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MAMMON & MORALITY


MAMMON & MORALITY Before it was a social science, economics was as a branch of moral philosophy. Economics was invested to be a tool to ascertain justice, promote happiness, challenge traditional authority, and promote human cooperation: it was not about making money. Modern economics aspire to be a descriptive science of human behavior -focused on the positive “is,” instead of the normative “ought.” However, many of the original moral judgments and value-laden vocabulary persist in economic analysis. This opening chapter seeks to provide a basic background in economic thought to allow the reader to identify the “moral squint” of economics as you become familiar with its theory and applications. While some economic ideas have long pedigrees, economics as a discipline developed in parallel with the rise of capitalism. As a result, one can read much of economic analysis as a commentary on the morality, immorality and amorality of capitalism. Due to capitalism’s protean nature, views of capitalism have evolved over time and developed differently in different contexts. In short, there is no “pure” capitalism to be discovered, but different capitalisms in different places at different times. We can view the development of economic thought and analysis as a conversation aiming to provide an ever more complete judgment on the value and operation of capitalism since 1800. This is an ongoing conversation, in part, because there is a fundamental tension -contradiction -- in economic thought. Economic journalist David Warsh has framed this as the battle between Adam Smith’s parables of the Pin Factory (Division of Labor / increasing returns) and the Invisible Hand (competitive market / constant returns) in the Wealth of Nations. Logically, these ideas exclude each other, but they exist side-by-side. The conversation about them has no resolution, because the balancing of these ideas must be done in each specific application.

1.0 ECONOMICS’ TWO GREAT INSIGHTS Economics has two great insights. The first is being good (virtuous) is the same as being happy. The second is that the public interest is not simply the sum of its component individual interests. In economics, the first principle is more often known as the “no free lunch” principle. Prior to economics, it was widely held that goodness and happiness went hand-in-hand: only a good person could be happy and happy people were good. Goodness involved qualities such as honesty, charity, and honor that required individuals to sacrifice individual benefit. For example, a good person, seeing someone suffering, would try to alleviate the suffering, i.e., by offering them a “free lunch.” Economics noted that there was no “free lunch” -- every charitable action came at the expense of someone, even if it only was some “forgotten man.” There was always a tradeoff. Therefore, doing things conventionally thought good would result in less happiness for someone, somewhere even if the identity of that person was not immediately obvious. As a result, one could not be good and happy. Ultimately, there was only so much to go around, virtuous action simply redistributed the pie. The second principle holds that the whole is either greater or less than the sum of its parts. Prior to economics, thinkers presumed that there was no inherent contradiction between individual interest and the social, or public, interest. To take the extreme case, it was “sweet and proper to die for one’s country” because defending the community on which you depended was ipso facto good for the individual. Family, society, or the polity was the thing and each person was only a part of the larger entity. To make a medical analogy, each organ is simply part of a an organism and what is good for the organism is good for the organ. In terms of ecology, no species is more important than the ecosystem and what is good for the ecosystem is good for the species, even if they are the prey for some predator. Aligned with the first insight, early economists imported this equation, but rather than see the individual as a part of a larger whole, it preached methodological and normative individualism. Only individuals make decisions and social welfare was the simple sum of the individual welfare: what was not good for the individual could not be good for the group. Later economists showed that there are many instances, however, when the whole is not the sum of the parts whether due to the aggregative processes, the role of money, increasing and decreasing return to scale, or the presence of positive and negative externalities. 1


1.1 FRAMEWORK One may classify economic thinkers by their answers to two basic questions. The first, represented by the horizontal axis on the chart to your right, is which insight of the two insights listed above is more fundamental. Those that embrace the first insight -- the “no free lunch” principle -- tend to view economics as a study of equilibrium; the economy, left to its own devices, is in balance. Broadly speaking, this includes the Classical School (and its modern scions, the Neo-Classical and Rational Expectations Schools) and also Libertarian economic philosophies. Those that favor the second insight -- the whole is greater/less than sum of its parts -- stress the possibility of disequilibrium, such as theories of over - and underconsumption, general “gluts” and the persistence of market failure due to negative externalities. Keynesian economists, as well as economists who take a historical or institutional approach to economics. The vertical axis divides those economists who are mainly concerned with the economic consequences of individual decisions and economic activity from those who are primarily concerned with the political consequences. Some economic thinkers focus on the efficient economic operation of the economic system. Namely, they ask if factors -- labor, land and capital -- are employed and if they are employed most efficiently. Others note the power implications of different distributions of resources. For example, a libertarian economist would prefer a decentralized system, even if efficient, to a centralized economy that used resources efficiently because it maximized the political value of freedom. In contrast, an institutional economist might have a problem with power-differences in production or consumption, even if resources are used efficiently, because it is inequitable. If we look at the boxes, we find the major schools of economic thought. In the upper right quadrant, we find the Classical school who, through doctrines such as Say’s Law and the Law of One Price -- exemplify the belief that the economic system tends toward equilibrium and the confidence that the stable equilibrium is also the most efficient equilibrium. In the upper left, we find the Keynesian (and proto-Keynesian) economists. They share the Classical school’s concern with economic efficiency -- and therefore share similar aims -- but disagree about the market’s ability to reach efficient equilibria without assistance. Keynesian are keen to note market failures, but suggest economic solutions (i.e., working through economic processes) to these problems by “finetuning” the economy through fiscal and monetary policy, “completing markets” or providing public goods. In the lower left, there are Institutional economists that include the diverse perspectives of Marx, Veblen, and Schumpeter. They differ from Keynesian economists because they all put a priority on the distributional consequences of political and economic policies and processes. Marx’s theories put class conflict at the center of his analysis; Veblen is famous for his description of conspicuous consumption of the “leisure class” and the balance of power within corporations; Schumpeter on the transformative role of entrepreneurs. All emphasize the role of history and institutions in shaping economic behavior and all focus on some imbalance driving the evolution of economic activity. For Marx, it was the accumulation of capital, while Veblen it was underconsumption driven by the displacement of “engineers” by managers in corporations. Schumpeter noted the dynamic “creative destruction” of entrepreneurs driving unbalanced economic development. Finally, in the lower right quadrant are the pure laissez-faire perspectives of libertarian (Austrian) economists who often combine their economic analyses with a stress on the market’s role in preserving individual freedom, especially from centralized state planning. They emphasize the role of markets as information processing mechanisms. While they hold different political values, they share the emphasis with Institutionalists on the implications of economics for preserving or undermining political values. 2


2.0 ECONOMIC MORALITY Economics began as moral philosophy and is still used to make moral judgments. We praise individuals for their work ethic, we elude judgment because “it’s business, not personal,” we praise frugality and gratitude (gratis = free, a price), we ration goods, services, and amenities by wealth, and use credit ratings to determine whether a person will make a good employee or not. “Debt” has not lost its historical association with the concept of “sin” and the phrase “debt forgiveness” echoes this connection. “Worthy” has the dual meaning of having economic value and deserving. Economic decisions balance “equity” with “efficiency.” We eschew providing assistance to the economic disadvantaged due to concerns about “moral hazard” and economic efficiency. Capitalism, more so than democracy, is America’s cardinal value of its public philosophy. Some circles view inflation and taxes as theft and divide individuals into “makers” and “moochers.” We ask everyone to “pay their fair share” of taxes, and if they do not, consider them “free-riders.” We call those without integrity “sell-outs” and remark that “I’m not buying it” when we do not believe something to be true. We criticize things for being “commercialized” and people for being “materialistic.” In the trinity of political goals, the “pursuit of happiness” (Jefferson’s formulation) is often substituted with “property” (Locke’s formulation). Religious texts remind us that the “pursuit of money is the root of all evil,” “blessed are the poor,” that the rich to enter heaven is like a “camel through the eye of a needle,” and and attachment to material things is the cause of human suffering. Some argue that “normative” analysis should be separated from “positive” analysis; what “ought” is not the same as “what is.” However, many purely descriptive and analytical concepts and vocabulary are rife with moral valences and connotations. Therefore, it helpful to interrogate these assumptions and flush out their origins and implications.

2.1 ASSUMPTIONS OF ECONOMICS As a largely deductive science, economics is fond of making assumptions, including that all decision makers are rational, utility maximizing individuals with perfect information operating in fully competitive and liquid markets where all resources are fully employed. While many of these assumptions are empirically ridiculous, they are often explicitly stated and can make the analysis of complex systems tractable. However, as Nobel laureate Gunnar Myrdal observed, there are “hidden assumptions” in economic analysis that prejudge the predicates drawn from the analysis. Myrdal identified three core assumptions in economics: the idea of value, the idea of freedom and the idea of collective housekeeping. Briefly, the idea of value refers to how economists infer “real” or “natural” value apart from actual economic transactions; the idea of freedom is the belief that economic processes are uncoerced -- free -- and therefore natural, while the results of political processes entail the use of power and are therefore, unfree and unnatural; the idea of collective housekeeping portrays the national economy as the operations of a personified household that aims to maximize general welfare and uses a unified budget.

2.1.1 THE IDEA OF VALUE The problem of value is captured in the saying, “beauty is in the eye of the beholder.” We can easily intuit that different individuals place a range of valuations on the same object. For practical purposes, this is not a problem; we can accept that there are “different strokes for different folks” or “one’s mileage may vary.” However, for economics to make valid generalizations about economic behavior, it must be able to infer real, or absolute, value and not rely on a subjective valuations. There must be some anchor for the relative valuations of individual economic products; there must be a common numeraire. In practice, this numeraire is money and we can compare unlike items in terms of their monetary value. However, this begs the question: what anchors the value of money? Economists have sought, unsuccessfully, to identify the source of 3


value, since the creation of value is the justification for economic reward. For Adam Smith, the source of value was human labor; for David Ricardo, it was the price of “corn” (grain = food); for goldbugs new and ancient, it has been the gold standard. Later, more quantitative economists, such as John Bates Clark, devised the concepts of the marginal product of the factors -- land, labor and capital -- of production. However, this runs into problems when one tries to parse the value of the hammer (capital) from the value of the carpenter (labor). In addition, like bodily organs, the absence of one factor reduces the productivity of other factors to zero. The hammer has zero productivity in the absence of the carpenter and the carpenter has zero productivity in the absence of the hammer. The problem with each of this formulations is that they are inherently arbitrary and reflect the values and priorities of specific interests and not objective gauges of “real value.” When pressed, it is clear that each standard of “real value” reflects the perspective of a certain subjective standards of value. The gold standard is much more favorable to those holding financial assets than those earning wage income. Most formulations of marginal factor productivities justify returns to capital at the expense of returns to labor. In short, the accounting for “real value” is not a neutral description of what generates value or who has a valid claim on economic income.

2.1.2 THE IDEA OF FREEDOM Economics is replete with the idea of freedom: free markets, freedom of contract, free enterprise, free lunch, free-riding, free labor, free exchange, free trade, liberalization, deregulation, self-governance and selfregulation. It is no accident that noted Nobel Prize-winning economist Milton Friedman titled his economic manifesto as Free to Choose. The close association of economic analysis and the political value of freedom is in part historical, in part analytical and in part philosophical. Economics developed in concert with the development of democracy and constitutional government. The economic arguments for the “invisible hand” of the market and the advantages of free trade came in response to the economic regulation of Mercantilism and the limits it placed on economic activity. In addition, it developed in the wake of in the wake of the English Civil Wars that gave rise to the social contract theories of John Locke and Thomas Hobbes and the framework of “possessive individualism” -- the notion that the ability to control and dispose private property is the essence of individual freedom. In this milieu, it seemed obvious to the first generation of economists that limiting government and maximizing individual freedom would be conducive to increasing economic welfare. However, equally important was the construct of “the state of nature” in the social contract theories. Whether human relations were seen as cooperative (Locke) or conflictual (Hobbes), free individuals would form effective communities in their “natural” state. Economics discovered “natural laws” that pre-existed society and governments and freedom was the natural condition of individuals in this state. As a result, economic activity and processes are inherent in human nature and efforts to interfere with their operation, unnatural. This appeal to natural law confers a legitimacy to economic processes and outcomes even if they offend our sense of justice and equity. On a second level, the idea of freedom is analytically necessary. Most of economic concepts derive from the notion of individual choice. Therefore, economists must explain economic outcomes as the result of individual choices, or methodological individualism. Social welfare is simply the aggregation of individual values and cultures and institutions simply patterns of individual choices. In addition, many of the noted conclusions of economics depend on the assumption that there are large numbers of small, independent buyers and sellers. If their choices are correlated, there are limits to arbitrage and competition rendering markets inefficient and suboptimal. In addition, as Marx (and others) astutely observed, capitalism requires the “double-freedom” of workers being free to sell their labor and free of feudal obligations to function. While some, such as Amartya Sen, argue that it is impossible to be a “Paretian liberal” because free choice is logically inconsistent with maximizing social welfare, most equilibrium theories presume free and independent decision makers. 4


The third dimension is philosophical. Economic systems appear to be free of explicit coercion. The key to Adam Smith’s “invisible hand” is that it is “invisible.” This allows us to view economic activities are free of considerations about power or force. All transactions are freely entered and therefore no one has a legitimate complaint about outcomes, regardless of misfortune or inequity. The problems with the idea of freedom in economics are threefold. The first is that individual choice may be inconsistent with maximizing welfare. Given the freedom to choose, students may pursue less education than is optimal, patients may demand less healthcare than maximizes their welfare, and individuals will save less than is necessary to support themselves in their retirement. In general, public goods such as crime protection, environmental quality and reliable information may be underprovided. In addition, without some institutional base or nudge, desirable markets may not form. Second, while there may not be explicit coercion, buyers and sellers are subject substantial pressures (and unwanted) pressures to their economic choices. Advertising may be more powerful than some suppose and poverty may create situations that force undesirable choices. For example, a poor person is more likely to consider the sale of an organ or the purchase of a lottery ticket than one who is wealthy. Structural, institutional and historical factors circumscribe the “menu” of our choices: one cannot be a knight-errant in the 21st century or be a democratically elected president in an authoritarian government. The structure and sequence of our choices can influence our decisions. Finally, choice itself may be a disutility; choosing itself can be a burden, cognitively and psychologically.

2.1.2 THE IDEA OF COLLECTIVE HOUSEKEEPING The word economics was coined from the Greek word for “household management.” In this incarnation, economics was simply personal finance: balancing the checkbook, organizing household production, and purchasing the necessities for the household’s lifestyle, etc. all under the supervision of the household head. The household is the only economic unit that most people experience directly. As a result,we often use it as an analogy for the operation of the larger economy. Although our decisions and actions influence them, and they influence us, we cannot observe directly “the market,” “inflation,” “capital accumulation,” “economic growth,” “debt” or “supply and demand.” As a result, it is common for us to think of corporate CEOs or presidents as “stewards” of the economic performance of their organization or nation and responsible for its success or failure. In addition, we tend to look at collective measures of economic welfare and performance, such as the competitiveness (and wages) of American workers vis-a-vis Chinese workers, growth of GDP, performance of critical economic sectors such as education, healthcare, finance or automobiles, we look at trade and budget deficits as common obligations. The first problem with this assumption it presume a harmony of interests and common purpose among its component parts. For example, opening an economy to foreign trade may increase collective wealth of a nation, but it is not true that all will share equally -- and many may lose -- in the gains from trade. Winners do not necessarily compensate losers. The chart to your right, showing age-specific survival rates, provides another example. In general, the US is an affluent country, and not surprisingly, has low age-specific mortality across the life-span. This conforms to the view that everyone is “lucky to be an American” and that the poor in America are much better off than the poor elsewhere. However, if one parses the data by race, one sees that AfricanAmerican men do worse than men in the poor countries of China (c. $1000/yr. per capita GDP, 2000) and the South Indian state of Kerala (c. $300/yr per capita GDP, 2000). Likewise, false analogies between national economies and firms lead to concerns about the state of economic competitiveness. One manifestation of this is the hand-wringing over American educational performance since 5


the publication of A Nation at Risk in the mid-1980s warned that it would undermine our economic prospects. As a result, for the last thirty years there have been perennial calls for reforming American education by introducing “21st century skills,” high-stakes testing, and dissolving teachers’ unions. However, as the charts to the right indicate, the devil is in the details. Whites and Asians attending suburban public schools score near the top of the world. The problems are largely in the poor performance of large urban school systems who disproportionately serve poor, ethnic and racial minority students. The model of collective housekeeping that looks only at “American Education” writ large ignore more salient distributional patterns. Similarly, calls to “buy American,” subsidize American companies or maintain a strong currency only make sense if one imposes a collective housekeeping framework. As Tonto replied to the Lone Ranger, “Who’s this ‘we,’ Kemo Sabe?” The appeal to collective housekeeping appears most often when someone asks for “shared sacrifice” to address an economic problem that primarily affects only one group. The other area that the metaphor of collective housekeeping impacts economic analysis is in discussion of public budgets and finance. In economic terms, one can view government in two ways. First, governments are producers of non-rival, non-excludable public goods such as environmental quality, common defense, police and fire protection, the administration of law and transportation and communication infrastructure. As a result, we should all pay for the cost of maintaining these common services equally and expenditures should be paid from a general revenue fund. The second view is that the government is the producer of a menu of services to citizens that can be “purchased” individually, such as hunting, fishing and driver’s licenses, grazing rights, postal service, education, health insurance and toll roads and bridges. Why should households without school-age children finance the education of households that do? Why do school districts not charge households by the pupil? Why should middle-aged workers pay for the healthcare of the retired? What have future generations done for us that we should not saddle them with debt or forego the consumption of natural resources? From the perspective of collective housekeeping, these are not problematic, just as one would care for one’s elderly grandparents, provide for one’s children; they are social functions, socially provided. However, every public policy has distributional implications and the collective housekeeping metaphor sublimates them, although there is some evidence that democratic governments tend to levy taxes on a benefit basis, whereby by progressive taxation supports national defense and regressive taxation supports social welfare and insurance.

3.0 PREMODERN PRECEDENTS Although the modern observer finds it easy to understand why being good may not bring happiness, it was taken for granted for most of human history for good reason. In ancient times, a good harvest meant a good economy and a good harvest depended on the cooperation of nature to send the right amount of rain, sun, and soil. If the people did not behave morally, god/nature would send drought, plague, pestilence, or make you 6


wander in the desert for 40 years. To appease the gods and restore prosperity, people offered contrition in the form of human or animal sacrifices ("scapegoats"). Happiness depended on good harvests; good harvests depended upon good behavior. This is the logic behind the Chinese "mandate of heaven," the Hindu idea of Karma, and Western notions of "suffering for sins." Most myths, fairy tales, and fables all end with the good being rewarded and the bad being punished. An example of this logic can be found in the Biblical story of Jonah. Attempting to escape the will of God, Jonah boards a ship that finds itself in a powerful tempest. His shipmates quickly infer that there must be a “sinful” person among them and promptly investigate. Discovering Jonah’s intransigence, they quickly hurl him overboard, bring calm to the seas, but Jonah is swallowed by the whale. In short, bad things can only happen to bad people. If you ever thought that bad luck was coming your way because you were mean to someone, thank your primordial ancestors for your guilt complex. Ancient philosophy did little better than religion. In Plato's most famous book, The Republic, he has Socrates arguing that a virtuous person can only be found in a virtuous city and virtuous cities had only virtuous people. A just person could not exist in an unjust world, nor an unjust world exist when people acted justly. Aristotle, in his books Eudaimean & Nicomachean Ethics argued that only a virtuous person could be happy. Aristotle also observed that happiness is an activity, not an object. One could "be happy," but one could not "have happiness." Having possessions or money could not make one happy, one must be able to love or be happy first and this depended on being just and virtuous. The Stoics argued virtue and happiness were united, so that even someone wracked with a disease or tortured on the rack could be happy as long as they remained virtuous. Others could take your possessions, but they could not take your virtue. Epicureans argued that virtue was to avoid pain and pursue pleasure was virtuous; if it made you feel good, it could not be wrong.

3.1 BOOK OF JOB A critical break in this line of thinking is the Book of Job. Even if you are not religious, this story is worth reading and knowing because it is among the first "modern" stories. It tries to explain why bad things can happen to good people and why bad things exist in a world that was created by a just, all-knowing, all-powerful god, or, for our purposes, why can bad things happen to good economies. The story begins with the devil, having travelled the world, plopping down on god's couch in heaven. God asks the devil if he had seen his good servant Job on his journeys. In a modern setting, I visualize this as the devil as some stoner-slacker who comes home after curfew to be confronted by an impatient parent, played by god. Devil: "I'm home" God: "Why can't you behave like your older brother, Job?" Devil: "Dude . . . why you bustin' my cabbage patch?** . . . Job only does what you want because you gave him the keys to the Audi, the latest model Blackberry, and tickets to the Warped Tour, not to mention that no-limit credit card. If you took those away I don't think Mr. Goody-Goody Two-Shoes would act so nice." God: "I don't think so . . ." Devil: "Wanna put your money where you mouth is?" God: "Deal" **An homage to the movie Chasing Amy

So god and the devil make a bet. The devil can do anything he wants to Job except kill him and if Job curses god, the devil wins. So the devil afflicts Job with disease and sores, destroys all his flocks and fields, and has lightning strike his mansion killing all his family inside. Act II shows Job as a homeless beggar living off the streets. His remaining friends come to visit him and urge him to repent, thinking like all early people that bad luck resulted form bad behavior. He must have done something really, really, really wrong for god to have sent this much bad luck his way. Job argues that he has nothing for which to apologize. Act III has Job, unaware of the wager between god and the devil, a little fed up with god and begins to question the divine wisdom and justice. God replies, like many parents do when teenagers think the world is unfair, 7


"I brought you in this world, I can take you out. Who are you to question my judgment?" The story ends with the devil losing the bet and God restoring Job's possessions. Meanwhile, in Greece, similar stories like Oedipus, Agamemnon, and Medea give rise to the Tragedy ("goat songs") which also try to explain why bad things happen to good/great people -- although these also usually identified an original sin (often, pride -- hubris) as the impetus for the tragic storyline. In a famous book titled The Birth of Tragedy, the scholar-philosopher Friedrich Nietzsche -- who plays a major role in creating the modern world we live in -- explains as the combination of the orderly world of Apollo where virtue and happiness are united with the chaotic, irrational world of Dionysius. Meanwhile, Plato writes Euthyphro asking the impertinent question of whether god likes good behavior because it is good, or, is it good behavior because God likes it? While Job’s story has little to do directly with economics, it does represent a break in how humans thought about morality in practice: acting virtuously was no guarantee of material welfare and misfortune was no indicator of personal virtue. Once the two are separated, the investigation of practical -- “economic” -- human behavior, such as, “How can I increase my household’s income?” becomes thinkable. It also subjects god (nature) to the “rationality” test: god is god because he is uber-rational. In the earliest myths, legends, and religious texts, gods are emotional and impulsive: they play tricks on humans, they have temper tantrums (like flooding the world when they are displeased), and are moody and fickle, but from the Axial Age on, the “rationality” was the litmus test. This elevated rationality into a cardinal virtue and the rationality assumption in economics is an intellectual descendant of this view: the more rational you are, the more you are like god, the more you are like god, the more virtuous you are. In addition, the standard economic assumptions that humans are omniscient (“perfect information”) and instrumentally rational (“efficient”), can be re-read as “if humans were more like god, the economy would behave . . .” In addition, if god is rational, rationality becomes the measure of ethical behavior: “Sure I would like to help the poor, but the policy is inefficient, so ‘no can do.’” 8


3.2 MODERN MORALITY The Middle Ages saw the rise of what is known today as a "moral economy." In bad times, Lords took less from their serfs and vassals, people should receive a "just and fair wage," and it was immoral to lend money with interest ("usury"). The contemporary arguments that criticize Wall Street because they do not produce anything tangible, or fault companies for shipping jobs overseas to exploit workers in the 3rd World and destroy the environment are modern versions of this way of thinking. Economic relationships were embedded in moral and ethical relationships. Virtue and Happiness were again one. However, beginning with the Renaissance, various thinkers began to doubt this conventional wisdom. Machiavelli famously argued that the "end justifies the means," suggesting that virtue was unimportant as long as the result was good. For example, if everyone in a class received an "A" provided one person received a "F" Machiavelli would say that the collective benefit justified the injustice to a single person. In addition, some have argued that torture is acceptable as long as the information saved lives. Whether one is Machiavellian or not, Machiavelli's point was that virtue and happiness are separable and must be calculated separately. Later, French social critic Bernard de Mandeville wrote a long poem entitled the Fable of the Bees that described a hive of selfish and immoral bees who were nonetheless better off because each pursued their own self-interest. When an outsider tries to impose morality on the hive, they soon find themselves in penury. The formula of "privates vices, public virtues" became a common theme of the Enlightenment. Finally, the social contract theorists such as Locke, Hobbes, and Rousseau countered the conventional wisdom supporting the divine right of kings. God appointed the King and so the King's interests were also the public interest which was also the best interest of the King's subjects. The idea of a social contract, where the people could replace an unjust or incompetent king, implied that the public interest and the private interest were not the same. These ideas matter to economics because until one can distinguish happiness from moral behavior, economic choices are the same as moral choices. Just do what you are told. Similarly, until one can distinguish the public interest from the private interests of individuals, there is no reason why one should not listen to a wise philosopher-king or government planner instead of your own determination.

4.0 CAPITALISM: ADAM SMITH’S GREAT LITTLE IDEA Many credit Adam Smith as the founder of modern economics and his 1776 book, The Wealth of Nations, outlined the main features that would define of the modern world. The Wealth of Nations is a classic -- a book that everyone refers to and few have actually read. Most of the "good stuff" is found in the first few chapters where he identifies three key elements of modern capitalism: the Division of Labor, the "Invisible Hand," and the "Labor Theory of Value" (LTV). Capitalism is an economic, not political, system and is consistent with both large and small, strong and weak, democratic and undemocratic governments. While Smith criticized 9


Mercantilists for equating the national welfare with the balance of trade, Smith provides many instances where regulation is beneficial and necessary to promote economic welfare. However, first we should explain the three legs of the capitalism’s “stool.”

4.1 DIVISION OF LABOR Smith argued that gains in economic productivity were the result of the division of labor, akin to the idea of teamwork. One player cannot do everything, even if they are the best in every area. Each player must play their role in order for the team to succeed. Each production process is broken down into many different tasks and each worker specializes in that task. For example, if the job was assembling a bike, one worker would put on the wheels, another would apply the chain, another would cast the frame, another provides the raw materials, and so on. Each worker improves their skill at their given task. No one loses time changing from one task to another and every one uses the specific technology to accomplish their task (a screwdriver can be used as a hammer, but it is much better used as a screwdriver). Workers organized by a division of labor are much more productive than each would be alone (Economic Insight # 2: The whole is not the sum of the parts). The advantages of the division of labor can be seen if we compare the modern industrial mode of production with the way things were done previously. Before the Industrial Revolution, most people were independent farmers living in small, but selfsufficient, villages. They not only grew their own food, but they also made their own clothes, built their own houses, provided their own entertainment, and make their own furniture. While premodern individuals were no doubt more skilled and intelligent than their modern counterparts -- a point made by Jared Diamond’s book Guns, Germs, and Steel -- the reason that Europeans "have more cargo" is that while it is difficult to be a good farmer, cook, carpenter, seamstress and entertainer, it is much more difficult to be proficient at all at the same time. It is critical to note how revolutionary Smith’s suggestion that the “wealth of nations” lay in the organization of production. Previously, Physiocrats held that a nation’s wealth in its natural endowments and particularly its ability to maintain food production. Others thought the accumulation of precious metals, particularly gold, was the key to riches. Still others, such as Montesquieu, pointed to cultural values (and implicitly race) as the source of wealth through the mechanisms of government under the influence of varying climates and geographic circumstance. In short, wealth and welfare were not under human control, but Smith proposed that they were: anyone could adopt the division of labor, regardless of resources, culture, or monetary wealth. 10


4.2 THE INVISIBLE HAND Even if the division of labor makes us much more productive, we still may produce too much of something we do not want, like pollution and too little of something we do want, like underwear. Don't laugh, in the 1980s, there was a high level economic meeting in the Soviet Union to discuss the production of women's nylon stockings. If too many people make cars and not enough people make food, the consequences could be dire. After the Great Leap Forward (1950s), 20 to 30 million Chinese died of hunger because farmers were given orders to operate small iron furnaces instead of growing food. The Great Leap Forward made China much more productive, but not in the things people wanted or needed in the proper proportion. Additionally, if people can choose what they want to do, what is to prevent too many people becoming doctors and teachers and not enough becoming engineers or nurses? In the past, most people did not have to worry about these decisions; they just did what they were told. Under the caste system, you did what your parents did and most other places did the same because of custom and tradition. Under European feudalism, vassals and serfs did what they were commanded to do by their lords. Most societies placed a high moral and ethical value on performing one's given role: Warriors should be Warriors; Bakers should be Bakers; Farmers should be Farmers -- and these divisions were enforced by dress codes, manners of speaking, and guild restrictions. Pity the Farmer who had the temerity to wear purple! While these mechanisms were adequate for simple, agricultural societies, they probably were inadequate for complex, industrial societies. Adam Smith argued that the organization of economic society was coordinated by a price system, the "Invisible Hand." Individuals did not provide goods and services because they were running a charity operation, or serving a social function, or driven by a moral or ethical code, or following an authority’s orders. They did it because they pursued their own self-interest. The Brewer, Baker, and Butcher did not provide us food because we are hungry, but to increase their own wealth. They do not wait for direct orders to produce: cattle ranchers in Oklahoma do not call New York restaurants to see how many prime rib steaks they require. They plan via signals of the price system. The hungrier I am, the more I am willing to pay for food, raising the price of food and signaling the profitable opportunity to producers. If the price becomes to high, I will buy less and the price declines. No one told me to consume more or less or the farmers to produce more or less, we were all guided by the "Invisible Hand" to serve our common interests. To have reliable prices, markets are necessary, where our "natural propensity to truck, barter, and trade" allows mutually beneficial exchanges. In addition, because we bear the full costs and benefits of producing and consuming, we will all make better decisions about how to use our limited resources to satisfy some of our unlimited wants (Economics Insight # 1: There is no such thing as a free lunch). 11


4.3 THE LABOR THEORY OF VALUE The third element of Smith's model of capitalism is the Labor Theory of Value. In short, he argued that the value of any item was equal to the amount of work that went into producing it. For example, the value of wood is not its intrinsic usefulness; it has no value until a person chops down the tree and carries it to market. Labor, measured in time, determines value. The relative value of two items could be found in the ratio of labor used to produce them. For example, if an ounce of gold took 40 hours to mine while a bushel of corn took only 1 hour to harvest, then one ounce of gold should purchase 40 bushels of corn. For Smith, and most early economists, value derived from input costs. If a worker was more productive, they commanded higher wages. This does not mean that everyone's time was equal and not everyone produces tangible commodities (i.e., teachers, inventors, doctors). Part of production costs is time spent in training and education. In this manner, Smith's thinking was entirely conventional for a late 18th century Scot. John Locke (although not a Scot) had written about the creation of property resulting from the admixture of labor with natural resources, hence governments existed to protect "life, liberty, and property." However, Smith had a problem. In 1776, it was all too clear that many individuals did not have control over their own labor. Slavery persisted in most Western European countries and their overseas colonies. In Eastern Europe, serfs had yet to be emancipated. As a result, it was common for early advocates of capitalism to be strident abolitionists. Perhaps the greatest example of this was the support of the Manchester and Liverpool textile workers for the Union during the American Civil War. They were adversely affected by the cotton embargo of the South, but they realized that workers could not be free anywhere unless slavery was abolished everywhere. In addition, many historians view the American Civil War as a conflict between the industrial, capitalist North and the agricultural, semifeudal South and not about slavery, union, etc. commonly discussed in American history textbooks. The LTV is usually contrasted with market (scarcity) and "adding-up" theories of economic value. In market theories, prices (and therefore value) are set by the "Laws of Supply and Demand" where the intersection of the supply and demand set prices. Marginal analysis and the use of supply and demand curves were not available to Smith. The "adding-up" theory argued that an item's value equaled factor inputs: land (a.k.a. natural resources), labor, and capital (machines, technology & money). Sum the inputs is the cost of the new commodity. There are problems: just because an item took more raw materials, more labor, greater investment and craftsmanship does not mean empirically or normatively that their compensation will be commensurate. The other key implication of the labor theory of value is the need for property rights. Individuals must have control over their labor for them to deploy it well. Therefore, there must exist a political and legal system that defines rights and obligations (rental contracts, wage agreements, titles, leases, etc.) otherwise, productive exchange and use of the factors of production will be impossible. This position has been most forcefully argued recently by Peruvian economist, Hernando de Soto in his book, The Mystery of Capital. He argues that the main difference between the developed and developing world is the strength of property rights.

5.0 CLASSICAL ECONOMICS: VICE AS VIRTUE While earlier thinkers argued mainly that virtue was irrelevant -- there was no relationship -- the Classical 12


economists went even further. Not only was vice permissible, it was downright desirable. Previously, good ends could come from bad means. This was not a case for vice. None insisted on greed or dishonesty or violence; they only noted that methods must be evaluated by their goals. However, the Classical economists of the early 19th century England began to make the case that vice was virtuous and behaviors and decisions that would normally be beyond the pale were not only acceptable, but praiseworthy. This analysis all derived from the "no such thing as a free lunch"notion. If you did something charitable, like give a hungry person a meal, you were taking food away from someone else. If you gave one student a grade better than their performance or abilities you were harming some other student who should have received that mark. Poverty was good because it taught self-reliance; misery and war were good because they checked population growth. While not the full-Gordon Gekko, many of the contrarian notions about self-interest, selfishness and greed being positive values have their origins in the conclusions of the Classical economists. Economics turned the standard of morality from “love thy neighbor” to the “forgotten man.”

5.1 MALTHUS & THE DISMAL SCIENCE The first of the these classic economists was Thomas Malthus, who wrote his Essay on Population in 1798. Since we will cover Malthus in detail later, a few words here will suffice. Malthus observed that resources (i.e., food) grew arithmetically, while population grows geometrically (exponentially, think bunnies). Eventually, we would overshoot the earth's capacity to provide our sustenance. Malthus had noticed that while England had, due to the Industrial Revolution, quickly became the richest nation in the world was also witnessing widespread penury. At the time, there were generous poor laws that provided food and shelter for the unemployed. Malthus argued that this policy was mistaken. If individuals could not provide for themselves, they should not receive assistance from others or the government. This food was only coming from someone else's table. Plus, it would invite "moral hazard," i.e. if you give someone food for free, they have no incentive to work for their own food. This would lead to less food being produced, more mouths to feed -- a sure recipe for environmental degradation and disaster. All modern environmentalists from Paul Ehrlich to Donella Meadows owe Malthus a great deal of their view to his analysis. Anyone who uses the word "sustainability" conjures the ghost of Malthus. Ultimately, our unlimited desires would run afoul of our limited resources. Therefore, we must be willing to be heartless now to save millions later.

5.2 RICARDO & ECONOMIC NATIONALISM Another classical economist was David Ricardo, who took many of Adam Smith's insights and expressed them in mathematical terms, examined the problem of trade and specialization. At the time, England placed high tariffs, called the "Corn Laws," on foreign food because the powerful English nobles owned most of the land and stood to benefit from forcing English workers to buy food grown on their large estates (think of Irish peasants subsisting on potatoes leading to the Great Irish Famine). Politicians called upon Englishmen to "Buy British" and not buy cheaply produced French and American grain. This lead to high food costs and high wages to pay for basic necessities. This is similar to current policies that urge use to "Buy American" and not cheaply made Chinese goods, however, the best current example are the high Japanese tariffs on imported rice. A 5 lb. bag of rice in Japan can cost $50 to $60, while it costs less than $5 in the US. Japanese politicians claim that the Japanese have "unique" stomachs that cannot digest foreign grown rice. Above and beyond these claims, these policies protect domestic workers and most people would rather protect the jobs of their countrymen than foreigners. 13


However, Ricardo argued that countries should not keep out foreign goods. If the English could buy cheap foreign grain they would have more money to spend on other things made by English industries. This may be bad for the landed English nobility, but it would be good for England. The video below gives a brief overview of Ricardo's ideas.

6.0 MARX ATTACKS The greatest critique of Classic economics was by a German journalist and political activist, Karl Marx. By the time that Marx wrote his major works in the 1840s and 1850s, the Industrial Revolution was in full swing. Marx, at the time, spent a lot of time in the British Museum’s reading room reading the works of Smith, Malthus, and Ricardo and concluded that, for the most part, they were all wrong. While it is common today to portray Marx as a revolutionary trying overthrow the status quo, but his criticism of capitalism and economics was quite traditional. Marx is often misquoted and misunderstood and many of the statements attributed to him come from either a) that few today read Marx because his prose is dense and his vocabulary opaque and b) willful misreadings. Perhaps the most common misinterpretation is the slogan of “from each according to his means and to each according to needs” suggesting radical equality and redistribution. What this quotation often leaves out is that Marx wrote in his Critique of the Gotha Programme that “our banner SHOULD NOT read from each according . . .” [emphasis added]. Marx appreciated the need to concentrate capital and invest, and despite his reputation, saw capitalism as a progressive force in world history. In the end, Marx was a first-rate journalist, a first-rate political scientist, a second-rate economist, and fourth-rate revolutionary. Many themes swirling in the winds today have their provenance in Marx’s ideas such as globalization, materialism, the growth of the state/public sector, and the socialization of risk and investment. To appreciate Marx’s perspective, it is necessary to separate him from the 20th century revolutionary movements that employed his economic (not political) theories, from Marx the observer of mid-19th century capitalism and his critique of Classical economics. Marx attacked the foundations of modern capitalism -- the division of labor, the "invisible hand" market system, and the labor theory of value -- laid out by Adam Smith. Marx thought modern capitalism was a "stark utopia". It was a utopia because it would enable humans to produce more than ever thought possible and we could escape persistent poverty and penury, but it was "stark" because while we could make paradise, we would never be able to enjoy it. Unlike Smith, who was writing at the beginning of the Industrial Revolution in the late 18th century, Marx was able to witness the growth of industrialization and urbanization and its immiseration of workers. Capitalism, in Marx's view, would turn us into cogs of a machine and eliminate our humanity by either turning us into brutish beats or soulless Naz-gul, not to mention it would probably destroy our planet, invite war and social conflict, and many other bad things in the process.

7.2 DIVISION OF LABOR v. ALIENATION Smith praised the division of labor because its ability to make human societies more productive. Marx, however, thought it would produce alienation. Marx observed that under the division of labor no one would actually make anything. We would only be a part of the process. We could not look at our work and be proud of it because we could not claim it as our own. For example, as a teacher, our "work" are students, but each individual teacher only produces a "part" of the student's education. We cannot claim the finished product as our own. We would become "alienated" from our work, merely replaceable cogs in a machine that capitalist managers would toss away and replace when they became worn out. 14


The larger social problem would be that we would create an "autistic" society of social morons who only understood our specific tasks, but could not relate to others, except through anti-social behavior. Think Pink Floyd's "Another Brick in the Wall," Green Day's "Longview" or The Who's "Quadrophenia" as examples of where Marx thought we were going. We can relate to things, but not people. We would only care about our little corner of the world, but unable to see the world as a whole. Later writers would extend this idea, in part, to the sphere of moral and political accountability, most famously by Hannah Arendt in her commentary on the Adolf Eichmann trial. Arendt worried that “evil” had become banal. Eichmann, the Nazi bureaucrat responsible for making the railroad timetables that sent Jews and others to concentration camps, had eluded capture after WWII. However, in the 1960s, he was captured by Israeli agents and put on trial in Jerusalem. His defense was that he was merely “following orders” and doing his job to coordinate rail traffic; he was not a war criminal, he was merely part of the “division of labor” that engineered the Shoah. Eichmann, according to Eichmann, did not think about the consequences of his actions; it did not matter if it was people or cattle, railroad schedules were railroad schedules. The problem of moral responsibility in a capitalist economy with an advanced division of labor is twofold. First, individuals no longer feel responsible for their actions, no matter how heinous. While some advocates call attention to these issues, most do not consider how their casual drug use leads to gang violence and poverty in Latin America, care whether their food or lifestyle is environmentally responsible, whether their clothing is produced with child labor or not or the civilian casualties of war. We are alienated from our actions and can plausibly claim that “it is not our fault” even to ourselves. George Orwell noted the problem in one of his essays: As I write, highly civilized human beings are flying overhead, trying to kill me. They do not feel any enmity against me as an individual, nor I against them. They are ‘only doing their duty’, as the saying goes. Most of them, I have no doubt, are kind-hearted law-abiding men who would never dream of committing murder in private life.

It also makes it more difficult to hold individuals responsible because responsibility has become diffuse. Under a division of labor, everyone is responsible and therefore, no one is. The best example is the 2008 Financial Crisis: great harm was done to a wide spectrum of innocent people, but there have been few prosecutions and widespread, multidirectional fingerpointing. In short, everyone: homeowners who took out large mortgages and purchased properties they could not afford, banks and financial institutions that took advantage of their clients, government regulators who looked the other way, legislators willingly under the thrall of lobbyists and special interests, developed nations with export-oriented currency manipulation, the “lapdog” media, and academics in relevant fields sold their expertise for money or did not speak up could be held partly responsible, but few have been held to account, wholly or in part. As a result, people direct blame at anonymous, amorphous entities: corporations, government, unions, or banks, instead of individuals. Although later writers questioned Arendt’s details of the Eichmann case, experiments such as Milgram’s “obedience to authority” and the Stanford prison experiment indicate that the point may still be generalized. Another aspect is the social impact of meaningless work. While the Division of Labor solves the “economic problem” of scarce resources, it spawned new sets of need, described by Maslow as “self-actualization.” The “identity politics” that began in the late 1960s and flourished in the “me” generation fo the 1970s ranging from religious fundamentalism, the women’s movement, LGBT liberation, the environmental movement, multiculturalism, the sexual revolution, new age spirituality all reflect the desire to assert and affirm personal identity against social pressures to conformity and uniformity of the previous postwar decades. In addition, the rise of the internet allows individuals to form self-selected identity communities that foster “bonding” social capital at the expense of “bridging” social capital. The concern raised by sociologist Emile Durkheim about the anomie of modern social life under the division of labor remains relevant.

7.3 INVISIBLE HAND vs. EXPLOITATION Marx’s second group of criticisms regarded Smith's "invisible hand." Smith, as was common among philosophers of the Scottish Enlightenment, believed in the natural harmony of human interests. The invisible hand coordinated individual self-interest to produce the common interest. For Marx, raised in the Hegelian 15


dialectic, saw history as the result of class struggles. There were always haves and have nots and one group exploiting another. The class who controlled the “means of production” In the Ancient World, it was masters over slaves; in the Middle Ages, lords exploited serfs, and now capitalists, who owned the factories would exploit workers. Applying the LTV, Marx inferred that social inequities under capitalism were due to the extraction of workers' surplus value through the circulation of capital. Therefore, workers did not reap the full compensation for their value added to production. Marx did not see this process of “evil” capitalists, but the product of historical laws of economics and class struggles. Marx believed that the capitalists would be their own “grave diggers” because the process of capital accumulation would lead to a decreasing efficiency of investment causing more hoarding of capital and less investment and growth. In this way, Marx shared the pessimism of later Classical economists such as Ricardo and Malthus, even while criticizing them in other ways. The key insight of Marx was to note that the terms of exchange between workers and the capital were not equal. It could not simply be analyzed as a technical question of production, but the power relationships inherent in economic activities and the structure of the economy should be scrutinized. To paraphrase E.E. Schattschneider, the flaw in the capitalist heaven is that the “heavenly chorus sings with a strong upper-class accent.” The debate over capitalism stills turns on whether its power to increase production raises more out of absolute poverty outweighs the social inequities generated by the capitalist organization of the economy. The second issue for Marx was the distinction between use values and exchange values of commodities. The use value is the intrinsic value an item has when "in use," i.e., the value of a hammer is its ability to drive nails. The exchange value is the price it commands in a market. The best example this is the demand for branded or designer merchandise. It has the same "use value" as generic merchandise, but individuals put a higher "exchange value" on the item because of its association with a brand. Marx thought this would a) fundamentally gum up the operation of the system because there was no objective system of determining value, and b) it would make us all materialistic or engage in “commodity fetishism.” If exchange values became the basis for economic valuations, price, rather than reflecting the underlying use value of commodities, would become the insecure anchor of economic transactions. Ultimately, we would treat everything like an economic commodity -- instrumentally -including human affection and human themselves. Labor would simply become one of many costs of production instead of the purpose of the production itself, resulting in a warped social morality.

7.4 FREE LABOR vs. WAGE SLAVERY The final axis of Marx's attack was on the LTV and the classical defense of free labor. Yes, Marx wrote, the institutions of slavery and serfdom had dissolved, but only to be reconstituted in capitalists exploiting wage 16


laborers. The form had changed, but the pattern of class conflict recurred. A famous study called Time on a Cross by Nobel Laureate Robert Fogel found that the nutritional level of Irish-American wage laborers in Boston was lower than for African-American slaves in the South before the American Civil War. This does not mean that slavery was not abhorrent, but that factory wage-laborers also did poorly and not sharing in the benefits of capitalism. For the capitalist factory owner, worker were disposable inputs, to be used to exhaustion and then replaced: there was no need to maintain the worker above subsistence. In contrast, a slave was a productive asset to the Southern plantation owner and maintaining this asset -- by feeding them well, for example -- made more economic sense.

At the time, many debated the real difference between “renting” oneself for a wage and “selling” oneself into slavery or indentured servitude. While this may seem apparent today, it was not for many in the 19th century. In addition, while many nations modernized their labor laws and institutions due to the social revolutions of the 19th century in Europe, the US maintained the English common law framework that enshrined the “lordservant” and “master-apprentice” relationships from the Middle Ages in contemporary labor law. At least in the US, this questions the reality of “free labor” and “freedom of contract.” In particular, Marx commented on the “double-freedom” that enabled modern capitalism. Workers had to be “free” from feudal obligations to purse the most productive and profitable occupations and they had to be “free” of the means of production (capital) to compel them to sell their labor -- and only their labor -- to those that did. Marx describes the inherent tension in his chapter, “The Working Day.” The capitalist, having “purchased” the labor, had an interest in maximizing the amount of work and therefore pushed for a longer “working day” and viewed “breaks” as theft or breach of contract. Workers, knowing that these conditions would shorten their “working life” argued that this would reduce the quantity of the good they could “sell” in the labor market. Both the capitalist and the worker’s claims are just in economic terms, the “tie” is broken by power of social relations. Before the Industrial Revolution, most households were self-sufficient: they grew their own food, built their houses, and made their own clothes. Now, crammed into small tenement apartments in cities, they depended upon earning money by working for someone else to provide for the basic necessities of life. They lived to work and did not work to live. Like animals raised for slaughter, capitalism condemned many to work 18 to 20 hour days, six or seven days-a-week simply to stay alive. In the end, Marx observed, this is not a humane way to organize society or the economy. In addition, workers were more dependent on wages than before. They could not, as they had as farmer-peasants, grow their own food, make their own clothing, build their own shelter, but depended on earning a wage from another to support themselves with the basic necessities of life. 17


8.1 RELIGION & THE MORAL ECONOMY Marx was an atheist and famously described religion as the "opiate of the masses." However, many religions shared his critique of capitalism. Most religions preach a version of communism, sans atheism. Most religions command us to share with the “widow and orphan,” to care for the less fortunate, and remind us of the emptiness of material riches (Sic transit gloria mundi). For example, one of the Islam’s pillars is zakat: the duty to give money to charitable causes and from Christianity there are norms of noblesse oblige, i.e. that rich people are responsible for providing for those less fortunate than themselves. Andrew Carnegie, the famous robber baron, wrote a tract called The Gospel of Wealth where he expressed his belief that someone who died rich had failed. For most of the Middle Ages, as dramatized by Shakespeare in The Merchant of Venice, usury, or lending money out at interest, was a sin. In Ancient Judaism, there was the year of jubilee that occurred every 40 years ( = one generation) where all land would be pooled and redivided equally so that inequities would not grow or be permanent. In most Asian religions, there is a decided indifference to wealth and merchants (and their family) were held in low esteem. Buddhism taught that attachment to material things (including wealth) was the cause of all suffering and Westerners chimed in with the notion that money was the root of all evil. Religious clergy in both the East and West tooks vows of poverty. For purposes of illustration consider these following passages from the Judaeo-Christian-Islamic Tradition: "It is easier for a camel to pass through the eye of a needle than for a rich man to enter the kingdom of heaven." "Blessed are the poor, theirs is the Kingdom of God." "Hearken to this, you who swallow up the needy and cut off the poor of the land. You who purchase the poor with money and the needy in order to inherit them and the refuse of the grain we will see. The Lord swore . . . I will never forget any of their deeds. Shall not the land quake and its inhabitants be destroyed? yea, it shall rise up wholly like the rain cloud and it shall sink like the river of Egypt."

8.1 WEBER, THE PROTESTANT ETHIC & CAPITALISM However, something happened on the way to the rapture. Beginning with the Protestant Reformation (and the rise of the heterodox Mohist sects in China and what sociologist Robert Bellah called "Tokugawa Religion" in Japan), the relationship between the eternal and the economic changed. Instead of stunting economic development, certain strands of Protestantism seemed to encourage profit-seeking behavior. This theory, popularized by famous German sociologist and economic historian Max Weber, argued that the tenets of Calvinism (a.k.a. Pilgrims and Puritans) was particularly conducive to the development of capitalism. In a study titled The Protestant Ethic and the Spirit of Capitalism, Weber argued that the Calvinist belief in predestination made them desperate for signs that they were among the elect. They could not change the final outcome, but they could find evidence to “read god’s mind” in their material prosperity. Those that God favored would enjoy earthly success as well. As a result, these new age religionists equated work with prayer, taking the Benedictine Rule “laborare est orare” – work is prayer – to its logical extreme and secularizing it. They wanted to earn money, but not spend it, leading to capital accumulation. In addition, because the foundation of faith was a human text and not the clerisy, it required a literate population, also a precondition for Smith’s division of labor. Finally, obsessed as they were with their own salvation, they became compulsive calculators – “time is money” and “idle hands make for the devil’s work.” They pioneered the mechanical clocks that made it possible to measure time – and hence effort – to the smallest increment. Before the Protestant Reformation, religious buildings had bell towers, or minarets in the Islamic world, but afterward clock towers replaced the 18


approximate time keeping of bell towers and minarets. Clocks are important to the development of the modern economy for two reasons. First, clocks are the epitome of the mechanical engineering and clockmaking cultures, such as the Netherlands, Switzerland, and Japan, will likely have the mechanical aptitude to develop the machines and machine tools needed for industrial production. It is not accidental that the only Western good the Chinese Qing Empire showed interest in were cuckoo clocks. Second, mechanical clocks allow people to measure labor in terms of time, enabling the compensation of labor based on time duration. Although later scholars challenged the specific empirical case made by Weber, there is some evidence for Weber’s broader theory linking cultural values and economic development. Areas strong in Calvinist Protestantism were at the fore of the Industrial Revolution: Scotland, Switzerland, and the Huguenots, the Pilgrims/Puritans/ Congregationalists of the New World were all descendants of this strict form of Protestant Christianity. So, instead of religion being a barrier to economic development, it became a midwife.

9.1 LAISSEZ-FAIRE & SOCIAL DARWINISM The latter half of the 19th century witnessed the rise of Darwinian biology, Victorian social mores, the expansion of Western overseas empires, and laissez-faire economics. These are not unrelated developments. Although laissez-faire economics has its origins in Classical economics, the late 19th century saw the addition of an element absent in previous formulations: competition. For the Classical economists, markets were primarily informational mechanisms that conveyed messages to producers and consumers. The presumption was that there is a harmony of interests and the market acted primarily as a coordination device to facilitate the pursuit of mutual or common interests. The Darwinian concepts of “natural selection” and “survival of the fittest” provided a different gloss to the operation of markets. Instead of coordination and communication, markets were selection mechanisms that winnowed the “random mutations” of good choices and products from the bad, allowing only the “fittest” to survive. Markets worked due to the dynamics of competition. In addition, emphasis from placed on the progressive nature of social evolution. Competition was necessary for societies to grow by selected only those who were best adapted to survive and reproduce. The biological basis of Darwin’s theories also supported the notion that competition was the natural state. Any “unfair advantage” distorted the process of social evolution produced by markets, and therefore, governments should not intervene -- laissez-faire -- in the economy to help those who could not compete. If one removed the artificial supports that enabled weaker elements of society to survive, society as a whole would have better traits and qualities passed on to the next generation promoting social evolution. Social Darwinism differed from Classical economics in another key respect. For the Classical economists, the consequence of intervention was a misallocation of resources -- waste, inefficiency, but for the Social Darwinists, the harm was the misalignment of incentives: the wrong people, products, and processes would be “selected” and social progress would be retarded. In their own view, the advocates of Social Darwinism were agents of progress. Trust and monopolies were engines of progress because they rationalized production processes; imperialism brought civilization to “unenlightened” peoples; war and trade were tests of a nation’s mettle. Of course, who received an “unfair” advantage through government policy and what traits were “best fitted” 19


depends on one’s perspective. During this period, the US pursued incredibly protectionist policies and high tariffs to protect manufacturing and granted railroads enormous land subsidies and devised the modern limited liability corporation to shield business owners from certain risks. Few advocated a consistent laissezfaire or Social Darwinist policy. What interests were protected, which risks were protected, and what classes benefited from government policy shaped the nature of capitalism in different developed nations.

9.2 POLITICO-ECONOMIC ORIGINS OF WELFARE STATES Despite the dominance of laissez-faire economic doctrines, welfare states and social insurance systems emerged from social contracts forged during this period. While all reacted to the twin developments of democratization and industrialization, the balance of interests differed from country to country. There are three basic economic factors: land, labor, and capital that also represent three social and political interests. As a factors of production, “Land” are natural resources, real estate, and quasi-rents, “Labor” is the time and efforts of workers, and “Capital” are tools, including money, necessary for production. Labor represents the interest of wage-earners. Land is the interests of farmers and rentiers including landlords, bondholders, and primary economic sectors such as agriculture and mining. Capital stands in for the interests of the investing class, including banks but also the owners of firms. Any economic product can be thought of as different proportions of these factors.At any time, one of the three factors is relatively scarce, allowing it to extract a higher return for its contribution. In response, the other two factors mobilize politically to balance the political influence and economic power of the scarce factor.

9.2.1 SOCIAL WELFARE & SOCIAL INSURANCE Social insurance protects individuals against the risks of a modern economy. Farmers and miners face the natural risks of bad harvests and fluctuating commodity prices. Workers face the risk of disability and unemployment, the need to attend to the care and raising of their children, and changes in the cost of living. Capitalists face the risks of competition from domestic and foreign firms, technological change, and runs on leveraged assets (bank runs). Welfare states provide insurance against these risks to facilitate the smooth operation of the economy. In the United States, price supports for agricultural products, subsidies for mineral discovery and extraction, and guarantees for bond and pensions insure the major risks of landed and rentier interests. For workers, unemployment insurance, Social Security, education and training programs, tax subsidies for employer-based health insurance, and maternity leave policies protect against many of the risks facing workers and their families. For investors and entrepreneurs, organizations like the FDIC insure deposits against bank runs, trade policies grant protection against unfair trade practices, and various regulatory agencies protect businesses against unfair trade or business practices by their competitors. In addition, interventions in financial markets to preserve asset prices also provide insurance against inflationary and deflationary risks.

9.2.2 TYPES OF SOCIAL INSURANCE Although classifications vary, scholars generally divide welfare states into three broad categories: liberal, corporatist, and social democratic. Liberal states attempt to provide social welfare mostly through marketbased policies, such as tax incentives, and the promotion of workforce skills, such as broad-based education and job retraining programs. In addition, welfare policies tend to be means-tested, meaning that services, such as Medicaid and unemployment insurance, are made available on a need-based criteria. Corporatist welfare states operate by giving organized groups, such as labor unions, agricultural cooperatives and trade associations, guaranteed representation and control over policies that affect their welfare that allow them to negotiate collectively for their groups interests. For example, German works councils provide labor representation on the corporate boards of companies that employ their workers. Social Democratic welfare 20


states aim at providing a minimum level of social welfare for all citizens through government programs with universal access. For example, they may provide longer maternity-leave, subsidized public and college education, and a guaranteed minimum and health insurance. They tend to be high tax states to support these public programs.

9.3 ORIGINS In the United States, the scarce factor was capital. Even in the late 19th century, land was plentiful relative to the human and financial resources of the country. Unlike Europe, there was not landed aristocracy that controlled the land. Labor was unorganized and low-skilled relative to its European counterparts. Open immigration further added to the labor supply. Capital, however, was in scarce supply, with the House of Morgan funneling European capital into American businesses. In short, capital was scarce compared to land and labor and the political battles were fought mostly between the Populist coalition of farmers in the South and West with industrial workers in the large urban centers and the financial and corporate interests of the Northeast and Midwest. This political division organized politics in the US along economic lines posing the “haves” versus the “have-nots.” It also enshrined laissez-faire and small government as governing principles, so that even when the New Deal passed a raft of social legislation, it was never as generous or comprehensive as its European counterparts. This coalition also yoked labor to farmers and Progressive reformers who shared a somewhat different social policy vision and precluded the emergence of labor as an independent and organized political force. Social policies developed piecemeal, starting with pensions for Union War veterans, and allowed the rise of private insurance provision through fraternal organizations and mutual aid societies. In central Europe, the scarce factor was labor, or more specifically, skilled labor. Labor was highly organized and radicalized in the industrial cores of many European countries. The unification of Germany was forged under Bismarck’s coalition of “iron and rye” -- Ruhr industrialists (Capital) and Prussian Junkers (Land). In Japan, the Meiji Restoration was accomplished by an alliance of Osaka merchants (Capital) and Samurai / Imperial landlords (Land). In Italy, Piedmont-Lombard industrialists teamed up with Southern agricultural landlords held power during this period. To a lesser extent, these political coalitions appeared in Latin America’s Southern Cone (Argentina & Brazil) with similar consequences. These political constellations gave social policy a decidedly conservative character. Many social welfare functions were left in the hands of religious and family institutions. It is also not accidental that many of these regimes lapsed into Fascism during the interwar period. However, they all faced powerful and rising trade-union movements and worker’s parties that challenged the status quo. Many of the social reforms, such as Bismarck’s social insurance (mimicked by Giolitti in Italy and Hara Kei in Japan) policies, were passed as measures by conservative political elites to co-opt or appease political pressures created by these movements. Division between the political and revolutionary wings of Socialist movements meant that they expanded their influence in both the 21


workplace and the public sphere. As labor evolved into “status quo” political force, they were often incorporated into shared power arrangements that gave labor organizations a voice and role in political decisions, but also preserved prerogatives and interests of conservative social and economic groups. In the countries that developed into Social Democratic welfare states, the scarce capital was often land. As small island nations (England) or near-Arctic climates (Scandinavia), arable land was in short supply, especially after the population explosion attending the onset of the Industrial Revolution. This land was often in the control of aristocratic landlords who lived off the agricultural rents of their estates. These nobles often had disproportionate political power and influence and used it to maintain their position and wealth by pursuing protectionist policies against agricultural products. The debates over the English Corn Laws is an example of these conflicts. High food prices raise the living costs of industrial workers, created wage pressures that reduced the profit for new industrial capitalists and entrepreneurs. Therefore, employers and workers found common cause in opposing the interests of the landed elites. The alliance between the Labour Party and the more bourgeois Liberal Party prior to WWI showed the continued relationship. The unity of “good government” reformers from middle-class and professional backgrounds combined with working class votes resulted in social policies that were more comprehensive, universal and publically administered than their Liberal or Corporatist counterparts. Although Labour was a pillar of the governing coalition, it was a junior partner, and not the independent and institutionalized agent of workers as it was on the European continent. While tensions remained between the interests of employers and workers, the political environment often meant that employer concerns were incorporated into the design of policies and the adversarial relationship found in other countries is muted. A key aspect of Social Democratic welfare states is that the policies are a statement of social solidarity, a political commitment that all citizens, regardless of merit or means, is entitled to material resources required for a decent life. The passage of the British NHS after WWII reflected the sense of solidarity created by the shared sacrifice in the war effort. Similarly, the passage of welfare policies in Scandinavia was intended to ameliorate underlying social conflicts. The “labor peace” and business-labor collaboration in the WWII war effort in the US also laid the ground for social legislation. As a result, the value of welfare state policies goes beyond its impact on economic outcomes alone.

10.0 NIETZSCHEAN ECONOMICS The philosopher and classicist Friedrich Nietzsche was not an economist, but his ideas had a significant impact on economic thinking through his influence of economist Joseph Schumpeter on entrepreneurship and “creative destruction” and the novelist and philosopher Ayn Rand. Nietzsche’s philosophic worldview is complex and difficult to summarize, but his concepts of the “will to power,” “supermen” (ubermensch), and the distinction between “master” and “slave” morality hold significant implications for the intersection of ethics and economics. In addition, capitalism’s seeming unique protean ability to recreate itself gives it a Nietzschean flavor. Nietzsche was less concerned with creating a new ethical system or advocating a particular set of moral values as he was interested in the origins, or “genealogy,” of our moral and ethical ideas. 22


He divided individuals into two groups: a small elite of “supermen” who created and lived by their own standard of morality and the larger “herd” who slavishly followed the ideas of others. The “supermen” possessed a “will to power”; they had a vision of the world and imposed their will on it; they did not accept the world as it is, but blazed their own path (for others to follow) and reshaped the world as a result. These “supermen” are natural masters, while the “herd” are natural slaves. “Supermen” base their morality on “excellence” and “success” -- even excellence and success in immoral ways -- and not on “good” and “evil.” For example, Odysseus could be an “excellent liar” or a “superior pillager of cities” even though conventional morality sees lying and pillaging as immoral. It was more important to be original than to be ethical. Nietzsche’s argued that the envy and resentment of the herd shamed those who possessed the “will to power” and subordinated their ethic to the Judaeo-Christian-Islamic ethic that emphasizes charity (Tzedekah, Zakat), pity, poverty (“blessed are the poor”), submission/obedience (Isaiah’s “suffering servant”; Muslim = “one who submits”), other-worldliness (“store up treasure in heaven”) and protecting the weak and vulnerable (“widows and orphans”). Conventional morality imposes the ethics of the priestly class on the ruling warrior class. For Nietzsche, only “supermen” express “sentiment,” but the “herd” expressed “re-sentiment” bringing the strong down. In the modern day, this is the purported “envy of success and wealth” or “haters gonna hate” idea. In terms of economics, the suspicion of wealth and success is rooted in the “slave-morality” of egalitarian ethics. In addition, the preference for the intelligence of experts over the “wisdom of the crowds” or “abstract” (booklearning) over “practical” (street-smarts) knowledge exemplifies the dichotomy Nietzsche draws.

10.1 SCHUMPETER & ENTREPRENEURSHIP Despite its emphasis on individual freedom, particular individuals played little role in economic thought prior to Nietzsche. Abstractions and personifications such as “capital” and “labor” and “producers” and “consumers,” generalized preferences and behavior. Marx’s capitalists behaved like capitalists, not as Andrew Carnegie, John D. Rockefeller or Cornelius Vanderbilt. There was little explicit role for innovation, technology, (sometimes explicitly so), or entrepreneurship. The impersonal forces of “supply and demand” or the “invisible hand” drove economic activity, not individual businesspersons or buyers. Influenced by Nietzsche’s ideas, Joseph Schumpeter reversed this conventional wisdom about economics and put the priority on entrepreneurship. It cannot be assumed simply because there is a need or opportunity that someone will fill it. Economic development requires individuals with “vision” such as Ford, Jobs, or Morgan, to reorder economic activity. Entrepreneurs see an opportunity, take risks, and make it happen. This is not moral or immoral, but simply successful or unsuccessful. These people are entrepreneurs. They do not simply seek conventional profits or maximize utility given existing economic structures, but revolutionize the economy through “creative destruction.” To “create” a renewableenergy economy, one must “destroy” the carbon-based one; to create “21st century education,” one must destroy traditional education. Entrepreneurs are the economic analog to Nietzsche’s “supermen”: they create their world, others just live in it. American economic vitality comes from “Yankee ingenuity,” pioneering innovation and entrepreneurship. While one may criticize the its economic inequities, its capacity for devising and implementing new products and businesses make it an engine for economic growth and development. Schumpeter also argued that business cycles are driven by waves of innovation that lead to economic productivity and growth. The chart below shows a stylized depiction of Schumpeter’s waves.

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10.2 AYN RAND & OBJECTIVISM Like Nietzsche, the writer Ayn Rand also had a significant impact on economic through her novels Atlas Shrugged and The Fountainhead and their protagonists John Galt and Howard Roark. She was an acquaintance of long time Federal Reserve Chair Alan Greenspan and has become an economic guru for many American conservatives. Rand believed that should live for their own interests and vision only and should not be required to put their talents and abilities at the service of others. Her novels pit self-made and talented individuals who face the pressures of conformity and collectivism, usually personified in their antagonists. The climax comes when the main character “goes Galt” and withholds his services and talents, collapsing the economy. The hero declares their independence and forces society to accept their terms for their contribution. In short, Rand’s protagonists embody the Nietzschean “superman” ideal who cast off the “slave morality” of their society. It divides the economy into two groups: the “makers” (“job creators”) and the “moochers” and implies that the makers are the dynamos of the economy and must be given special treatment to do their essential work. In addition, they are makers of their own moral standards and cannot be judged by those who depend on them for their economic welfare. In her non-fiction works -- Capitalism: The Unknown Ideal and The Virtue of Selfishness -- Rand outlined her philosophy of Objectivism. Objectivism argues that priority should be given to objective reality and that rational self-interest trumps other moral claims, particularly those that urge social justice or egalitarian redistribution, especially at the direction of government. In Rand’s view only unfettered capitalism is consistent with the preservation of individual egoism a prerequisite of rational thought. Rand’s influence is indisputable: in a 1990s survey by the Library of Congress, respondents rated Rand’s Atlas Shrugged as the second most influential book of all time after the Bible. As John Rogers wryly observed: There are two novels that can change a bookish fourteen-year old's life: The Lord of the Rings and Atlas Shrugged. One is a childish fantasy that often engenders a lifelong obsession with its unbelievable heroes, leading to an emotionally stunted, socially crippled adulthood, unable to deal with the real world. The other, of course, involves orcs.

10.3 VEBLEN & THE INSTINCT OF WORKMANSHIP Another key economic thinker influenced by Nietzsche, but who came to diametrically different conclusions, was Thorstein Veblen. Like Nietzsche, Veblen tried to identify the historical basis of our ethical norms and instincts and found Victorian morality with its emphasis on propriety and prudence unnatural and hypocritical. He also put his faith in a creative class of “engineers” as the drivers of human progress and economic development, but stopped short of equating material success with creativity or value. In addition, while also identifying a division of “master” and “slave” morality in human history, he largely rejected Nietzsche’s endorsement of the master morality and found much value in the feminine and nurturing dimensions of conventional morality. In addition, he questioned the value of a “work ethic” in isolation of other human goals. Veblen believed that humans were driven by an “instinct of workmanship” and not simply economic interests and incentives. In particular, engineers were not driven by profit or economic gain, but by the desire to “build a better mousetrap,” solve puzzles, and the ideal of craftsmanship. One did become more creative simply because one was paid more. In fact, the usefulness of work made it “irksome,” while individuals gladly would labor in a unproductive pursuit. For example, many students find it difficult to memorize vocabulary for school, even though they appreciate its necessity, but have little problem memorizing song lyrics. 24


Practically, Veblen was concerned about the new leadership of business enterprises and corporations. In the past, businesses were run by individuals who created them and cared about the quality of goods produced. Generally speaking, these were practical individuals whose value came from understanding the firm’s production process. Broadly speaking, engineers. However, the rise of limited liability corporations run by professional managers (accountants and marketers) changed the nature of business operations. Instead of focusing on the quality of production, they emphasizing maximizing sales and profits. The result is businesses run Dilbert-style, as shown in the comic to the right. Veblen’s concern can be illustrated by comparing a family-owned restaurant and a franchise chain. In the case of the former, the focus is on the quality of the food and service, irrespective of cost, while the franchised restaurant looks to maximize profit by using cheaper ingredients, inventory control and marketing. Veblen’s workmanship instinct can be compared to professional ethics that impose economic costs on practitioners. However, when decisions are removed from professional control, quality may decline in return for economic gain. Veblen would later lampoon the self-important pretensions of the “rich and famous” in his book Theory of the Leisure Class, reminding us that wealth and success is no good measure of intelligence, taste or economic importance. As celebrity reality TV programs repeatedly attest, fame and wealth do not improve judgment or economic contribution. As Veblen warned, many of the wealthy are as likely to be parasites as producers.

11.0 KEYNESIAN REVOLUTIONS Two principles guided economic policy leading up to the Great Depression: prudence and pragmatism. Prudence meant “living within one’s means,” balancing one’s budget and never taking rash or reckless measures. In addition, prudence advised the adherence to “sound” money and finance, which in practice, meant preservation of the international gold standard, despite economic suffering. Pragmatism, the dominant public philosophy in America between the Civil War and the First World War, counseled that policies be judged by their effectiveness and efficiency, eschewing dogmatic or ideological considerations: reform, do not revolutionize. Both prudence and pragmatism made a virtue of moderation and prized cool, levelheaded,”serious,” rational thought over emotion and extremism. In practice, this meant never straying too far from conventional wisdom as epitomized by Sinclair Lewis’ character of Babbitt. Whether Midwestern middleclass morality, “bourgeois virtues,” or Victorian morality, the acme of virtuous life was providing for one’s family, paying the mortgage, mind your own business, putting a little money away for a rainy day, and never straying too far from societal expectations in one’s private or public life. The political calamity of WWI followed by the economic calamities of hyperinflation (for Germany) and the worldwide Great Depression shook the confidence both the public and elites in laissez-faire economic and social policy that dominated the previous century. In 1926, the economist J.M. Keynes would declare the “end of laissez-faire,” in 1939, noted management specialist Peter Drucker would attribute the rise of fascism to the “end of economic man,” and economic historian Karl Polanyi concurred, noting the collapse in faith in the 25


pillars of the “Hundred Years’ Peace” (1814-1914): the gold standard, the self-regulating market, the balance of power, and the liberal state paved the path for European fascism. Keynes summarized the view: The decadent international but individualistic capitalism in the hands of which we found ourselves after the war is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn't deliver the goods.

Still, when the Great Depression hit, many interpreted it as punishment for moral failing. As Herbert Hoover recalls the view of his Treasury Secretary Andrew W. Mellon in his memoir: The ‘leave-it-alone liquidationists’ headed by Secretary of the Treasury Mellon felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: ‘Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate’.He held that even panic was not altogether a bad thing. He said: ‘It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people’

Eminent economist Joseph Schumpeter remarked that, “a depression is for capitalism like a good, cold douche.” These views echo the pre-Book of Job view that economic hardship must be the consequence of individual and collective moral failing. The suffering of the Great Depression was a necessary corrective to the “irrational exuberance” and excess of the Roaring 20s. If we all tightened our belts and atoned for our misdeeds, the economy would be humming in no time. In short: no pain, no gain. The economist J.M. Keynes challenged this view of economics. As a peripheral member of the libertine Bloomsbury Group, he was well-positioned to challenge the received morality of Victorian England. Unlike other economists of his time, Keynes saw the Depression as amenable to a technical fix -- a “dynamo” problem -- and not a case of self-flagellating belt-tightening. In short, economics was not a morality play. Keynes’ analysis was also unique insofar as it was unconcerned about the causes of the Depression. The causes were not a roadmap to the solution as much as backing up would undo running over someone with a car. The key innovation of Keynes’ was the “paradox of thrift.” In ordinary times, thrift -- savings -- is the essence of prudence. However, in a depressed economy, it reduces demand and fails to accomplish the objective of increasing savings. At the economy level, one person’s spending is another person’s revenue. In ordinary times, if one person decides to save, there is enough demand to mobilize this saving as investment without undercutting the aggregate demand for goods and services. However, when everyone tries to save more simultaneously, as is often the case in a depressed economy, everyone’s income decreases, forcing all to pare down their saving balance to finance current consumption. As a result, not only does consumption decrease, but ultimately, savings and investment also decline, leading to a high-unemployment equilibrium. Additional suffering does not solve the problem nor does it provide incentive to avoid bad behavior. During normal times, concerns about waste, fraud and inefficiency govern whether private or public enterprises should be undertaken. However, when resources are unemployed, even “make work” projects. Keynes argued that paying half the workforce to bury dollars in mines and paying the other half to uncover them would increase wealth in a depressed economy. He observes. “Wasteful” loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if . . . classical economics stands in the way of anything better. It is curious how common sense . . . has been apt to reach a preference for wholly “wasteful” forms . . . rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict “business” principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world . . . is the most acceptable of all solutions. If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again . . . there need be no more unemployment and . . . the real income of the community . . . would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. The analogy between this expedient and the goldmines of the real world is complete.

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Mammon & Morality  

Draft Chapter of HS Economics Text. No copyright asserted

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