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Summary History of Economics (part II)
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History of economics; Part II, economic policyLecture five: Introduction to part II. debates over socialism, capitalism and
laissez-faire (Hayek, Schumpeter, socialist calculation debate)
Capitalism and socialism: What is at stake?
- The dynamics of the Western economic system: from capitalism to socialism?
- Theoretical arguments for or against socialism
- Government intervention and the role of markets: do we need more or less government intervention
- Key ideas of the 20th century economics along the way
Capitalism Socialism
- Private ownership of most of resources - Collective/government ownership
- Individualism - Community interests, social preferences
- Competition and liberty - Cooperation and democracy (in theory)
- Resource allocation: decentralized free decision- making on - Resource allocation: Planning
markets - First developed in theory and then (at the global
- First developed historically and then as a theoretical construct scale) attempted in real societies
- Changed throughout the 20th century and incorporated - Changed dramatically over the 1980s
elements of socialism
Joseph Schumpeter (1883-1950), Capitalism, Socialism and Democracy (1942)
- Socialism will replace capitalism, not as capitalism will fail (as Marx thought), but as it will succeed
- Instead of entrepreneurs, managers of large corporations come into play
- Large corporations, together with critical intellectuals, will remove the political support of capitalism
Shumpeter: ‘Opening up of new markets, foreign or domestic, and the organizational development illustrate the
process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly
destroying the old one, incessantly creating a new one. This process of creative destruction is the essential fact
about capitalism. It is what capitalism consists of and what every capitalist concern has got to live in.’
- Creative destruction: you destroy the old forms and create new ones
Is socialism possible? The answer of economic theory
- Vilfredo Pareto: the notion of the optimum of the economy, marginalist school
- Since the 1930s taken up in the concept of a social welfare function: if we plan society we
need to understand what is good for society (we need a utility function for all)
- General competitive equilibrium is possible (Walras); why not enact it through planning?
- Enrico Barone: ministry of production sets the prices (= minimum costs) and the welfare is maximized
The first critique: Ludwig von Mises (1881-1973)
‘Economic Calculation In the Socialist Commonwealth’ (1920)
- How to define the monetary value of goods if they are not subjects to exchange?
- No independent owners of the production factors → no factor markets → no prices
- ‘No single man can master all possibilities of production, innumerable as they are, as to be in a position
to make straightway evident judgments of value without the aid of some system of computation’
- This is the idea of apples and oranges: you cannot compare those, when talking about
optimization and rational allocation of resources you need monetary value
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, - There would be no means of determining what was rational, and hence it is obvious that production
could never be directed by economic considerations [...] How will [the administration] be able to decide
whether this or that method of production is the more profitable?
- Where there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no
economic calculation
- Thus: socialism is not feasible as an economic system
But what if the state itself becomes an economist?
- Fred Taylor (1929): the task is to compute the equilibrium price vector and to take the functions of the
market upon the socialist state, armed with economic theory
- Method: trial-and-error adjustment process
Taylor: ‘If economic authorities of a socialist state would recognize equality between cost of production on one
hand and demand price of the buyer on the other as being adequate and the only adequate proof that the
commodity in question ought to be produced, they could perform their duties with well-founded confidence that
they would never make any other than the right use of the economic resources placed at their disposal’
Counter-critique: Oskar Lange (1904-1965) and ‘market socialism‘
- Economic Theory of Socialism (1936): Mises was wrong to claim that no prices are possible in
socialism
- Prices can be derived from existing scarcities
The economic problem is a problem of choice between different alternatives, to solve the problem three
data are needed:
1. A preference scale which guides the activity of choice: this is now called the utility function
2. Knowledge of the terms on which alternatives are offered: prices
3. Knowledge of the amount of resources available: now ‘how much resources I have’
- Those three data given, the problem of choice is soluble
The function of market (allocating resources by trial and error) is taken by the central planning board
- Consumer goods and services of labor are sold at a genuine market
- Capital goods and other productive resources are not traded
‘Central Planning Board performs functions of the market. It establishes rules for combining factors of production
and choosing the scale of output of a plant, for determining the output of an industry and for the allocation of
resources. Finally, it fixes the prices so as to balance the quantity supplied and demanded of each commodity.’
The critique by Friedrich Hayek (1899-1992): The Use of Knowledge in Society (1945)
- Optimal allocation of resources under socialism is possible in theory, but impossible in practice
→ Why? Because knowledge is dispersed and often also tacit: to rationally plan we need to know
this, but this knowledge is not given and cannot be retrieved by the central planning board
- The data from which the economic calculus starts are never for the whole society given to a
single mind which could work out the implications and can never be so given
- Lots of important information is created by the market interaction itself: if you prohibit
trade, this information is never revealed
- Thus, the economic problem is something different: how to secure the best use of resources known to
any of the members of society, for ends whose relative importance only these individuals know
- Or it is a problem of the utilization of knowledge which is not given to anyone in its totality
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, - Central planning based on statistical information by its nature cannot take direct account of these
circumstances of time and place
Hayek‘s theoretical perspective
‘Prices collect and communicate information, thus registering the changes in the interconnected economy. In a
system in which the knowledge of the relevant facts is dispersed among many people, prices can act to
coordinate the separate actions of different people in the same way as subjective values help the individual to
coordinate the parts of his plan’
- This coordination comes from the market, not from the central body which gathers all information (it
cannot gather this information)
- It happens in a decentralized and interconnected way (Walras, when something changes, everything
changes), for Hayek it all evolves spontaneously
Hayek’s dynamic view of economy and competition (The Meaning of Competition, 1948)
- Competitive process as an act of discovery: knowledge revealed only in the process of competition
- In competition you discover new things (more economic ways of producing), the outcome of
competition is less certain than portrayed in the models (more dynamic view)
- Critique of the static idea of competitive equilibrium and perfect competition, open-endedness
‘Competition is a process of formation of opinion: by spreading information, it creates that unity and coherence
of economic system which we presuppose when we think of it as one market. It creates views people have about
what is best and cheapest, and it is because of it that people know at least as much about possibilities and
opportunities as they in fact do. It is thus a process which involves a continuous change in the data and whose
significance must therefore be completely missed by any theory which treats these data as constant.’
For Hayek, perfectly competitive model (Walras) is a nonsense
Why?: Because it does not correspond to what is actually happening during competition
- It is worth recalling that, according to Dr. Johnson, competition is the action of endeavoring to gain
what another endeavors to gain at the same time
‘Now, how many of the devices adopted in ordinary life to that end would still be open to a seller in a market in
which so-called perfect competition prevails? I believe that the answer is exactly none. Advertising, undercutting
and improving (differentiating) the goods or services produced are all excluded by definition, perfect competition
means indeed the absence of all competitive activities.’
Theoretical and political challenges
- Equilibrium, disequilibrium, equilibration: most contemporary models still do not demonstrate how
agents arrive at some mutually consistent plans of action
- We know that general equilibrium exists, its properties and we can find it, but we do not have a
good theory arriving at the equilibrium
- The role of information and communication on markets, especially in the age of big data
- ‘How are prices set today?’ and ‘What information do they transmit?’
- What is the role of planning in the contemporary economy?
- Mechanism design as a response to Hayek: designing the social state so it has good properties
- Bigger corporations (recall Schumpeter): always increasing due to technology
- Capitalism versus socialism
- Questions about inequality, efficiency and incentives
- How can we compare?
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, Workgroup four: Ethical foundations of economics
Dupont chapter two
Ethics (ethical foundations): how people should behave, the theory if right behavior, theory of good and bad,
its normastive (how it should be)
- Normative versus descriptive/positive: normative is how it should be, descriptive is how it is
Three main categories of normative ethical theories, helpful in exploring the origins of the ideas that form
modern economics:
1. Virtue ethics: this approach emphasizes the role of one’s character and the importance of cultivating virtuous
habits, finding middle grounds between the extremes
- Oldest ethical system, originates from scholarship of Plato and Aristotle
- In economics you always have trade-offs: it assumes things go in different ways and you need to find
a balance/equilibrium
2. Deontological ethics: this approach suggests that we have obligations or duties to act in certain ways
- Deontological: you do not care whether people follow the rule of duty, this rule is valid independently
of whether anyone follows it or not (Kant)
- Ontology: the science of what exists
- Connection with economics: formalison, it defines the form of right ethics
3. Consequentialist ethics: this approach suggests that moral conduct is determined by reference only to the
consequences of our actions
- Consequentialism: utilitarianism important here, focused on the outcome of the actions (Bentham),
balance of pleasures and pays (= felicific (happiness) calculus)
- Utility for Bentham is the amount of please minus pay
- Morally right actions under this ethical system arise whenever our actions generate, on balance, more
good (pleasure) than bad (pain)
- The subdivision of utilitarianism is most important as it forms the basis for the models of utility
maximization that emerged in economic scholarship in the 19th century
- According to the utilitarian system: we should do whatever produces the best overall
consequence for every one
The ideas of justice in ancient economic thought
Socrates: human flourishing is the goal of human behaviour
- Human flourishing: did not entail the pursuit of wealth or the accumulation of material things, it is
conceptually distinct from modern utilitarianism
- Xenophon: introduced the concept of division of labor, while expressing some concern for the ethical
aspects of the productive process
- Division of labor potentially entails both physical harm (utterly ruin the bodies of those who
work at them) and spiritual harm (the soul can become even more diseased)
Plato: described a stable class structure that reflects the virtues in a just city
- Warrior class: is an important part of this structure, it is created through the selection of especially
spirited children who are trained from childhood to serve the state as its guardians
- The best warriors are chosen to become rulers: rulers embody the virtue of wisdom, warriors have
the virtue of courage and the entire city exhibits the virtues of justice and moderation
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