Monthly Archives: April 2010

The Problem is Structural…

Martin Wolf, a British journalist, recently commented on the Austrian Business Cycle Theory (ABCT) at his Financial Times blog entitled the Martin Wolf Exchange. While he acknowledges that much of what the Austrians say could very well be correct, he disagrees with their view that markets should be allowed to liquidate without government intervention.

But Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing.

The problem here is that while he may agree with Austrians that fractional-reserve banking could be inherently unstable, he misses the real heart of the theory: malinvestments within the capital structure. During the boom stage of the business cycle capital is misallocated into sectors of the economy it otherwise would not have been were it not for the artificially low interest rates that misled entrepreneurs. Roger Garrison, in his book Time and Money, says

…credit expansion sets into motion a process of capital restructuring that is at odds with the unchanged preferences [of consumers] and is ultimately ill-fated.

The problem, then, is structural. It is a structural problem within the production process that ultimately leads to the bust. Now, I realize most mainstream economic theories typically think of capital as a homogeneous “k” where a “structure of production” is ultimately meaningless. But just for a moment take the ABCT on its own terms. If the problem is ultimately structural and not simply a lack of effective aggregate demand than it becomes immediately apparent why government attempts to boost aggregate demand will end in failure. Increasing aggregate demand is not going to help the production process straighten out its  structural problems. In fact, it will probably exasperate it.

I should point out that if Wolf’s concern is for the general population most effected during the “liquidation period” than I can see no serious objection within Austrian economics to providing some sort of short-term safety net. Of course many Austrian economists would object to a government safety net out of hand, but that would be more as “libertarians” than “Austrian economists”. While there are good economic reasons for being wary of the long-term effects of unemployment insurance and other safety nets, used sparingly I can’t see this as halting, in any meaningful sense, the capital restructuring necessary for the economy to get back on its feet.

The Evolution of Markets

Last March, the journal Science published a fascinating study by researchers from around the globe entitled, “Markets, Religion, Community Size, and the Evolution of Fairness and Punishment,” which sets out to research the ways in which large-scale human societies are able to foster trade and cooperation. Obviously, we haven’t always lived in large, interconnected groups of people like we do now. Once upon a time humans lived in small, closely related groups that were held together by the innate bonds of kinship. But getting from small groups of related people to large interconnected societies has always puzzled sociobiological researchers.

Sadly, the full journal article is only available to subscribers so I haven’t been able to read the full thing. This article, from USAToday, seems to be a pretty good summary. The abstract of the study says this

Large-scale societies in which strangers regularly engage in mutually beneficial transactions are puzzling. The evolutionary mechanisms associated with kinship and reciprocity, which underpin much of primate sociality, do not readily extend to large unrelated groups. Theory suggests that the evolution of such societies may have required norms and institutions that sustain fairness in ephemeral exchanges. If that is true, then engagement in larger-scale institutions, such as markets and world religions, should be associated with greater fairness, and larger communities should punish unfairness more. Using three behavioral experiments administered across 15 diverse populations, we show that market integration (measured as the percentage of purchased calories) positively covaries with fairness while community size positively covaries with punishment. Participation in a world religion is associated with fairness, although not across all measures. These results suggest that modern prosociality is not solely the product of an innate psychology, but also reflects norms and institutions that have emerged over the course of human history.

Russ Roberts, the host of the great economic podcast EconTalk and professor of economics at George Mason University, never tires of defining economics as the study of incentives, and I think this is exactly what this study is talking about. What they are really examining is the incentives that led small groups of people to interact and cooperate with other small groups of people, rather than just fighting them in all out tribal warfare. As Hans-Hermann Hoppe explains in his paper “On the Origin of Private Property and the Family“, the hunter-gatherer societies were essentially parasitic. They took from the land but never produced anything. Once these resources were depleted these societies had to either wait for the replenishment of vegetation and animal herds or migrate. Migration worked for a time, but, the supply of land being fixed as it is, there came a point in which human societies simply could not escape each other and it came down to either warring over land or hunkering down and cooperating.

The question, then, is how to cooperate and trade with groups of people you would normally consider enemies. Ludwig Von Mises, in Human Action, describes the tendency for humans to cooperate,

If and as far as labor under the division of labor is more productive than isolated labor, and if and as far as man is able to realize this fact, human action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare.

What Mises is saying here is that as the opportunity cost of not trading rises relative to remaining in small, splintered groups people will begin to trade. They begin to trade by establishing norms and rules (that could be explicit or implicit) in order to facilitate trade.  As the paper notes, groups of people that do engage in trade show greater amounts of fairness towards strangers than those that do not. This can be explained by the concept of “social capital” which compares human relationships analogously to  financial transactions. The sociologist James Coleman describes social capital in terms of credit slips. When person A does something for person B it establishes a mutual relationship and the concept of credit slips describe the “debt” person B then holds for person A. Social capital is the trust and obligations that people hold toward one another.

People went from war to peaceful exchange via “growing” their social capital by engaging in trade. Although many today are apt to see trade and competition as “cutthroat” and somehow inherently hostile, trade is actually an action which establishes people as allies rather than enemies because each party knows the trade is mutually advantageous (A and B engage in trade because they desire what the other party has and if they didn’t the trade would not happen). Fairness is a natural outcome of the creation of social capital.

When economists say markets can overcome this problem or that problem it may make more sense to bring it down to the individual level. People solve problems when there are good reasons, and strong incentives, for doing so. Often times critics of the market conceive of the market as some abstract, homogeneous institution rather than the nexus that ties human action together. When we think in terms of individuals it becomes easier to understand why markets can solve problems- because people do. This study demonstrates just one of the numerous ways in which this is true.

There’s a reason history should be taught…

I’ve been trying to think of a good first post to kick this blog off, and it seems the latest David Boaz article that seems to be sweeping the blogosphere is as good a place as any to start. So without further adieu…

On April 6th, published an article by the Cato Institute’s David Boaz entitled, “Up From Slavery“. The main premise of the article is that, hey, there never was a golden age of liberty and so libertarians should stop being so backward looking and appreciate the gains in liberty that have been made up to the present. For example, he says

“For the past 70 years or so conservatives have opposed the demands for equal respect and equal rights by Jews, blacks, women, and gay people. Libertarians have not opposed those appeals for freedom, but too often we (or our forebears) paid too little attention to them. And one of the ways we do that is by saying “Americans used to be free, but now we’re not”—which is a historical argument that doesn’t ring true to an awful lot of Jewish, black, female, and gay Americans.”

While I can certainly sympathize with the advice that those concerned with the spread of freedom acknowledge the fact that there never has been a “golden age of liberty”, it seems to be entirely possible to fall into the opposite fallacy: Ignoring what was once good by focusing too much on what was bad. This type of fallacy strikes me as even more dangerous than thinking we should all live like its 1885 because everybody already knows the types of injustices that were perpetuated onto blacks, females, gays and so forth. What many people, especially the young and those in college,  do not know is the amazing sense of individualism and freedom that has always characterized the American spirit and which made possible the freedom that practically all groups of people experience today. The civil rights movement did not originate out of a vacuum. It was, in so many respects, a quintessentially American movement; something not unlike a continuation of the American Revolution itself. And if David Boaz wants freedom to move even further along it would behoove him to keep the spirit of the American Revolution going.

Allan Bloom, in his classic book “The Closing of the American Mind”, makes this point well. He writes,

There is no immediate, sensual experience of the nation’s meaning or its project, which would provide the basis the for adult reflection on regimes and statesmanship. Students now arrive at the university ignorant and cynical about our political heritage, lacking the wherewithal to be either inspired by it or seriously critical of it.

Point being, if the American Revolution is maligned as nothing more than an exercise in white, male hegemony than what sort of incentive would anyone have to look for the good in it? Bloom is right- the American Revolution should be inspiring. While nobody claims it was perfect, one cannot help but admire the principled resistance to tyranny the early Americans brought to the table and the system of government they developed to try and keep tyranny at bay. There is good there and we should recognize that good on its own terms. We should also try to emulate that same resistance to tyranny and oppression.

Boaz’s point is well taken: Not everyone experienced liberty. Indeed, the majority of people in America probably didn’t experience the type of liberty Boaz advocates. But that is no reason to malign it all. Elsewhere in “The Closing of the American Mind” Bloom talks about

…the openness that invites us to the quest for knowledge and certitude, for which history and the various cultures provide a brilliant array of examples for examination.

His point is that true openness in the search for truth allows us to sift through historical situations and discover what was good and what was bad; what will be useful to us in the present and what we should discard. Boaz’s entire article strikes me as throwing the baby out with the bath water. This is wrong. A sense of historical identity is of the utmost importance. If people don’t know where we’ve come from, they won’t know where to continue going. If the good parts of American history aren’t known, what is left to imitate? Nothing, which is a very problematic concept indeed.