The Clash of Economic Ideas

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Lawrence H. White. The Clash of Economic Ideas. Cambridge: Cambridge University Press, 2012.

George Mason University economist Lawrence White provides a lively and accessible introduction to economic ideas. He zeros in on the main economic arguments with a minimum of quantitative formulas and technical details. Rather than present economic theories devoid of social context, he tries to “trace the connections running from historical events to debates among economists, and from economic ideas to major economic policy experiments.”

White’s focus is primarily on the twentieth century, but he takes occasional excursions into earlier times to provide additional background on the thinkers he discusses. In the Introduction, White poses the central question that has shaped twentieth-century economic debate: “Are competitive markets, guided by impersonal forces of profit and loss, better than government command-and-control for directing investment toward the greatest prosperity?” His next sentence places the field of economics squarely on the affirmative side: “The key insight of economics as a discipline–its greatest contribution to understanding the social world and to avoiding harmful policies–is that, under the right conditions, an economic order arises without central design that effectively serves the ends of its participants.”

Nevertheless, the strengthening of government’s role in the economy is central to the story of the past century. The book’s first chapter is “The Turn Away from Laissez-Faire.” (“Laissez-faire” is a shortened form of the phrase “laissez-faire, laissez-passer“–literally “let do, let pass”–attributed to an eighteenth-century free-trade advocate named Vincent de Gournay.) Economists since Adam Smith have appreciated the social value of letting individuals produce whatever they can profitably exchange with others, without interference from the state:

By directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this…led by an invisible hand to promote an end which was not part of his intention….By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.

The doctrine of laissez-faire was a reaction against mercantilist policies such as trade barriers and state-sponsored monopolies, policies oriented more to the protection of existing wealth than to the expansion of national production. It became a centerpiece of liberal thinking in the nineteenth century. Where free-market capitalism came to prevail, support for laissez-faire was increasingly support for the status quo, so that classical economic liberalism came to be considered conservative.

By the Progressive Era (1890-1920), economists were coming to doubt that the “invisible hand” of the market always produced socially desirable outcomes. In 1907, Irving Fisher published the essay, “Why Has the Doctrine of Laissez Faire Been Abandoned?” He gave two main reasons: that individuals often lack the expertise to make the best decisions, and that actions beneficial to individuals often have external effects that injure society.

The second issue is what modern economists call “externalities”. Buyers and sellers may benefit from the marketing of a certain product, but people who are not parties to the transaction can suffer from the environmental damage resulting from its production.  White does not explicitly link working-class poverty and other social problems deplored by the Progressives to such market failures, but that is the obvious implication. The new “institutionalist” economics looked to improved social institutions, not just free individuals to generate social progress. Scientific expertise, especially the findings of the emerging social sciences including economics itself, was to be an important basis for social reform. The American Economic Association was originally led by institutionalist economists opposed to laissez-faire thinking.

The path away from classical laissez-faire was also the path toward more radical collectivism. White establishes just how widespread socialist ideas were in the early twentieth century, most notably in the centrally planned economies of communist countries, but also in Nazi Germany, India after British rule, and even the US under the New Deal and Britain under the Labour Party. For example, Roosevelt’s National Recovery Administration “organized industries into federally supervised Code Authorities, government-sponsored cartels for arranging collusion among the participating firms. The Code Authorities decided and enforced prices, production quotas, employment, and distribution methods.” The Supreme Court ruled the NRA unconstitutional in 1935. In 1945, the British Labour Party was elected on a platform that called for “a Socialist Commonwealth of Great Britain” where the government would have “a firm constructive hand on our whole productive machinery.” Industries employing about 20% of all workers were nationalized.

The popularity of socialism provoked a strong intellectual reaction, especially among Austrian economists such as Ludwig von Mises and Friedrich von Hayek. In the 1920s, Mises launched a strong attack against socialism, questioning the whole idea that the government could calculate the value of economic inputs better than competitors in a free market. “Mises’s argument embodied the neoclassical marginal productivity theory of factor prices, which teaches that the price of a productive input (raw material, machine-hour, labor-hour), in a market where entrepreneurs competitively bid for it, reflects the value of the input’s marginal contribution to the revenue from output sales.” Hayek’s critique of socialism added the argument that knowledge is distributed widely in society rather than concentrated in government, so that, in White’s words, “The Central Planning Board can’t know all that it would need to know to match the market’s use of knowledge….”

In the worst economic crisis of the century, the Great Depression, market critics and government critics squared off in the intellectual battle that continues to this day. For opponents of laissez-faire, most notably John Maynard Keynes, the Great Depression was a conspicuous market failure (a failure of “aggregate demand” in particular), demonstrating the need for at least moderate economic intervention (more on that in the next post). For Hayek, on the other hand, the Depression resulted mainly from central bank mismanagement of the money supply. Loose monetary policy in the 1920s had over-expanded the money supply, held down interest rates, and encouraged an unsustainable investment boom.

The author himself is more in the Austrian camp than the Keynesian camp. Throughout the book, he seems much more comfortable talking about government failures than market failures. That may be why he is so vague about the reasons for the decline of free-market thinking he describes in the first chapter. Although he tries to present both sides, I notice more criticism of Keynesian ideas than monetarist ideas in the book as a whole.

Continued

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