.  But there are a ton of people looking at it.  I wonder when it will be moved from the footnotes and into the main text.

Lastly, just to rub it in.  This is from Simon in 1979:

“In the views of Mason and Friedman, fundamental inquiry into rational human behavior in the context of business organizations is simply not (by definition) economics – that is to say, political economy – unless it contributes in a major way to that purpose. This is sometimes even interpreted to mean that economic theories of decision making are not falsified in any interesting or relevant sense when their empirical predictions of micro-phenomena are found to be grossly incompatible with the observed data. Such theories, we are told, are still realistic “enough” provided that they do not contradict aggregate observations of concern to political economy. Thus economists who are zealous in insisting that economic actors maximize turn around and become satisficers when the evaluation of their own theories is concerned. They believe that businessmen maximize, but they know that economic theorists satisfice.”

He gets us back to Sraffa’s critique.  Economists dither endlessly.  They postulate great certain edifices and then waffle weakly about their foundations.  I have always loved the Friedman dodge on the need for realism in assumptions or on the approximation that theories have to reality.  Economists theorize one way and then live their own lives another.  Just how many of them “optimize” or “maximize” their own economic activity?  How would they know if they did?  And how many of them actually believe that the farce they call a production function is how stuff gets produced and distributed in a modern economy?

I think we can all agree not many do.

They just bury their own experiences in the footnotes so as not to muddle the utopia they teach.

 

Addendum:

I realize that I used the phrase “universal prosperity” in the above text.  I mean it.  As Philippon recently remakes, economics has two major questions to answer: how is that prosperity grows; and how is it that prosperity is distributed.  The first is about the timeless and universal battle against scarcity.  The second is about the equally timeless and universal apportionment of the spoils of that battle. The great leap forward in our useful knowledge during the past two to three centuries has solved the first.  We know how to overcome scarcity — perhaps a little too well given the abundance of consumerism in some places.  We are yet to solve the second question to everyone’s liking.

So, yes, we are living in an era of universal prosperity.  Whether that prosperity is well distributed is an entirely different matter.

 

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Complex Ideas

The economy as a sea of information, constantly churning, far from equilibrium, with computation its key activity.  It is complex.  It is inscrutable to any method that fails to accommodate its multitude of layers, interconnections, feedback loops, and constant dynamism.  Since reading Ilya Prigogine ages ago I have never understood how anyone could not view the economy through such a lens.  The interplay between creative forces needed to sustain life and the constant dissipation or disordering that inevitably follows upon such creativity is, to me, the central theme being played out in an economy.

Given this, attempts to contain analysis within a neat box simply defy reality.  The instances of an economy that are unstable and out of equilibrium far outnumber, enormously, those that are stable or in equilibrium.  Disorder is normal.  Order is rare.  Vanishingly so.  And, given the radical uncertainty that permeates the economy, we can only focus on the short term.

So, an economy can never be “efficient” because we have no way of knowing how to anchor the universal analysis of such efficiency.

Nor can it be “optimal” because we simply don’t have enough information to draw such a conclusion.  Or, rather, an economy may well be in an optimal position, but we could never know if it was.  It is incalculable. This is essentially Hayek’s argument against central planning re-focused on any argument that relies upon complete information.  We just cannot know.

Efficiency and optimality thus become arbitrary points fixed by choosing a slice of reality, attempting to control it, and ignoring all the rest. The much vaunted price system is such a slice.  No one knows whether it contains all relevant information.  No one.  Discussions of both efficiency and optimality lie outside the domain of pure economics once we realize the foolhardiness of any attempt to pin them down.  What is “optimal” is a political decision not an economic one because economics cannot discuss optimality without stepping outside reality.   Likewise efficiency is better discussed in the realm of some place like business where a small space can be carved out and controlled temporarily.  Even then any conclusion about efficiency is dependent entirely upon the space in question and is not scalable to the entire economy.

By the same token the entire heritage of general equilibrium within economics is invalid.  We know this not only because it fails to engage complexity, but also because of it internal admission: it can only appear to be valid by expunging the real world.  It then becomes an interesting intellectual exercise about something other than an economy.  It is a tour de force of art.  Wonderful to behold and of no significance to our understanding of economies.

I am not alone.

The list of famous economists who have broached the issue of complexity is long.  To quote Flavio Comim at length:

“Indeed, Alfred Marshall’s famous appeal for “economic biology” as the “Mecca of the economist”, Maynard Keynes’ emphasis on the instability of equilibrium positions and the role of expectations, Piero Sraffa’s and Nicholas Kaldor’s criticism of the partial equilibrium method due to the existence of increasing returns and non-linearities in economic processes, and Joan Robinson’s argument for the asymmetric consequences of time in economic theory are just a few examples of the importance of themes relating to complexity in the intellectual history of economics.”

He goes on to mention Schumpeter, Shackle, Hayek, and Goodwin also.

Just to pick out one short quote from Marshall:

“Nature’s action is complex: and nothing is gained in the long run by pretending that it is simple, and trying to describe it in a series of elementary propositions.”

Brian Arthur sees it this way:

“To state in another way, formally, we can say that the economy is an ongoing computation — a vast, distributed, massively parallel, stochastic one.  Viewed this way, the economy becomes a system that evolves procedurally in a series of events; it becomes algorithmic.”

Or, more provocatively, in the words of Cesar Hidalgo:

“Emphasizing the ability of products to augment human capacities can help us refine what we understand as the economy.  It helps us see the economy not as the careful management of resources, the wealth of a nation, or a network of financial transactions, but as a system that amplifies the practical uses of knowledge and knowhow through the physical embodiment of information and the context-specific properties that this information helps carry.  This is an interpretation of the economy as a knowledge and knowhow amplifier, or a knowledge and knowhow amplification engine: a complex sociotechnical system able to produce physical packages containing the information needed to augment the humans who participate in it.  Ultimately, the economy is the collective system by which humans make information grow.”

Knowledge amplification seems a very apt description of what an economy does.

It cannot be an accident that the modern rush to prosperity, what some call the “Great Enrichment”, coincides with an explosion of useful knowledge along with the cultural acceptance that deploying such knowledge is, indeed, useful.  It is neither capital nor labor that underlies the rush to prosperity, they are a power relation and are not economic quantities, but it is the application of an ever growing pool of useful knowledge to various sources of energy that produces wealth.

Pure economics, then, is a very narrow discipline.  It is the analysis of a system similar to Hidalgo’s that incorporates knowledge with energy in order to produce wealth.  It has a sort of Schumepterian narrative in that it needs to explain how growth occurs within such a system.  It is the story of how scarcity is overcome by applied knowledge.

Practical economics is much more broad and yet it is far less universal. It is no longer a discussion of the system.  It is a discussion of how various localized decisions have different outcomes.  Its focus is on problems of distribution, allocation, optimality and efficiency subject to the reality mentioned earlier.  It recognizes that those problems are riven through with arbitrary or ideological contingencies.  It takes into account human frailties and behaviors.  Its is intensely pragmatic and real-world.  It is far distant from Friedman’s “positive economics”. As such it is an adjunct to politics.

All this is my attempt to separate two entirely different discussions.  The first is about growth and the battle with scarcity.  The second is about the politics of how the fruits of the victory over scarcity are allocated.   They are two different conversations that need to co-habit rather than co-mingle.  By muddling the two conversations into one modern economics became a handmaiden to a particular political point of view.  It is fine to be an ideologically committed economist.  It is not fine to be obscure about that commitment.

It’s a question of ethics.