Category Archive for: History of Thought [Return to Main]

Wednesday, June 28, 2006

This Day in History: Keynes Predicts Economic Chaos

On a whim, I went to This Day in History at the History Channel web site. This is what I found:

Keynes Predicts Economic Chaos, June 28, 1919: ...By the fall of 1918, it was apparent to the leaders of Germany that defeat was inevitable in World War I. After four years of terrible attrition, Germany no longer had the men or resources to resist the Allies, who had been given a tremendous boost by the infusion of American manpower and supplies. In order to avert an Allied invasion of Germany, the German government contacted U.S. President Woodrow Wilson in October 1918 and asked him to arrange a general armistice. Earlier that year, Wilson had proclaimed his "Fourteen Points," which proposed terms for a "just and stable peace" ... The Germans asked that the armistice be established along these terms... On November 11, 1918, the armistice was signed and went into effect, and fighting in World War I came to an end.

In January 1919, John Maynard Keynes traveled to the Paris Peace Conference as the chief representative of the British Treasury. The brilliant 35-year-old economist had previously won acclaim for his work with the Indian currency and his management of British finances during the war. In Paris, he sat on an economic council and advised British Prime Minister David Lloyd George, but the important peacemaking decisions were out of his hands, and President Wilson, Prime Minister Lloyd George, and French Prime Minister Georges Clemenceau wielded the real authority. Germany had no role in the negotiations deciding its fate...

It soon became apparent that the treaty would bear only a faint resemblance to the Fourteen Points that had been proposed by Wilson and embraced by the Germans. Wilson, a great idealist, had few negotiating skills, and he soon buckled under the pressure of Clemenceau, who hoped to punish Germany as severely as it had punished France in the Treaty of Frankfurt that ended the Franco-Prussian War in 1871. ...

The treaty that began to emerge was a thinly veiled Carthaginian Peace, an agreement that accomplished Clemenceau's hope to crush France's old rival. According to its terms, Germany was to relinquish 10 percent of its territory. It was to be disarmed, and its overseas empire taken over by the Allies. Most detrimental to Germany's immediate future, however, was the confiscation of its foreign financial holdings and its merchant carrier fleet. The German economy, already devastated by the war, was thus further crippled, and the stiff war reparations demanded ensured that it would not soon return to its feet. ...

Keynes, horrified by the terms of the emerging treaty, presented a plan to the Allied leaders in which the German government be given a substantial loan, thus allowing it to buy food and materials while beginning reparations payments immediately. ... President Wilson turned it down because he feared it would not receive congressional approval. In a private letter to a friend, Keynes called the idealistic American president "the greatest fraud on earth." On June 5, 1919, Keynes wrote a note to Lloyd George informing the prime minister that he was resigning his post in protest of the impending "devastation of Europe."

The Germans initially refused to sign the Treaty of Versailles, and it took an ultimatum from the Allies to bring the German delegation to Paris on June 28. .... Clemenceau chose the location for the signing of the treaty: the Hall of Mirrors in Versailles Palace, site of the signing of the Treaty of Frankfurt that ended the Franco-Prussian War. At the ceremony, General Jan Christiaan Smuts, soon to be president of South Africa, was the only Allied leader to protest formally the Treaty of Versailles, saying it would do grave injury to the industrial revival of Europe.

At Smuts' urging, Keynes began work on The Economic Consequences of the Peace. It was published in December 1919 and was widely read. In the book, Keynes made a grim prophecy that would have particular relevance to the next generation of Europeans: "If we aim at the impoverishment of Central Europe, vengeance, I dare say, will not limp. Nothing can then delay for very long the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the later German war will fade into nothing, and which will destroy, whoever is victor, the civilisation and the progress of our generation."

Germany soon fell hopelessly behind in its reparations payments, and in 1923 France and Belgium occupied the industrial Ruhr region as a means of forcing payment. In protest, workers and employers closed down the factories in the region. Catastrophic inflation ensued, and Germany's fragile economy began quickly to collapse. By the time the crash came in November 1923, a lifetime of savings could not buy a loaf of bread. That month, the Nazi Party led by Adolf Hitler launched an abortive coup against Germany's government. The Nazis were crushed and Hitler was imprisoned, but many resentful Germans sympathized with the Nazis and their hatred of the Treaty of Versailles.

A decade later, Hitler would exploit this continuing bitterness among Germans to seize control of the German state. In the 1930s, the Treaty of Versailles was significantly revised and altered in Germany's favor, but this belated amendment could not stop the rise of German militarism and the subsequent outbreak of World War II....

Thursday, June 22, 2006

What Ended Serfdom?

While surfing for material related to another post, I came across this piece by Paul Krugman written in 2003 on the end of serfdom. It's interesting to think about the analysis in terms of the global labor market developing today, China, India, the decline of unions, the loss health and retirement benefits as the social contract changes, sweatshops, etc., but the main reason for passing it along is for its general historical interest and its analysis of the economics underlying the end of the feudal era:

Serf's Up!, by Paul Krugman: James Surowiecki writes fine columns, and this one is no exception. But he's got the story of the effects of the Black Death on serfdom backwards. He - and anyone else curious about history - should read  Evsey Domar's  classic 1970 paper "The causes of slavery or serfdom: a hypothesis." (Sorry, doesn't seem to be available online. Update: Domar's paper is available here. Thanks smk - Brad DeLong too for posting it.)

Here's what Surowiecki says: "The Black Death helped undermine feudalism. The population decline was so severe that the individual’s labor grew more valuable, which enabled serfs to abandon their lords and become tenant farmers or urban workers." That sounds plausible, but it's not the way it happened. According to Domar, serfdom actually withered away before the Black Death, as European population grew close to its Malthusian limit. The puzzle is why serfdom wasn't reinstituted after the Black Death.

Domar was motivated by his knowledge of Russian history. Serfdom in Russia, he knew, wasn't an institution that dated back to the Dark Ages. Instead, it was mainly a 16th-century creation, contemporaneous with the beginning of the great Russian expansion into the steppes. Why?

He came up with a simple yet powerful insight: there's no point in enslaving or enserfing a man unless the wage you would have to pay him if he was free is substantially above the cost of feeding, housing, and clothing him.

Imagine a pre-industrial society where population is pressing on limited land supplies, and the marginal product of labor - and hence the real wage rate under competitive conditions - is barely at subsistence. In that case, why bother establishing property rights in human beings? It costs no more to hire a free worker than to feed an indentured laborer. Indeed, by 1300 - with Europe very much a Malthusian society - serfdom had withered away from lack of interest.

But now suppose that for some reason land becomes abundant, and labor scarce. Then competition among landowners will tend to push up wages of free workers, and the ruling class will try, if it can, to pin peasants down and prevent them from bargaining for a higher standard of living. In Russia, it was all about gunpowder: suddenly steppe nomads were no longer so formidable, and the rich lands of the Ukraine were open for settlement. Serfdom was an effort to keep peasants from taking advantage of this situation. (And if I've got it right, those who were venturesome enough to run away and set up outside the system became Cossacks.)

Meanwhile, the New World opened in the west. Sure enough, the colonizing powers tried various forms of indentured servitude - making serfs of the Indians in Spanish territories, bringing over indentured servants in Virginia. But eventually they hit on a better solution, from their point of view: importing slaves from Africa.

Here's the puzzle. In Europe circa 1100, with population scarce, serfdom was useful to the ruling class. By 1300 it wasn't, and had been allowed to drift away. But after 1348 it should have been worthwhile again. Yet it wasn't effectively reimposed. There were attempts to restrain wages and limit labor mobility, as well as attempts to tax the peasants (Wat Tyler's rebellion fits into all this.) But all-out feudalism didn't return. Why?

And an even bigger question: why hasn't indentured servitude made a comeback in the modern era? Yes, I know, human rights and all that - but if it was profitable to have indentured servants in the modern world, I'm sure that Richard Scaife's think tanks would have no trouble finding justifications, and assorted Christian groups would explain why it's God's will.

Anyway, have to get back to real work. But try to find a copy of Domar's paper and read it.

Monday, June 12, 2006

Adam Smith's Harmony of Interests

There's a new book on Adam Smith:

Adam Smith Bio Recalls Moralist, Hypochondria, by Matthew Lynn, Bloomberg: Economics has become a big deal in book publishing of late. ... Right on cue comes James Buchan's ''Adam Smith and the Pursuit of Perfect Liberty''... Buchan's thesis is that Smith was really a moralist, not an economist. ... It's an intriguing argument, and one Buchan almost pulls off.

Buchan ... doesn't waste too much time on Smith's life, and rightly so. The doings of economists are on the dry side of things, and Smith was a dullish fish even among his own kind. Try as he might, Buchan can't breathe much human warmth into his subject.

Smith ... rarely traveled, was regularly unwell and had a gloomy disposition... ''At Oxford, we have the first signs of the depression and hypochondria that is the ruling principle of Smith's character,'' Buchan writes. The Scotsman never married, nor has Buchan dug up any serious liaisons. ... No matter. Smith the man needn't detain us for long. Smith the thinker is what matters...

Most people these days regard Smith as the founder of free-market economics. He's the hero of the get-the-government-off-our-backs crowd. He's the pin-up boy of the flat-taxers and the business-knows-best crew.

None of this would have resonated in 18th-century Edinburgh and Glasgow, however. Smith was essentially a moral philosopher, and he viewed economics as a branch of that inquiry, as Buchan reminds us. Smith's vision of the ''invisible hand'' of the market grew out of a wider vision of a moral and just society.

Almost two decades before he published ''The Wealth of Nations,'' the book for which he is rightly remembered, Smith brought out ''The Theory of Moral Sentiments,'' to wide acclaim. That volume, which appeared in 1759, went through six editions in his lifetime and was translated into French and German. ''It was not eclipsed by 'The Wealth of Nations' till the rise of political economy amid the battles and factory smoke of the Victorian age,'' Buchan writes. ...

Most people these days accept that a free market is the best way to organize an economy. Yet many increasingly worry about whether it's a moral system... So it's good to be reminded that Smith first started to question government meddling in the economy because he was interested in morality and freedom...

His purpose was to build a just society. When each human is allowed to earn his own living in his own way, Smith argued, he ultimately benefits the society around him... Although Smith will still be remembered primarily as an economist, Buchan is right to try to restore the philosophical Smith to the prominence he deserves.

Let me take this a bit further. Smith understands that unbridled self-interest where, for example, the strong can devour the weak will not lead to an harmonious, just society.

The Theory of Moral Sentiments discusses how sympathy, empathy, benevolence, generosity, compassion, etc., which "Nature has lighted up in the human heart" restrain selfishness in socially optimal ways, and in The Wealth of Nations competition directs the restrained self-interest to the social optimum. This process of channeling self-interest to produce the social optimum through moral sentiments and competition is the invisible hand at work.

When invoking Adam Smith's name to explain, say, CEO pay and the widening income distribution as free market outcomes, it's important to remember that the social optimum will not occur without the appropriate restraints on the pursuit of self-interest in the surrounding social, political, and economic environment.

Wednesday, June 07, 2006

Nothing But the Revised Facts?

I wonder if economists will ever suffer the fate of historians in Florida and be prevented from talking about relative values. "We've heard you are teaching that prices are correctly interpreted as relative and not absolute. That so? Off to jail Mr. ivory tower smarty-pants":

All history is 'revisionist', by Jonathan Zimmerman, Commentary, LA Times: Just when you thought it was safe to study American history again … the revisionists are back!

You know, those relativists who distort or simply fabricate the past to make it fit their present-day biases. For instance, ... in 2003, President Bush attacked "revisionist historians" who questioned his justifications for using force against Saddam Hussein. He did it again on Veterans Day in 2005. "It is deeply irresponsible," he declared, "to rewrite the history of how the war began."

And just last week, in an unprecedented move, the president's brother approved a law barring revisionist history in Florida public schools. "The history of the United States shall be taught as genuine history and shall not follow the revisionist or postmodernist viewpoints of relative truth," declares Florida's Education Omnibus Bill, signed by Gov. Jeb Bush. "American history shall be viewed as factual, not as constructed."

Ironically, the Florida law is itself revisionist history. Once upon a time, it theorizes, history — especially about the founding of the country — was based on facts. But sometime during the 1960s ... American historians supposedly started embracing newfangled theories of moral relativism and French postmodernism, abandoning their traditional quest for facts, truth and certainty.

The result was a flurry of new interpretations, casting doubt on the entire past as we had previously understood it. Because one theory was as good as another, then nothing could be true or false. God, nation, family and school: It was all up for grabs.

There's just one problem with this history-of-our-history: It's wrong.

Hardly a brainchild of the flower-power '60s, the concept of historical interpretation has been at the heart of our profession from the 1920s... Before that time, ... some historians believed that they could render a purely factual and objective account of the past. But most of them had given up on what historian Charles Beard called the "noble dream" by the interwar period, when scholars came to realize that the very selection of facts was an act of interpretation.

That's why Cornell's Carl Becker chose the title "Everyman His Own Historian" for his 1931 address to the American Historical Assn., probably the most famous short piece of writing in our profession. ...

For instance, try to recount everything you did yesterday. Not just a few things, ... but everything. You can't. Even if you kept a diary and recorded what you did each minute, you would inevitably omit some detail: a sound in your ear, a twitch in your nose... So when somebody asks what you did yesterday, you select a certain few facts about your day and spin a story around them.

As do professional historians. They may draw on a wider array of facts and theories but, just like "Everyman," they choose certain data points and omit others, as well they must. ... [S]urely one of the biggest myths ... is that history is simply about "facts." This year marks the 75th anniversary of Becker's famous speech, yet Americans appear no nearer to understanding that all pasts are "constructed," that all facts require interpretation and that all history is "revisionist" history...

Saturday, May 13, 2006

Keynes: The World Economic Outlook

This essay that Keynes wrote in 1932 has been referenced recently in a few places, so I thought it might be of interest. It was written during the Great Depression and Keynes' primary concern at this point is to stabilize the financial sector. He also wants to find a way to stimulate output, but he makes it clear that this is of secondary importance, stabilizing the financial sector must come first. Note his concern over self-reinforcing deflationary episodes, something central bank remain concerned about today (this is one argument for an inflation target above zero as it provides an insurance cushion against such an outcome), and Keynes' hope that even the "deadheads" will come to understand that a new type of fiscal policy, deficit spending, can be used to overcome economic depressions:

Keynes: The World Economic Outlook: The immediate problem for which the world needs a solution to-day is ... to avoid a far-reaching financial crisis. There is now no possibility of reaching a normal level of production in the near future. Our efforts are directed toward the attainment of more limited hopes. Can we prevent an almost complete collapse of the financial structure of modern capitalism? With no financial leadership left in the world and profound intellectual error as to causes and cures prevailing in the responsible seats of power, one begins to wonder and to doubt. At any rate, no one is likely to dispute that for the world as a whole the avoidance of financial collapse, rather than the stimulation of industrial activity, is now the front-rank problem. ...

The immediate causes of the world financial panic ... are to be found in a catastrophic fall in the money value, not only of commodities, but of practically every kind of asset. The 'margins,' as we call them, upon confidence in the maintenance of which the debt and credit structure of the modern world depends, have 'run off.' In many countries the assets of the banks are no longer equal, conservatively valued, to their liabilities to their depositors. Debtors of all kinds find that their securities are no longer the equal of their debts. Few governments still have revenues sufficient to cover the fixed money charges for which they have made themselves liable.

Moreover, a collapse of this kind feeds on itself. We are now in the phase where the risk of carrying assets with borrowed money is so great that there is a competitive panic to get liquid. And each individual who succeeds in getting more liquid forces down the price of assets in the process of getting liquid, with the result that the margins of other individuals are impaired and their courage undermined. And so the process continues. It is, indeed, in the United States itself that this has proceeded to the most incredible lengths. ... But the United States only offers an example ... of a state of affairs which exists in some degree almost everywhere.

The competitive struggle for liquidity has now extended beyond individuals and institutions to nations and to governments, each of which endeavors to make its internal balance sheet more liquid by restricting imports and stimulating exports by every possible means, the success of each one in this direction meaning the defeat of someone else. Moreover, each country discourages capital development within its own borders for fear of the effect on its international balance. Yet it will only be successful in its object in so far as its progress toward negation is greater than that of its neighbors.


We have here an extreme example of the disharmony of general and particular interest. Each nation, in an effort to improve its relative position, takes measures injurious to the absolute prosperity of its neighbors; and, since its example is not confined to itself, it suffers more from similar action by its neighbors than it gains by such action itself. Practically all the remedies popularly advocated to-day are of this internecine character. Competitive wage reductions, competitive tariffs, competitive liquidation of foreign assets, competitive currency deflations, competitive economy campaigns--all are of this beggar-my-neighbor description. ... Thus, while we undoubtedly increase our own margin, we diminish that of someone else; and if the practice is universally followed everyone will be worse off. An individual may be forced by his private circumstances to curtail his normal expenditure, and no one can blame him. But let no one suppose that he is performing a public duty in behaving in such a way...

Unfortunately the popular mind has been educated away from the truth, away from common sense. The average man has been taught to believe what his own common sense, if he relied on it, would tell him was absurd. Even remedies of a right tendency have become discredited... Now, at last, under the teaching of hard experience, there may be some slight improvement toward wiser counsels. But through lack of foresight, and constructive imagination the financial and political authorities of the world have lacked the courage or the conviction ... to apply the available remedies in sufficiently drastic doses; and by now they have allowed the collapse to reach a point where the whole system may have lost its resiliency and its capacity for a rebound.

Meanwhile the problem of reparations and war debts darkens the whole scene. ... I cannot, therefore, extract much comfort or prospective hope from developments in this sphere of international finance.

Continue reading "Keynes: The World Economic Outlook" »

Friday, May 05, 2006

Alfred Marshall on Mathematics in Economics

There is a discussion in the comments to the post about economists writing for general audiences about the role of mathematics in economics and how it dominates professional training, undermines communication with more general audiences, and so on.

In 1906 Alfred Marshall wrote about his skepticism regarding the use of mathematics in economics1:

[I had] a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules - (1) Use mathematics as a shorthand language, rather than an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can't succeed in (4), burn (3). This last I did often.

I don't mind the mathematics, it's useful and necessary, but it's too bad the history of economic thought is no longer required or even offered in many graduate and undergraduate programs. That's a loss.
1The quote is in Brue, The Evolution of Economic Thought, 5th ed., pg. 294.

Tuesday, March 28, 2006

Adam Smith on Relative Poverty

Many fans of Adam Smith make the following argument concerning poverty statistics:

Treasury Secretary John Snow ... says ... How the average family is doing in absolute terms is more important than how it is doing relative to others...

Here's a Wall Street Journal commentary by Douglas Besharova from a few days ago that is cited by Donald Luskin in his claim that "The official poverty statistics just can't be right -- showing that the same percentage of Americans lives in poverty as did in 1968":

Each year the Census Bureau calculates the nation's poverty rate, based on the number of people with incomes below the official poverty line... But many analysts ... have pointed out that ... poor people's physical and material well-being is considerably better now than in the late '60s. How else to explain why so many poor now have color TV (93%) ... Millions of low-income Americans are living better lives than they did before. Period.

Adam Smith had something to say on this topic. This is from an article about Mollie Orshansky's development of poverty statistics (long, but worth it) appearing in The New Yorker:

Relatively Deprived, by John Cassidy, The New Yorker: ...The concept of relative deprivation was first described by Adam Smith in “The Wealth of Nations,” in a passage on the “necessaries” of daily life:

By necessaries I understand not only the commodities which are indispensably necessary for the support of life, but what ever the customs of the country renders it indecent for creditable people, even the lowest order, to be without. A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably, though they had no linen. But in the present times, through the greater part of Europe, a creditable day-laborer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into, without extreme bad conduct. Custom, in the same manner, has rendered leather shoes a necessary of life in England.

Let's use the TV example. A TV, is, "strictly speaking, not a necessary of life." Suppose a family cannot afford a color TV (a 20" flat screen is less than $100). Would the presumption be that the family is living in a "degree of poverty which ... nobody can well fall into, without extreme bad conduct"? Would a parent "be ashamed" to have their children's friends find out they cannot afford a color TV when they come over to visit? If the answer is yes, then Smith would say they are impoverished.

Sunday, January 01, 2006

How Fragile is China?

More on China's development troubles:

In rural China, a time bomb is ticking, by Joshua Muldavin, International Herald Tribune: The recent police killing in China's Guangdong Province of as many as 20 villagers who were protesting the government's seizure of land for a power plant is symptomatic of an emerging pattern of rural unrest that challenges the very legitimacy of the Chinese state... China's fabulous growth since the 1980s was achieved through environmental destruction and social and economic polarization which now threaten its continuation. ... While rural strife is not new - in 1994, I witnessed thousands of peasants in Henan Province fight a local government militia over unpopular taxation and state policies - its scope and frequency have increased greatly. ... In 2004, according to official estimates, there were 74,000 uprisings throughout the country ...

Peasant land loss is a time bomb for the state. While avoiding full land privatization and, until recently, massive landlessness of the rural majority, Beijing still allows unregulated rural land development for new industries and infrastructure. Land seized from peasants reduces their minimal subsistence base, leaving them with what is called "two-mouth" lands insufficient to feed most families, thus forcing members of many households to join China's 200 million migrants in search of work across the country. In many areas..., some households have lost even these small subsistence lands, swelling the ranks of China's landless peasants, who number a staggering 70 million according to official estimates. ...

The Chinese state is very clear on the rural roots of the 1949 revolution, ones emanating from massive inequality and social insecurity. But there is a new clarity now for peasants and rural workers, who have seen the state increasingly side with the newly rich over the past two decades... This harks back to the period prior to China's 1949 revolution when enormous numbers of landless peasants formed the core of the largely rural movement led by Mao and others. Following their victory, it was the redistribution of land to the poorest peasants that gave the Communist Party its greatest enduring legitimacy in rural areas. It is the loss of this legitimacy that lies at the heart of the most recent strife.

Beijing could use the violence in Guangdong as an opportunity to address the structural roots of the larger unrest... Instead the state is opting to characterize the killings as the mistake of an overly zealous local police officer rather than a systematic attempt to contain rural discontent by any means. The dilemma for China is not a public relations one... Unless overall policies are altered to address the needs of China's vulnerable rural majority, Beijing will surely face more protracted and violent challenges from the victims of the country's development "success."

This reminds me of the enclosure movement in England:

Enclosure (also historically inclosure) is the process of subdivision of common land for individual ownership. There were two main processes of enclosure in England. One was the division of the large open fields which had been common in some areas of the country into individually managed plots of land, usually hedged and known at the time as "severals". All of the strips of land in these open fields had been privately owned, but communually ploughed ... and open to communal grazing after the harvest or in fallow years. ...[M]edieval manors usually had two to three large open fields, so that crops could be rotated. In the process of enclosure, these were consolidated and divided into severals, to be individually managed. ...

The second process of enclosure was the division and privatisation of common fens and marshes, moors and other "wastes" (in the original sense of "uninhabited places"). These enclosures created new private plots... The second form of enclosure affected particularly those areas, such as the North, the far south west and unique regions such as the East Anglian Fens, where grazing had been plentiful on otherwise marginal lands, such as marshes and moors. Access to these common resources was an essential part of the economic life in these strongly pastoral regions. In the Fens, large riots broke out both in the seventeenth century, when attempts to drain the peat and silt marshes were combined with proposals to also partially enclose them.

From as early as the 12th century, some open fields in Britain were being enclosed into individually owned fields. In Great Britain, the process sped up during the 15th and 16th centuries as sheep farming grew more profitable. In the 16th and early 17th centuries, the practice of enclosure was denounced by the Church and the government, particularly depopulating enclosure, and legislation was drawn up against it. However, the tide of elite opinion began to turn towards support for enclosure, and rate of enclosure increased in the seventeenth century. ... Sir Thomas More, in his 1516 work Utopia suggests that the practice of enclosure is responsible for some of the social problems affecting England at the time ... By the end of the 19th century the process of enclosure was largely complete.

Many believe the enclosure movement was an essential factor in England's industrialization and the emergence of capitalism as it helped to create a class of citizens with nothing but their labor to sell in order to survive, though there were many other factors such as the decline of guilds that were important as well.

As adults often forget their own foibles in childhood as they discipline their children, I think we often forget that we went through difficult growing pains much like those that China is experiencing. For example, we too were willing to trade environmental degradation for growth in our younger development years, and England and other European countries made the same choice as capitalism was emerging, perhaps to a much larger extent than China has. Awful working conditions, worker riots, and so on are in our past as well and we should be careful about insisting that other countries do better than we were able to do when confronted with similar economic development issues. I am not defending or excusing any of these practices, not at all, and we should continue to pressure China to do better, but remembering and acknowledging our own past as we do so could help us deliver the message in a way that is more likely to get a positive reception.

Thursday, September 15, 2005

Yapping About Money: The Stone Money of Yap

The stone money of Yap is an interesting case to consider when thinking about what money is and what role it plays in the economic and social affairs of a community. This article by Michael Bryan of the Federal Reserve Bank of Cleveland describes the stone wheels of Yap, how they were obtained and used as gift markers both within and between tribes, and whether the stones fit the textbook definition of money.  I came across this getting ready for a class this fall and thought I'd pass it along:

Federal Reserve Bank of Cleveland, Island Money, by Michael F. Bryan:  ...In this Commentary, I … consider… the unique and curious money of Yap, a small group of islands in the South Pacific. … For at least a few centuries leading up to today, the Yapese have used giant stone wheels called rai when executing certain exchanges. The stones are made from a shimmering limestone that is not indigenous to Yap, but quarried and shipped, primarily from the islands of Palau, 250 miles to the southwest.

The size of the stones varies; some are as small as a few inches in diameter and weigh a couple of pounds, while others may reach a diameter of 12 feet and weigh thousands of pounds. A hole is carved into the middle of each stone so that it may be carried, either by coconut rope strung through the smaller pieces, or by wooden poles inserted into the larger stones. These great stones require the combined effort of many men to lift. Expeditions to acquire new stones were authorized by a chief who would retain all of the larger stones and two-fifths of the smaller ones, reportedly a fairly common distribution of production that served as a tax on the Yapese. In effect, the Yap chiefs acted as the island’s central bankers; they controlled the quantity of stones in circulation. …

The quarrying and transport of rai was a substantial part of the Yapese economy. In 1882, British naturalist Jan S. Kubary reported seeing 400 Yapese men producing stones on the island of Palau for transport back to Yap. Given the population of the island at the time … more than 10 percent of the island’s adult male population was in the money-cutting business. Curiously, rai are not known to have any particular use other than as a representation of value. The stones were not functional, nor were they spiritually significant to their owners, and by most accounts, the stones have no obvious ornamental value to the Yapese. If it is true that Yap stones have no nonmonetary usefulness, they would be different from most “primitive” forms of money. Usually an item becomes a medium of exchange after its commodity value—sometimes called intrinsic worth—has been widely established...

Precisely how the value of each stone was determined is somewhat unclear. We know that size was at best only a rough approximation of worth and that stone values varied depending upon the cost or difficulty of bringing them to the island. For example, stones gotten at great peril, perhaps even loss of life, are valued most highly. Similarly, stones that were cut using shell tools and carried by canoes are more valuable than comparably sized stones that were quarried with the aid of iron tools and transported by large Western ships. The more valuable stones were given names, such as that of the chief for whom the stone was quarried or the canoe on which it was transported. Naming the stone may have secured its value since such identification would convey to all the costs associated with obtaining it...

Continue reading "Yapping About Money: The Stone Money of Yap" »

Wednesday, September 07, 2005

Robert Reich and The Physiocrats

No too long ago I posted a commentary by Robert Reich, former secretary of labor in the Clinton administration, where he discusses the current tendency to erect both internal and external barriers to trade in the name of increasing employment. His point is  that while individually each of these seems to be a good idea, collectively they undermine the ability of markets to best respond to our collective wishes.

Continue reading "Robert Reich and The Physiocrats" »

Monday, September 05, 2005

Thorstein Veblen Explains Why Labor Always Gets Exploited

I know a lot of you have little use for all the equations, all of the talk of marginal this equals marginal that, that sometimes goes on here. So rather than going through some long economic analysis on labor markets, since it’s Labor Day, I thought an institutional approach to labor’s relationship to government under capitalism as expressed by Thorstein Veblen might be more interesting.  The neoclassical position developed by J.B. Clark in The Distribution of Wealth is presented in the post below this one.

Thorstein Veblen (1857-1929) believed government existed to protect the existing social relationships and, in a capitalist system, that meant protection of property and the privileges of ownership.  In a capitalist system, power ultimately resides in the hands of the ownership class because this class controls government. According to Veblen:

Continue reading "Thorstein Veblen Explains Why Labor Always Gets Exploited" »

John Bates Clark Explains Why Labor Never Gets Exploited

Having presented Veblen’s institutionalist view of labor and its interaction with the capitalist power structure in the post above this one, here is the alternative neoclassical view of payments to labor, the view that prevails today. Within the neoclassical analytical structure, there is no exploitation, each factor of production returns to its owner the value of what the factor produces. That is, each factor receives an income equal to the value of marginal product and, importantly, this is true for both workers and owners:

J.B. Clark (1847-1938), Preface to The Distribution of Wealth: It is the purpose of this work to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates. However wages may be adjusted by bargains freely made between individual men, the rates of pay that result from such transactions tend, it is here claimed, to equal that part of the product of industry which is traceable to the labor itself; and however interest may be adjusted by similarly free bargaining, it naturally tends to equal the fractional product that is separately traceable to capital. At the point in the economic system where titles to property originate,—where labor and capital come into possession of the amounts that the state afterwards treats as their own,—the social procedure is true to the principle on which the right of property rests. So far as it is not obstructed, it assigns to every one what he has specifically produced.

Because there is no class that exploits another class in the neoclassical model, an important distinction between classes disappears. Clark, with this book, completes a line of thought from Say and Senior before him by showing the payments to capitalists and laborers under capitalism are based upon natural law, a law that rewards each factor according to its contribution to production. In doing so, he provides capitalism with an important intellectual defense against the competing ideas at the time from the socialists and institutionalists that one group, the owners, exploited another, the workers, through the social and economic relationships inherent in the capitalist structure.

Monday, August 22, 2005

A Common Misconception Regarding Keynes and Neoclassical Economics

This editorial expresses a common misconception, that embracing Keynesian policy rejects the ideas of Adam Smith as expressed by neoclassical economics and therefore rejects individual liberty.  The editorial also says that intellectuals and politicians forget about Adam Smith, so let’s see what we can remember about Smith, Keynes, and neoclassical economists:

America benefits from the wisdom of Adam Smith, by Thomas Bray, The Detroit News: In 1971, seeking to justify the scrapping of the gold standard … Richard Nixon declared "we are all Keynesians now." He was referring to British economist John Maynard Keynes, who in the 1930s called the gold standard a "barbarous relic" ... Alas for Nixon, those policies were no more successful in the 1970s than they had been in combating the long Depression.  … President Bush responded to the bursting of the economic bubble of the late 1990s in quite a different fashion ... He cut tax rates and has generally supported Federal Reserve Board Chairman Alan Greenspan's efforts to keep prices on an even keel. ... As a result, the economy has responded with two years of uninterrupted, low-inflation growth, despite the phenomenal spike in oil prices. Bush might say we are all Adam Smithians now, referring to the British economist who argued for the market system and against unbridled government intervention. Indeed, last February, no less than Alan Greenspan paid a remarkable homage to Adam Smith in a lecture in Kirkaldy, Scotland, Smith's birthplace. … Nonetheless, intellectuals and politicians forgot about Smith. They rushed to embrace Keynesian theory, whose near-mystical complexities allowed them to believe government could stimulate the economy to even higher performance. Alas, most of their imagined improvements turned out to have counterproductive long-term effects. As a result, Smith is getting a fresh hearing, as the Greenspan lecture suggests…

First, note that Bray congratulates Greenspan and Bush for their use of tax and monetary policy to manage the economy, then states how faithful this is to the ideas of Adam Smith.  Sorry, but that’s not quite the laissez faire approach Smith had in mind.  But my main purpose is not this particular point so let’s move along. The editorial proceeds on an incorrect premise, one that is common so it’s worth dispelling.

Continue reading "A Common Misconception Regarding Keynes and Neoclassical Economics" »

Wednesday, July 06, 2005

Nassau Senior and the Poor Laws – Everything Old is New Again

Nassau Senior (1790-1864) was a lawyer with an interest in social, economic, and political issues. He was a friend of many of the more prominent members of the Whig party and he was the party’s general adviser on matters involving economic and social issues. In 1825 he was appointed to the first chair of political economy at Oxford University. In his early years, his main concern was the causes and consequences of poverty and the standard of living of the poor. Prior to 1830 Senior had considerable sympathy for the plight of the poor, and his concern appears to have been generally benevolent. He rejected Malthus’ population theory which implied long-run misery for the masses and instead believed that improvements in productivity would coincide with increases in moral character to lift the poor from their misery. He saw moral education as the only answer to poverty and actively promoted efforts to uplift intellectual and moral standards.

Conditions for the working class during this time were almost, if not surely sub-human. Exploitation and degradation were commonplace and there came a time in the 1820s and 1830s when labor began to organize and fight back. The result was widespread strikes, industrial sabotage, riots, and fires, all of which had a great influence on Senior. He changed. He particularly cited “the fires and insurrections which terrified the south of England in the frightful autumn of 1830” (Nassau Senior, Industrial Efficiency and Social Economy, 2 vols. (New York: Holt, 1928), 2:156). He came to believe that the poor laws and government’s dole to the poor and the unemployed were the principle causes and consequences of poverty and that this threatened to undermine the very existence of capitalism in England.

In 1830 Senior published Three lectures on the Rate of Wages (New York: Augustus M. Kelley, 1966). After the unrests in the autumn of 1830, he added a preface called “The Causes and Remedies of the Present Circumstances” the source of the famous wages fund doctrine. Setting aside all the finer details, the essence is that there is a fixed pool of income to divide among workers and the size of the pool is determined solely by labor productivity. Thus, to improve living conditions, labor productivity has to rise or the number of poor depending upon the fixed fund has to fall.

How to increase labor productivity? He advocated two solutions. First, the removal of all restrictions on free commerce and the accumulation of capital. Second, abolition of the poor laws which “made wages not a matter of contract between the master and the workman, but a right for one, and a tax on the other.” Senior was no longer worried about the misery caused by poverty. The events of 1830 led him to worry about the “threat of an arrogant laboring class, resorting to strikes, violence, and [unions], a threat to the foundation not merely of wealth but of existence itself.” Poor laws and dole led to a decreased incentive to work and created the arrogant attitude that workers and their families had a right to exist even if they could not or would not find work.

With his connections to the powerful Whig party, Senior was able to put some of his ideas into practice. In 1832 he was appointed to the Poor Law Inquiry Commission which was to study existing poor laws and methods of dealing with poverty and recommend reform. The report issued in 1834 was by all accounts largely Senior’s work. The new law stated:

1. Workers should accept any job the market offered, regardless of working conditions or pay.
2. Any person who would not or could not find work should be given just enough to prevent physical starvation.
3. The dole given to such a person should be substantially lower than the lowest wage offered on the market, and the workers general condition should be so miserable and should so stigmatize so as to motivate the search for employment irrespective of pay or conditions.

One historian, E.J. Hobsbawn (Industry and Empire: An Economic History of Britain since 1750, London: Weidenfeld & Nicolson, 1968) wrote about the poor law Senior was influential in creating and said the law was

…an engine of degradation and oppression more than a means of material relief. There have been few more inhuman statutes than the Poor Law of 1834, which made relief “less eligible” than the lowest wage outside, confined it to the jail-like workhouse, forcibly separated husbands, wives, and children in order to punish the poor for their destitution, and discourage them from the dangerous temptation of procreating further paupers.

With so much discussion of economic security today, it's hard not to be reminded of this time period in history. Whenever I go back and read about these times, the people, the policies, echoes of present day policy debates are everywhere. It is quite remarkable how little is truly new in this world. A close look at the principles underlying contemporary rules for Unemployment Compensation reveals strong echoes of Senior’s policies. Much of the rhetoric surrounding welfare reform, Social Security reform and so on can be found in the literature surrounding the birth of capitalism and its struggle against socialist ideas, ideas abounding during Senior’s time. As we embark upon another episode where these same ideas clash, are we fully aware of how this resolved itself in the past when societies struggled with the same issues?

*This dicussion follows E.K. Hunt's History of Economic Thought:  A Critical Perspective, Wadsworth:  Belmont, California, 1979 treatment of this topic.

Saturday, July 02, 2005

Alfred Marshall’s Ideological Defense of Capitalism

Alfred Marshall's theory of the firm led him to the belief that, in general, large-scale firms are more efficient.  But this created a problem for him because he also believed in the virtues of competition and large firms appeared inconsistent with the competitive model needed for markets to function properly.  To reconcile this, Marshall appealed to a long-run evolutionary view of nature and applied it to the business world. (There are bigger issues here that relate to the utilitarian foundations of the invisible hand and Marshall's beliefs, “Marshall did not realize that the utilitarian social ethic was utterly incompatible with an evolutionary approach to economic theory,” E.K. Hunt, History of Economic Thought, Wadsworth, pg. 283, but I'll let Brad DeLong cover the consistency of various social philosophies with utilitarianism - see here, here, and here - Marshall's philosophy discriminates among pleasures and thus contradicts the intellectual foundations of utlitarianism). This quote from Alfred Marshall (1842-1924), Principles of Economics, Book IV, Chapter VIII (1890) illustrates his evolutionary defense of capitalism:

But here we may read a lesson from the young trees of the forest as they struggle upwards through the benumbing shade of their older rivals. Many succumb on the way, and a few only survive; those few become stronger with every year, they get a larger share of light and air with every increase of their height, and at last in their turn they tower above their neighbours, and seem as though they would grow on for ever, and for ever become stronger as they grow. But they do not. One tree will last longer in full vigour and attain a greater size than another; but sooner or later age tells on them all. Though the taller ones have a better access to light and air than their rivals, they gradually lose vitality; and one after another they give place to others, which, though of less material strength, have on their side the vigour of youth.  And as with the growth of trees, so was it with the growth of businesses as a general rule before the great recent development of vast joint-stock companies, which often stagnate, but do not readily die. Now that rule is far from universal, but it still holds in many industries and trades. Nature still presses on the private business by limiting the length of the life of its original founders, and by limiting even more narrowly that part of their lives in which their faculties retain full vigour.

Competition will eventually topple even the tallest tree.  Marshall came to mind as I read this article from the NY Times:

The Next Heavyweight Champion of Banks, by Julie Creswell, NY Times:  This is a tale of two really, really big banks.  Both are heavyweights in financial services with trillions of dollars in assets and billions in market capitalizations. Both offer a cornucopia of products and services to consumers and large corporate customers. Both have exhibited voracious appetites in recent years, gobbling up competitors to establish themselves as megabanks with coast-to-coast and even international reach.  On the surface, the two financial giants, Citigroup and Bank of America, have business models that appear to be very similar. But there are significant differences. While Citigroup chased after the higher-fee businesses from corporations in the late 1990's, Bank of America focused on the more staid, boring business of serving retail customers.  That bet seems to have paid off. ... While it is still the nation's largest bank with $1.48 trillion in assets and a $240 billion market value, Citigroup these days seems stuck. ... Bank of America, from its base in North Carolina, is acting like the Citigroup of old. ... Some on Wall Street are fascinated by the role reversal. "Citigroup has been so traumatized by the events of the last five years that it is no more the wild-eyed risk taker," said Richard X. Bove, an analyst at Punk Ziegel & Company. "We're seeing one company shrink while the other expands. It's only a matter of time before Bank of America is bigger than Citigroup." ...

I can remember when people worried about IBM taking over the business world, "People in ... business would talk of "IBM and the seven dwarfs" ... IBM's success in the mid-1960s led to inquiries as to IBM antitrust violations by the U.S. Department of Justice, which filed a complaint ... in ... 1969."  Was Marshall right?  My own view follows Keynes, "In the long-run we're all dead," and I would prefer more vigilance against market power in the short-run than is currently in vogue among regulators.

Tuesday, March 22, 2005

The Visible Hand: Adam Smith on Equity

The Social Security debate is beginning to acknowledge the need for social insurance and the debate is shifting to how generous the social guarantee ought to be.

The right is arguing that the guarantee ought to be just above the poverty level. According to this line of reasoning, anything more generous than a poverty guarantee undermines the individual's incentive to take care of their own needs prior to retirement and makes them dependent upon the state for their existence. For example, a little discussed but important feature of private accounts is a mandatory annuity upon retirement to guarantee an income just above poverty. The AP reports that:

After a brief phase in, younger workers could invest two-thirds of their payroll taxes in the new personal accounts. They would be required to purchase an investment guaranteed to keep their income above the federal poverty level during retirement.

Note an important feature of this statement. The administration has no plans to guarantee the elderly anything above this minimal "poverty annuity."

What is a socially acceptable income guarantee for a citizen of the U.S.? This is a question of values and as such we cannot find the answer in economic theory. As I think about this, I have in mind a citizen who throughout his or her life contributed to society by going to work everyday, raising a family, doing charitable work, and so on, in short an outstanding citizen and valuable member of the community throughout his or her life.

Imagine that person, perhaps your mom, who has saved diligently for her retirement years. However suppose her husband has passed away, her only child is lost in an accident, and unexpected health issues at age 70 wiped out the considerable stock earnings she had accumulated over the years. Left all alone and devoid of resources, what guarantee should society provide to such a person as she lives into her 80's and 90's? What type of life is society willing to tolerate for such a person?

Adam Smith (1723–1790) is often cited in debates concerning the superiority of the private sector over government in the provision of goods and services, and his notion of an invisible hand is often used to justify a laissez faire approach to social problems.

What did Adam Smith say about how we should treat our poorest citizens? Here's a quote from An Inquiry into the Nature and Causes of the Wealth of Nations, Book 1, Chapter 8: Of the Wages of Labour, pg. 32:

Is this improvement in the circumstances of the lower ranks of the people to be regarded as an advantage or as an inconveniency to the society? The answer seems at first sight abundantly plain. Servants, labourers, and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, clothe, and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, clothed, and lodged.

I don't think Adam Smith would have objected to a social guarantee that ensures people are "tolerably well fed, clothed, and lodged" as opposed to a poverty level guatantee for our disadvantaged and elderly citizens, and he recognized the need for government intervention into private markets when they do not provide adequate amounts of desired services. Those who espouse the virtues of the private market in every circumstance would be wise to heed Smith's words.

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