Blogroll: Mises Institute
I read blogs, as well as write one. The 'blogroll' on this site reproduces some posts from some of the people I enjoy reading. There are currently 244 posts from the blog 'Mises Institute.'
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Steven Kates is an Australian economist and the author of Say's Law and the Keynesian Revolution: How Macroeconomic Theory Lost Its Way and Free Market Economics: An Introduction for the General Reader, now in its third edition He has long been a perceptive and unrelenting critic of current Keynesian-style macroeconomics and an unabashed defender of Say’s Law. In addition he has composed a modern version of classical economics that focuses on prices, profits, and the entrepreneur as the motive forces of economic efficiency and sustainable economic growth .
I am happy to report that Kates has just published a timely and lucid little pamphlet, I, Mechanical Pencil: Why a Socialist Economy Can Never Work, which as you may have guessed from its title, is inspired by Leonard Read’s classic essay “I, Pencil.” The narrator of Kate’s piece is the mechanical pencil that is a descendent of the simple pencil in Read’s story and owes its existence to the economic progress that an unhampered market economy brings about. According to the mechanical pencil, its ancestor “just didn’t go far enough” in explaining the seemingly miraculous results of the market economy. Thus, Kates’s mechanical pencil explicitly identifies and clearly spells out the six key elements necessary for a market economy to work its magic and argues that the socialist program negates all of these elements.
Our modern pencil narrator sums up its lesson thusly:
In its own way, it’s sad that no one really appreciates just how complex even a pencil actually is. . . . But I hope that now that you have read this you will have a deeper understanding of the way our market economy works, and will never be bamboozled by anyone who tells you that you can become more prosperous by getting rid of our economic system; based as it is on entrepreneurial decision making, the price mechanism and the incentives provided by the desire to earn profits. And you should especially make sure you realise that the market economy is the source of your own personal freedom as well. Without the one you cannot have the other.
Kates’s essay stands on its own but is well worth reading in conjunction with Read’s classic essay.
Due to Jeff Bezos’ public accusations against the National Enquirer, the topic of blackmail is in the news. Tyler Cowen wrote an article for Bloomberg in which he largely took it for granted that blackmail was a bad practice, but he at least linked to a 1985 law review article by Walter Block and David Gordon arguing that the practice should be legalized (if not necessarily praised).
Continuing the discussion, over at the website EconLog, David R. Henderson chimed in on the side of Block and Gordon, and also linked to Robin Hanson , who thinks nobody has ever offered a good argument for keeping blackmail illegal. On the other hand, at the same EconLog website, Scott Sumner rejects these defenses and argues that blackmail is a socially harmful practice that the government rightfully outlaws.
In the present article, I’ll summarize and elaborate upon Block and Gordon’s case for legalizing blackmail, and I’ll point out some of the major problems with Sumner’s arguments in favor of its current prohibition.Blackmail Is Not Extortion
Although people (even some of those linked above) often conflate the terms, blackmail and extortion are distinct. As Block and Gordon use the terms, extortion refers to demanding money (or other compensation) from a victim under the threat of doing something that violates rights—such as initiating physical assault or arson.
In contrast, merely blackmailing someone only involves “threatening” to do what the blackmailer has every right to do: namely, spreading gossip or embarrassing photos, etc. From a libertarian standpoint, this is a critical distinction. Consider: If nobody would object to the legal right of the National Enquirer to publish stories about Bezo’s infidelity, and the photos that go along with the gossip, and furthermore nobody denies the Enquirer’s legal right to refrain from publishing this material, then how in the world can it be a rights-violation for the Enquirer to ask Bezos for a financial contribution to determine which of these perfectly legal alternatives it will choose?
As with other defenses of unpopular characters, here too Block and Gordon are not necessarily saying we should admire the blackmailer. We may even go so far as to condemn him morally, and to denounce him as a bad person. But from the standpoint of libertarian theory, the activity of blackmail doesn’t violate anybody’s rights and therefore should be legal in a just society.Possible Social Benefits of Institutional Blackmail
We can take the analysis further, using economics (rather than libertarian philosophy). Notwithstanding the popular revulsion against blackmail, there are actually potential social benefits that would flow from its legalization. In other words, the current policy of legally prohibiting blackmail might carry some significant unintended consequences.
First and foremost, allowing for legal blackmail contracts would probably bolster people’s privacy and reputations. Yes, it’s true that the prospect of a big payoff from a “blackmailee” would give an incentive for people to dig up dirt (especially on the rich and famous), but the whole point of digging up the dirt is to charge the blackmailee for silence.
Right now, tabloid magazines and websites have the incentive to dig up dirt on celebrities. But they monetize their gossip and embarrassing photos by selling papers (or motivating website clicks). If blackmail were legal, then they could also monetize their findings by offering to sell silence to a rich “target” in question.
For example, if a tabloid has a lurid photo of a famous musician cheating on his wife, maybe it can make $10,000 (all things considered) by publishing the photo on its front page and thereby sell more copies of that issue. (This possibility is why the tabloid would pay the amateur photographer who took the photo a sizeable amount of money for it.) But if the tabloid approaches the musician privately, maybe he would be willing to pay $12,000 for the photo. In a standard economic analysis, the “efficient” outcome is for the photo to go to the musician, rather than get published. And yet the government currently renders this “efficient” outcome illegal. In this example, far from hurting the privacy or reputation of the musician, the possibility of blackmail protects it, relative to the situation where blackmail is illegal.Blackmail, Inc.1
It’s important to keep in mind that right now, in the real world, blackmail still occurs—as the Jeff Bezos case makes clear. But because the practice is illegal, blackmail transactions occur in a murky black market. Consider: If someone approaches a famous actress with a dark secret from her past, and demands (say) $100,000 to keep quiet about it, then the immediate problem facing the actress is that even if she pays, the blackmailer might go ahead and publicize the secret anyway. Or—as so often happens in murder mysteries like Columbo—perhaps the blackmailer will keep coming back, demanding more and more money over the years.
In contrast, if the market for blackmail were fully legal, then we can imagine professional companies with name-brand recognition would emerge. They would offer bounties to the general public for bringing them “marketable” information, and then they would approach the affected parties and ask for payment. The targets of these offers would of course wish the situation never arose, but at least they could be assured by signing enforceable contracts.
For example, suppose The Truth Hurts Corp.—the companies would probably avoid unsavory names using the word “blackmail” itself—develops a reputation for impeccable accuracy in the material it publishes. Just like WikiLeaks in our world, the people in the community might disapprove of The Truth Hurts and wish it would disappear, but nobody had ever proven that it published something false. In order to maintain its reputation, the company would have serious vetting procedures in place before running with a story.
Given this track record, when The Truth Hurts approached a target, it would have more leverage than some other fly-by-night organization (like CNN). Consequently, it could demand more in payment to sit on a story—and this of course is why The Truth Hurts would be so careful in building and maintaining its reputation. Its targets would lament having to pay, of course, but they would be confident of success. Indeed, the standard contract might have a clause in which the target’s money was refunded if the secret ever came to light (whether from The Truth Hurts itself or some other organization).
Likewise, on the front end, The Truth Hurts might pay for juicy stories with a contract that said something like, “You will get $1,000 every year that the story remains silent, up to 10 years.” This would incentivize the original tipsters to keep their mouths shut, too.Informal Norm Enforcement
The interesting aspect of this system is that it would provide an informal means of “fining” people for violating social taboos. Although this might strike some (such as Scott Sumner, whom we’ll discuss in the next section) as a horrifying means of puritanical social control, we could alternatively view it as a useful mechanism of minimizing socially undesirable behavior that augments more conventional law enforcement.
For example, consider the infamous case of the comedian Louis C.K. According to him, he always officially got consent from women before engaging in his wildly inappropriate behavior. So assuming that he is telling the truth, he didn’t engage in officially criminal behavior.
Even so, most observers agree that what he did was WRONG and should be actively discouraged by social pressure, including economic incentives. In a society with a mature, legal blackmail industry, as soon as Louis C.K. started earning some real money, the women involved could have told their stories to a company like The Truth Hurts. After its internal investigators verified the allegations and were confident “something was there,” they would approach Louis and ask (say) $200,000 for every year that they sat on the story. Out of that payment, perhaps the company would transfer half to the women complainants, likewise ensuring their annual payments so long as the public never learned of the allegations.
Now it’s true, some observers might think the outcome I just sketched is a woeful miscarriage of justice, where the rich and powerful can do whatever they want and just write checks to buy off their victims. But isn’t it better than the alternative? Right now, in the real world, Louis C.K. continued for years with his aberrant behavior, until finally some of the women from his past came forward. They were promptly vilified on social media (being called all sorts of horrible names), and didn’t receive any compensation. For his part, Louis suffered a huge hit to his income and reputation, for which he will never be able to recover.
In contrast, in my hypothetical world with legalized blackmail, the women complainants could have come forward much sooner, knowing that their stories would be kept quiet. They would have gotten a healthy portion of the payment flowing from Louis. And, perhaps most significantly, Louis would have paid a hefty “fine” for his early actions, and presumably would have stopped behaving like that, if for no other reason than because it was so expensive. He could have learned from his mistakes, and then moved on with his life, without a significant portion of the public forever branding him a monster and accusing him of far worse things than he actually did.
More generally, there are aspects in which a legalized blackmail industry can effectively “internalize negative externalities.” For example, in standard libertarian theory, it’s not a crime to cheat on one’s wife, but most people think that it is a destructive social behavior that should be strongly discouraged. Well, a legalized blackmail industry would effectively “fine” people for cheating on their spouses, and it would do so in a relatively swift yet discreet fashion. It’s not a perfect system, to be sure, but it has a lot going for it that barely anybody ever considers.Sumner’s Objections
In this section, I’ll address some of the arguments economist Scott Sumner deployed in favor of the prohibition on blackmail. As we’ll see, they are quite weak.
For example, Sumner writes:
Consider that privacy and good reputations are widely viewed as being desirable. Most of us would like a bit of privacy and also a good reputation with the general public. That’s why libel and slander are illegal. Legalizing blackmail is effectively creating an industry that devotes resources to destroying privacy and destroying reputations.
Here Sumner has things backwards. Blackmail devotes resources to maintaining privacy and sparing reputations. When the tabloids get their hands on a naughty photo, the possibility of legalized blackmail lets them first offer it to the “victim.” By making blackmail illegal, the government currently makes it far more difficult for people to maintain their privacy and reputations.
At face value, Sumner’s claim would be akin to saying, “Legalizing automobiles is effectively creating an industry that devotes resources to destroying mobility and destroying transportation.”
Now in fairness, what Sumner is getting at is that with the option of legalized blackmail on the table, people will have an incentive to dig up dirt, who otherwise might not bother to do so. But as I explained in the previous section, to the extent that the “targeted” behaviors are actually socially destructive, then it’s good that society is devoting more resources to discouraging them.
In response, Sumner claims that “most blackmail involves issues of sex, gender and drugs..[L]et me just say that I believe that our society is unable to think rationally in these areas.” That may be true, but bringing in economic calculation is a way of helping to rationalize social norms. For example, hypocritical social attitudes would at least be made transparently obvious in the type of society I’m describing. Right now, with blackmail illegal as Sumner desires, people in polite society can claim to be shocked, shocked when some high-profile celebrity or politician gets caught doing something that a majority of them do as well, behind closed doors. But in a world of legalized blackmail, it would be harder for philanderers to denounce Bill Clinton (or Donald Trump) when they were currently paying monthly hush money to a company which had proof of their own infidelities.
What’s very interesting is that Sumner is a utilitarian , and yet in this case he doesn’t even attempt to justify the prohibition of blackmail on utilitarian grounds. Instead, he merely dismisses the preferences of most Americans as wrong:
I don’t want to legalize an industry that will draw in thousands of people who then devote enormous resources toward digging up dirt that destroys reputations because our sad, sick, gossip-obsessed society views those activities as naughty.
This omission is all the more striking, because in a different post on his own blog , Sumner advocates marginal tax rates on the super rich in the range of 70 or 80 percent (on consumption though, not income or wealth). Well when it comes to a legalized blackmail industry, one obvious outcome would be a redistribution of income away from rich celebrities and into the pockets of the relatively powerless people they trample over, as well as the relatively low-paid photographers and other snoopers who dig up dirt. And if the whole thing driving this process is the preferences of the majority, it’s really hard to oppose the outcome on utilitarian grounds. It seems Sumner is a utilitarian except when he founds the outcome yucky.Conclusion
The recent controversy over Jeff Bezos has spawned an interesting debate among free-market economists on whether blackmail should be legalized. Although we might find blackmail to be an odious activity from a moral perspective, in terms of libertarian theory it doesn’t violate rights and so should be legal. Furthermore, by augmenting the actual legal code, a mature blackmail industry could enact “fines” for socially inappropriate behavior that steer people in a desirable direction in a relatively efficient and discreet manner, as well as compensating those who suffer from inappropriate but legal behavior, or who are victims of an actual crime but do not want the matter publicized. The quick dismissal of blackmail as an activity that should “obviously” be illegal often rests on a very shallow analysis.
- 1. Some of the arguments I develop in this section go beyond what Block and Gordon discuss in their 1985 article, but they also wrote an unpublished paper (which David Gordon shared with me via email) that echoes some of my thoughts on how a mature blackmail industry might function.
[Found among the papers of Bettina Bien Greaves and reprinted from Plain Talk (1949), Editor's comment: Those millions of illiterate and semi-literate armed men now in action from the borders of the Yellow Sea to the mountains of Greece have been set in motion by a ponderous and little-read study of economics — Das Kapital — written nearly a century ago by a German scholar named Karl Marx. Today when Marxist theory has half of the world in an iron grip and the other half is lost in an intellectual wilderness, the publication of Ludwig von Mises' life-work, Human Action — a thousand-page treatise on economics — may well prove a history-making event in reversing the Marxist tide.
As a contemporary critic of state socialism, Professor von Mises has no peer. Famous as the head of the so-called Austrian school of economics, of which Hayek is perhaps his best-known pupil, and noted as the author of Omnipotent Government and Bureaucracy, Mises long ago predicted the rise of the police state wherever statism triumphed.
Dr. von Mises taught at the University of Vienna for a quarter of a century. A refugee from Hitler's National Socialism, he now makes his home in the United States. Anticipating the appearance of his monumental study, we asked him to write for us his own explanation of the mainspring of Human Action.]Economics versus Pseudo-Economics
There are no ivory towers to house economists. Whether he likes it or not, the economist is always dragged into the turmoil of the arena in which nations, parties and pressure groups are battling. Nothing absorbs the minds of our contempornries more intensely than the pros and cons of economic doctrines. Economic issues engross the attention of modern writers and artists more than any other problem. Philosophers and theologians deal today more often with economic themes than with those topics which were once considered as the proper field of philosophical and theological studies. What divides mankind into two hostile camps, whose violent clash may destroy civilization, is antagonistic ideas with regard to the economic interpretation of human life and action.
Politicians proclaim their utter contempt for what they label as "mere theory." They pretend that their own approach to economic problems is purely practical and free from any dogmatic prepossessions. They fail to realize that their policies are determined by definite assumptions about causal relations, i.e., that they are based on definite theories. Acting man, in choosing certain means for the attainment of ends aimed at, is necessarily always guided by "mere theory"; there is no practice without an underlying doctrine. In denying this truth, the politician tries in vain to withdraw the faulty, self-contradictory and a hundred-times refuted misapprehensions directing his conduct of affairs from the criticism of the economists.
The social function of economic science consists precisely in developing sound economic theories and in exploding the fallacies of vicious reasoning. In the pursuit of this task the economist incurs the deadly enmity of all mountebanks and charlatans whose shortcuts to an earthly paradise he debunks. The less these quacks are able to advance plausible objections to an economist's argument, the more furiously do they insult him.Sound Money versus lnflationism and Expansionism
At the beginning of our century the governments of the civilized nations were committed either to the so-called classical gold standard or to the gold exchange standard. Their conduct of monetary and credit policies was, to be sure, not free from mistakes, and they indulged in a certain amount of credit expansion. But they were, when compared with conditions after 1914, moderate in their expansionist ventures and spurned the fantastic projects of the so-called monetary cranks who advocated boundless inflation and credit expansion as the patent medicine for all economic ills.
Yet this rejection of the plans which aimed at making people prosperous through increasing the quantity of money and fiduciary media was not founded upon a satisfactory cognition of the inevitable and undesired consequences of such a policy. The governments were disinclined to deviate from traditional standards of monetary management because with the older statesmen the memory of the troubles engendered by earlier inflations had not yet been obliterated and some vestiges of the prestige of the classical economists still prevailed. Professors and bankers loathed the writings of Ernest Solvay, Silvio Gesell and a host of other expansionists. But hardly anybody knew why these authors were wrong and how to refute them. In fact the doctrines generally accepted by the treasuries, the central banks, the financial press and the universities did not differ essentially from the ideas advanced by the cranks. These champions of a sweeping social reform to be accomplished by monetary measures only drew from the official doctrine its ultimate logical consequences. It was to be expected that in a coming emergency, such as a great war or revolution, those in office would turn away from their cautious reserve and that orgies of inflation and credit expansion would be rife.
Such was the state of monetary and credit theory when I published my Theory of Money and Credit.1 I tried to construct a theory entirely based upon the modern subjectivist methods of dealing with economic issues, the marginal utility concept. I demonstrated that what at that time was called inflation and is today passionately praised under the labels of deficit spending and pump-priming can never make a nation more prosperous. It may bring about a shift of income and wealth from some groups of the population to other groups, but it invariably tends to impair the prosperity of the whole nation. I pointed out that interest, i.e., the higher valuation of present goods as against future goods, is an ineluctable category of human conduct which does not depend on the particular structure of society's economic organization and cannot be abolished by any statutes or reforms. The endeavors to keep the rate of interest below the height it would attain on a market not sabotaged by credit expansion are in the long run doomed to failure. In the short run they result in an artificial boom which inevitably ends in a crash and slump. The recurrence of periods of economic depression is not a phenomenon inherent in the very course of affairs under laissez-faire capitalism. It is, on the contrary, the outcome of the reiterated attempts to "improve" the operation of capitalism by "cheap money" and credit expansion. If one wants to avert depressions, one must abstain from any tampering with the rate of interest. I thus elaborated the theory which supporters and critics of my ideas very soon began to call the "Austrian theory of the trade cycle."
As I had expected, my theses were furiously vilified by the apologists of the official doctrine. Especially abusive was the response on the part of the German professors, this self-styled "intellectual bodyguard of the House of Hohenzollern." In exemplifying one of my points, I had resorted to the hypothetical assumption that the purchasing power of the German mark might drop to a millionth fraction of its previous equivalent. "What a muddle-headed man who — if only hypothetically — dares to introduce such a fantastic assumption!" shouted one of the reviewers. But a few years later the purchasing power of the mark was down to one-billionth of its prewar amount!
It is a sad fact that people are reluctant to learn either from theory or from experience. Neither the disasters manifestly brought about by the deficit spending and low-interest-rate policies nor the confirmation of my theories by such eminent thinkers as Frederick van Hayek, Henry Hazlitt and the late Benjamin M. Anderson have up to now been able to put an end to the popularity of the fiat money frenzy. The monetary and credit policies of all nations are headed for a new catastrophe, probably more disastrous than any of the older slumps.The Economic Theory of Socialism
Sixty years ago Sidney Webb boasted that the economic history of the century is an almost continuous record of the progress of socialism. A few years later an eminent British statesman, Sir William Harcourt, asserted: "We are all Socialists now." There could not be any doubt that all nations pursued policies which were bound to result finally in the establishment of all-round planning exclusively by the government, i.e., socialism or communism.
Yet nobody ventured to analyze the economic problems of a socialist system. Karl Marx had outlawed such studies as merely "utopian" and "unscientific." As he saw it, the mythical productive forces which inevitably determine the course of history and direct the conduct of men" independently of their wills" will in due time arrange everything in the best possible way; it would be a vain presumption of mortal men to arrogate to themselves a judgment in these matters. This Marxian taboo was strictly observed. Hosts of pseudo-economists and pseudo-experts dealt with alleged shortcomings of capitalism and praised the blessings of government control of all human activities; but hardly anybody had the intellectual honesty to investigate the economic problems of socialism.
To put an end to this intolerable state of affairs I published several essays and finally my book on Socialism.2 The main result of my studies was the proof that a socialist commonwealth would not be in a position to apply economic calculation. When socialism is limited to one or to a few countries only, the Socialists can still resort to economic calculation on the basis of prices determined on the markets of non-socialist countries. But once all countries adopt socialism, there is no longer any market for the factors of production, they are no longer sold and bought and no prices are determined for them.
This means that it becomes impossible for a socialist management to reduce the various factors of production to a common denominator and thereby to resort to calculation in planning future action and in appraising the result of past action. Such a socialist management would simply not know whether or not what it plans and executes is the most appropriate procedure to attain the ends sought. It would operate in the dark. It would squander scarce factors of production, both material and human (labor). The paradox of planning is precisely that it abolishes the conditions required for rational action based on weighing of cost (input) and result (output). What is advocated as conscious planning is in fact the elimination of conscious purposive action.
The Socialist and Communist authors could not help admitting that my demonstration was irrefutable. To save face they radically reversed their argument. Until 1920, the year in which I first published my thesis, all Socialists had declared that the essence of socialism is the elimination of the market and of market prices. All the blessings which they expected from the realization of socialism were described as the result of this abolition of the price system. But now they are anxious to show that markets and market prices can be preserved even under socialism. They are drafting spurious and self-contradictory schemes of a socialism in which people "play" market in the way children play war or railroad. They do not comprehend in what respect such childish play differs from the real thing it tries to imitate.The Middle Way
Many politicians and authors believe that they could avoid the necessity of choosing between capitalism (laissez-faire) and socialism ( communism, planning). They recommend a third solution which — as they say — is as far from capitalism as it is from socialism. In imperial Germany this third system was called Sozialpolitik; in the United States it is known as the New Deal. Economists prefer the term used by the French, interventionism. The idea is that private ownership of the means of production should not be entirely abolished; but the government should "improve" and correct the operation of the market in interfering — by means of orders and prohibitions, of the power to tax and of subsidies — with the operations of the capitalists and entrepreneurs.
I tried to show that interventionism cannot work as a permanent system of society's economic organization. The various measures recommended must necessarily bring about results which — from the point of view of their own advocates and the governments resorting to them — are more unsatisfactory than the previous state of affairs which they were designed to alter. If the government neither acquiesces in this outcome nor derives from it the conclusion that it is advisable to abstain from all such measures, it is forced to supplement its first steps by more and more interference until it has abolished private control of the means of production entirely and thus established socialism. The conduct of economic affairs, i.e., the determination for what purposes the factors of production should be employed, can ultimately be directed either by buying and abstention from buying on the part of consumers or by government decrees. There is no middle way. Control is indivisible.
It is interventionism that produces all those evils for which a misguided public opinion indicts laissez-faire capitalism. As has been pointed out above, the endeavors to lower the rate of interest by means of credit expansion generate the recurrence of depression. The attempts to raise wage rates above the height they would attain in an unhampered market result in prolonged mass unemployment. "Soak-the-rich" taxation results in capital consumption. The joint outcome of all interventionist measures is general impoverishment. It is a misnomer to call the interventionist state the welfare state. What it ultimately achieves is not improving but lowering the common man's standard of living. The unprecedented economic development of the United States and the high standard of living of its population were achievements of the free enterprise system.The Interconnectedness of All Economic Phenomena
Economics does not allow of any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts condition one another mutually. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires. All monographs remain fragmentary if not integrated into a systematic treatment of the whole body of social and economic relations.
To provide such a comprehensive analysis is the task of my book Human Action, a Treatise on Economics. It is the consummation of lifelong studies and investigations, the precipitate of half a century of experience. I saw the forces operating which could not but annihilate the high civilization and prosperity of Europe. What I aimed at in writing my book was to contribute my share to the endeavors of our most eminent contemporaries to prevent this country from following the path which leads to the abyss.
It is fairly easy to imagine the regressive left having childishly high time preference; they see some current social ill (homelessness, potholes , student debt, inequality) and want them abolished right away. If your position is: "solve the problem now, damn the future consequences," you show a very high discount rate; future costs pale in the face of the current disaster. Let me use former Fed chairman Bernanke’s famous “Firefighter” analogy to illustrate that this is a common conviction among even the moderate left. Fighting back against fears over moral hazard as objections to the Fed’s lender-of-last-resort policies during the financial crisis, Bernanke answered:
"You have a neighbor, who smokes in bed... Suppose he sets fire to his house… “You might say to yourself . . . ‘I’m not gonna call the fire department. Let his house burn down. It’s fine with me.’ But then, of course, what if your house is made of wood? And it’s right next door to his house? What if the whole town is made of wood?” The editorial writers of the Financial Times and the Wall Street Journal in September 2008 would, presumably, have argued for letting the fire burn. Saving the sleepy smoker would only encourage others to smoke in bed. But a much better course is to put out the fire, then punish the smoker, and, if necessary, make and enforce new rules to promote fire safety.
The same point can be made in Krugman’s love for government spending: the cost and problems of future budget deficit are of no concern in the midst of a recession — we’re facing disaster now and must solve that now. In other words: very high discount rates apply.
And if the left stayed with their child-like levels of discounting the future, it would be a quirk of their convictions (perhaps biology) that we may object to on other grounds. But, when it suits them, they conveniently opt for extraordinarily low discount rates instead:Are We Concerned About the Long Term or Aren't We?
Here’s an example. Imagine you face a costly, damaging disaster 100 year hence. You could either absorb the cost way off in the future, or build up preparations for that cost now. Building preparations would reduce the damage down the line, but at the expense of your current standard of living – you need to sacrifice some present resources to avoid damage down the line. Add some numbers and even college sophomores can solve this conundrum: you discount the future costs by the compounded yearly interest rate, the rate at which you discount the future. For purposes of illustration, you may perceive of this as the rate of return you may have earn on the sacrificed resources. Should this amount be bigger than the cost of the disaster, you’d rather just stash the money and await the bill.
But now let’s pretend that this was an example of the future costs of climate change and how to deal with them. In that scenario, the Left’s argument would have been one of insanely low discount rates; the livelihoods of those not-yet-born are of utmost importance, +2 degrees Celsius in the year 2100 would be a catastrophic event – indeed the “collapse of civilization” itself. In stark contrast to the urgent high-discount rate stories above, economists of less preachy persuasion argue over which discount rates to use in assessing the future damage of climate change. Surprisingly, the most aggressive leftists, those adamant on preventing societies current ills above, have now flipped one-eighty, and argue for astonishingly low discount rates – even flirting with zero, so as to increase the weight put on future costs, and increase their present discounted value.
When the topic involves poverty, bank failures , unemployment or inequality, the advocates of whatever fashionable policy is urgently needed implore us to take immediate action, almost regardless of the costs down the line. Enter climate change and this seemingly changes everything. For some unfathomable reason climate change means that the living conditions of non-existing peoples of the future are now supremely valuable (over and above the currently living ones). Whereas, say, homelessness or poverty require us to consider the currently living. Concerning climate change, the picture shifts to the valuation of those yet unborn. The future state of society a century hence is all that matters – in a way entirely foreign to the damn-the-consequences position of other topics.
To add insult to injury, the Left pretends that their position is entirely consistent, indeed inseparable, without realizing that their implied discount rates are at cross-purposes. Either the future is immensely important, at which point current “solutions” with long-term costs like budget deficits and bank bailouts are ruled out, or the future is not very important, at which point measures to combat climate change are largely unneeded. Pick one.
There was a time when communities took care of the medical needs of their members without the intervention of governments and without the corrupting influence of health insurance. Can we ever go back to a system of mutual aid at a time when healthcare costs have grown astronomical?
Our guest today shows us that the idea of cost sharing is not only viable but is a lived reality for thousands of families across the United States. Dale Bellis began his work in healthcare in 1988 as an administrator with the first cost-sharing ministry ever begun in modern times. He was instrumental in passing legislation in 11 states exempting cost sharing ministries from insurance regulations. He also introduced technology and administrative techniques to streamline person to person cost-sharing. In 2012, he founded Liberty Healthshare, which provides an opportunity to live free from insurance and government-mandated healthcare to a large and growing number of American families that share fundamental values and a strong belief in personal responsibility.
The Battle of Fort Donelson would take place over several days. Waged from two fronts, the land and the river, the battle would seem to be turning in favor of the Confederates. While Ulysses S. Grant was off the battlefield consulting with the naval commander, Captain Foote, the Confederates would push the Union back, opening the door for escape.
Chris Calton recounts the controversial history of the Civil War. You may support this podcast financially at Mises.org/SupportHC. Subscribe today at Spotify, Google Play, iTunes, SoundCloud, Stitcher, or via RSS.
With more than a decade having passed since the financial crisis of 2007/8, the mainstream economics profession still seems to be almost as far from agreeing on the ultimate causes of that crisis as they were from being able to foresee its arrival back in the mid-2000’s. If asked about the causes of that crash, the average non-Austrian economist is unlikely to dwell on the prickly question of what ultimately caused the housing bubble and bust, and will more likely pivot to the easier, more widely agreed upon issue of how collateralized debt obligations (CDOs) created channels for the housing crisis to spread into a full-blown financial crisis. In the run-up to the crisis, US financial institutions heavily invested in particular types of CDOs called mortgage-backed securities, which essentially packaged together mortgages from a wide array of different locations. It was thought unlikely that house prices could decline across the whole of the US simultaneously, and the housing market was booming, so packaging together mortgages from different locations into CDOs seemed like a profitable and risk-free investment. By the time house prices began to decline, however, key banks had invested so heavily in these mortgage-backed CDOs that the housing crash brought down the whole financial system with it. Such, in very broad and simple terms, is the account of the causes of the 2007/8 crash with which many mainstream economists would agree.
In light of this, it can easily be understood why the financial press assumed such a worried tone when reporting on recent research by the Bank of England, which revealed the extent to which financial institutions around the world have again begun heavily investing in CDOs. The report revealed that international financial institutions have so far amassed a $405 billion exposure to ‘junk debt’ packaged within CDOs, while the broader market for this low-rated debt has swelled to $1.4 trillion.
Discussing the research during a Treasury committee hearing last month, Bank of England Governor Mark Carney said that the Bank was “concerned” by the “rapid” growth of this market, which he said had “all the hallmarks” of the sub-prime mortgage bubble which preceded the 2007/8 crash. One MP present at the hearing warned Mr Carney “you can hear the ghosts of sub-prime mortgages clanking their chains”, and the report apparently also sparked fears amongst policymakers at the Federal Reserve and the European Central Bank.
The key difference between this new wave of CDOs, compared with those that precipitated the 2008 crash, is that the new CDOs are packages of low-rated ‘junk’ business debt, rather than packages of ‘sub-prime’ mortgages. This rapidly growing market for high-risk, high-return debt is currently populated by hundreds of US companies with ‘below investment grade’ credit ratings, including such household names as American Airlines, Uber, and Burger King. It has also been argued that these sorts of leveraged loans played a role in the recent bankruptcies of such companies as Toys R Us and Sears.
Just as mainstream economists struggled to explain the ultimate causes behind the housing bubble of the mid-2000s, so too have the explanations for this new boom in the junk debt market been brief and vague; the Bank of England report which raised the issue gave the non-answer of simply attributing it to “strong creditor risk appetite”. Viewed from the perspective of Ludwig von Mises’ Austrian Business Cycle Theory, however, the picture becomes much clearer. The ultra-low interest rates which central banks have facilitated since 2008 have lowered borrowing costs and lending standards, allowing companies to pursue risky and long-term projects by taking on more debt than they otherwise would have found possible, while at the same time making creditors more eager to lend to high-risk companies in pursuit of their accompanying slightly higher returns. When the threat of inflation finally forces central banks to raise interest rates again, as they are already beginning to do, many of these borrowers will be forced to default on their increasingly expensive debts, and the crash will have begun. The greater the extent to which global financial institutions have exposed themselves to these junk debt CDOs by that point, the more quickly will the crisis spread throughout the financial system.
Evidence of these declining lending standards is given by the fact that, at present, around 80% of the leveraged loan market consists of “covenant-lite” loans, as compared with around 25% before the 2007/8 crisis. ‘Covenant-lite’ loans are loans which have partly or wholly discarded the ‘covenants’ which traditionally protected investors by requiring borrowers to meet various financial health standards before the loan is granted.
Furthermore, the stimulus to risk-taking encouraged by artificially low interest rates is illustrated by the fact that $150 billion worth of the ‘junk’ debt CDOs are currently being held by insurers and pension funds, institutions typically characterized by their desire to hold safe assets.
As central banks continue to slowly normalize interest rates, the foundations of the overinflated junk debt market have already begun to crumble away. This past December saw the leveraged loan market suffer its biggest monthly decline since mid-2011, wiping out nearly the entirety of 2018’s gains in the S&P/LSTA leveraged loans index. This sharp and sudden decline bumped 2018’s overall performance in that index down to the third worst in the past 20 years.
Predictably enough, the guardians of conventional opinion have already begun preparing their usual shallow, politically-motivated arguments about what caused this phenomenon and what needs to be done. The Telegraph’s article, for example, warned that a potential junk debt crash, if it arrives, would have been caused by the “eagerness in the US to liberate Wall Street from Obama-era restrictions”, citing a US appeals court ruling from last year which found that CDO managers no longer had to hold onto a portion of the risk they sold to others. The application of these politically convenient cure-alls can do nothing, however, to shield the true responsible parties from scrutiny, provided that priority is given to spreading public understanding of Mises’ Austrian Business Cycle Theory, which alone is capable of shedding light on the real causes of the coming crash.
Most economists are familiar with the controversy on the possibility of economic calculation under socialism, and with the fact that Ludwig von Mises and Oscar Lange were the two major protagonists of that debate.1 Many are also familiar with Lange's ironic gibe that, for having posed the problem which Lange believed that socialism could readily solve, “a statue of Professor Mises ought to occupy an honorable place in the great hall of the Ministry of Socialization or of the Central Planning Board of the socialist state.”2 In the light of the rapid retreat from socialist central planning and toward a free market in the Eastern Europe of recent years, it seems that Lange's irony might well have boomeranged.
Far less known, however, is a parallel retreat from Marxist economic theory in Oskar Lange's last years, a retreat, furthermore, made in long strides toward the economic theory and the methodology of none other than his old opponent. Mises' most distinctive contribution to economics was his concept and elaboration of economic theory as praxeology (or praxiology), the formal, general logic of human action, of human purposive activity using scarce means to achieve the most preferred ends.3 As a leading Polish economist, Lange was very familiar with the praxeological theories of the distinguished contemporary Polish philosopher, Tadeusz Kotarbinski. While Kotarbinski's specific conception of praxeology differs considerably from Mises, stressing analysis of efficient as well as hostile action, they unite in emphasizing the essence of praxeology as a general theory of rational action.45 In his final, posthumous work, designed as the first of a multi-volume treatise on economics, Oskar Lange devoted a great deal of time to the painful acknowledgement that economics must encompass praxeology as well as Marxism. The particular irony is that Lange devoted a great amount of attention to an economic theory of his old antisocialist rival which still remains almost unknown in conventional Western economic thought.
Lange entitled Chapter 5 of his posthumous Political Economy, “The Principle of Economic Rationality. Political Economy and Praxiology.” He begins the chapter with the decidedly un-Marxist but praxeological statement that “Human economic activity is conscious and purposive activity”, that “consists in the realization of given ends by the use of certain means.”6 He proceeds to point out that the capitalist market economy had not only developed gainful activity, but that this gainful activity was a rational one, quantifying ends and means through a calculation in terms of money. Here Lange is implicitly harking back to the old calculation controversy. The economic calculation made possible by money and the invention of double-entry bookkeeping in the capitalist market, enabled action toward the maximizing of money profit and income, and thereby toward the most efficient realization of man's ends. In this way, maximization of profit under capitalism is accomplished by following the economic principle or principle of economic rationality, a principle enabling the maximum degree of realization of one's ends per given outlay, as well as the minimal outlay of means for a given degree of realization of one's ends. The former variant is the “principle of greatest efficiency”; the latter, the “principle of minimum outlay, or economy, of means”, or mimimum cost.7 The rational use of means, according to these criteria, is their optimum use; any other use of means Lange agrees to consider a waste. In support of these economic principles, Lange cites Kotarbinski's general praxeological concept: “The more valuable the product of a given experience the more productive is behavior; on the other hand, the less the outlay in the achievement of a given aim, the more economical is behavior.”
Lange proceeds to pay tribute to the great achievement of the capitalist market economy in arriving at this rational economic principle. Despite the prevailing private rather than “social” rationality, and despite such problems as the business cycle, Lange declares that “the rationalization of economic activity within the capitalist enterprise, the practice of proceeding according to the principle of economic rationality, and especially the consciousness of this principle in human thought, all constitute an achievement of historic significance ... on a par with the imposing advance in material technique made within the capitalist mode of production ... itself closely connected with the application of the principle of economic rationality in enterprise.”8
After rather perfunctorily asserting that socialism will proceed to expand this rationality to social planning, and to such areas of action as input-output analysis, technology, and military strategy and tactics,9 Lange goes on to identify this study of the rational principles of action as praxeology, the logic of rational activity, and details the history of this concept. From Mises, Lange had discovered that the term “praxeology” was first used by the French historian Alfred Espinas in 1890.1011
Proceeding to the more developed praxeological work of Kotarbinski, Lange criticizes the Polish philosopher's narrow and technological treatment of the concept as the science of effective or efficient activity; instead, notes Lange, praxeology is really a broader “methodological rationality”, a doing of one's best according to one's knowledge, so that it is better to define praxeology as the science of rational activity. In opting for this broader, more formal, and more general concept, Lange goes a long way from the Kotarbinskian and toward the Misesian formulation of the theory. Praxeology, adds Lange, encompasses under this rubric of rational activity such categories as: ends and means, method, action, plan, efficiency, and economy. Praxeological principles of behavior comprise the relations between the praxeological categories, and the principle of economic rationality (or the “economic principle”) is one of these praxeological principles of behavior. In this way, Lange agrees with Mises that the economic principle is itself embedded in the wider praxeological principles of general human action. Furthermore, he agrees that the praxeological principles had until now been elaborated only in the field of economics, as Mises affirms, and in ethics as well.
Lange, however, now found himself at the brink of a precarious position: the Mises thesis that praxeology had so far been elaborated only in economic theory, and that therefore economics and praxeology, while conceivably of different scope in the future, are now virtually identical. To take such a position would mean, for Lange, being close to becoming a Misesian and an Austrian School economist. Drawing back from this precipice, Lange hastens to add that praxeology includes, not only Mises-type economic theory, but also the general theory of statistical decisions, operations research, programming, input-output analysis, and cybernetics. Lange did not seem to realize that by rushing to include these disciplines, along with economic theory, in the rubric of praxeology, he was returning to the very different technological concept—the technological manipulation of means to reach a given end—that Lange had already rejected in Kotarbinski.12 Remembering suddenly to pay his respects to Marxism, Lange adds as an afterthought that dialectical materialism partly bases its cognition on the “praxeological principle” of proceeding according to the “criterion of practice.”13
From the praxeological principles of behavior, and especially the economic principle, adds Lange, a considerable edifice of economic laws can be deduced: such as a general attempt to maximize profit and investing capital at the highest rate of profit, thereby leading to a tendency toward a uniform rate of profit throughout the economy. In this way, Lange accepts the essential deductive Misesian methodology for economic theory: beginning with broadly general praxeological principles as axioms, and from these elaborating necessary laws by logical deduction. While Lange attempts to qualify this agreement by stating that empirical testing is needed to see whether various economic actions are “rational” or “customary-traditional”, his basic alignment with Misesian methodology still remains.
Later in the book, Lange returns to grapple with praxeology through a critique of subjective utility theory, itself a topic that usually rates little or no space in Marxian works.14 He begins with a history of value theory, and of the basis of economics in the nineteenth century, that is perfectly acceptable to any modern economist: from the classical “economic man” to Benthamite utilitarianism and hedonism to Bastiat's exchange of services and on to the subjective, marginal utility school. The latter began with Jevonian hedonism and then developed into the Austrian, praxeological interpretation of utility not as “pleasure”, but as the realization one's aim of economic activity, regardless of the nature of that aim. The aim may be pleasure, money, power, health, or whatever; the Austrian view simply states that economic activity has some aim, or preference, that forms the goal of action. As Lange correctly concludes: “In this praxiological interpretation, the subjectivist trend leaves aside all psychological considerations and transforms itself into a logic of ‘rational choice’ aimed at the maximization of preference.”15
Lange then proceeds to a history of the development of this general, formal theory of utility as ordinal preference. He sees that the Austrian School (Menger, Wieser, Böhm-Bawerk) was far more thoroughgoing in its application of subjective marginal utility theory than the currently far more influential Lausanne School (Walras, Pareto) or than Alfred Marshall. For the Austrians applied marginal utility theory to all gainful activity, whereas the latter applied it only to consumers. In the Austrian and praxeological view, both the consumers' aim of maximizing utility and the producers' aim of maximizing money income or profit fall under the single rubric of maximizing preferences and of marginal utility. Lange's history here is deficient in identifying Pareto partially with the Austrian approach while totally neglecting the praxeological role of Pareto's Italian opponent Benedetto Croce. Moreover, he also neglects the adoption of a general and purely ordinal concept of marginal utility by the Czech Austrian School economist Franz Cuhel, and following Cuhel by Ludwig von Mises in 1912, long before the famous Hicks and Allen article of 1934.16
Lange is correct, however, in citing a praxeological interpretation of utility by Max Weber as early as 1908, in which Weber stated that marginal utility should be formulated, not in such psychological terms as pleasure, but in such “pragmatic” categories as ends and means. 17
Thus far our Marxian was willing to go with praxeological economics. But here Lange confronted a precipice even steeper than before: for just as it was important for him to deny that praxeology might be confined to economics, so it was still more important for him to deny that all of economic theory is a subset of praxeology. For if that were really the case, where would that leave Marxism? And so Lange separates himself from the final step in the development of praxeological economics: the transformation of economics into a branch of praxeology. Separated now from concrete objects, economic analysis became a formal science of rational behavior, of the maximization of magnitudes. Conversely, the formal aspects of all rational behavior became analyzable by the economic principle.18
For this transformation of economics into a branch of praxeology, Lange cites Lionel Robbins and his well-known depiction of economics as a certain aspect of all activity, namely the relation between scarce means and alternative ends, and the choice among those ends.19 He also devotes attention to the Austrian economist Hans Mayer, and to Max Weber, who had originated the Robbinsian distinction between economics as choice of means between ends and technology as the choice of means to realize a given end.20 While this distinction is rather simplistic - neglecting, for example, the point that economic as well as technological considerations enter even into the choice of means toward a single end - Lange is incorrect in charging that the distinction is meaningless because the hierarcy of alternative ends are all aimed toward one principal end: the maximization of utility. Lange does not realize that “utility”, for the praxeological school, is not a thing or an entity in itself, but is simply the label placed upon the preference rankings which everyone makees among his vrious ends. “Maximizing utility” simply means the formal principle that a man attempts to attain his highest ranking, his most preferred, rather than his less preferred end.21
Lange than points out that this transformation of economics into a branch of the universal science of praxeology culminated in Ludwig von Mises' Human Action in 1949. Classical political economy was now fully transformed into a general theory of human action, of the acts of choice. Economics becomes no longer an empirical science with “real” phenomena, but a formal logic of choice, where the only criterion of truth is agreement with the original axioms. The economic theory becomes empirically true insofar as any concrete action is governed by the economic principle. Lange is particularly critical because all of the laws of praxeological, subjective economics are considered by Mises and the preceding Austrians to be applicable to Crusoe economics as well as to the exchange economy. Lange's hostility to this “unrealism” stems precisely from the fact, as he points out, that application to Crusoe economics implies that the laws of economics are universal and apodictic for every time and place, regardless of the concrete content of social relations or economic activity. By means of praxeology, economics, like the natural sciences, has transcended the concrete and changing data of history and has assumed the character of a universal and apodictic science. As Lange characterizes this position: “Historically conditioned social relations may influence the concrete form in which these laws manifest themselves but they cannot change their basic character.”22 While Lange is willing to concede this universal and trans-historical character to praxeology, he is not willing to concede economics to be only a subset of praxeology and therefore to take on the same timeless character. For if he were, Marxism, with its proclaimed laws of historical determinism, would have to be completely abandoned.
The characteristic method of the praxeological economists in developing their analysis, Lange points out, is to begin with the economics of an isolated Robinson Crusoe, an analysis which elucidates the basic laws of men in relation to things. Then, other people are brought in, and exchanges between these individuals explained as each person choosing to give up something he wants less in order to obtain something he wants more. Exchanges thus become the resultants of the subjective attitudes and preferences of the participating individuals. Lange complains that this process of beginning with man vis à vis nature is the opposite of the Marxian conception, which concentrates on “economic relations among men - relations of production and relations of distribution.” He further quotes from the Marxist Rudolf Hilferding, in his charge that the Austrian School economics of Böhm-Bawerk “takes as the starting point of its system the individual relation of man to things. It conceives relations from a psychological point of view, as subject to natural invariable laws; it excludes socially determined relations of production, and ... development of the economic process according to definite laws is quite foreign to it.”23 This, to be sure, is the liquidation of the classical “political economy.”
But while Lange accuses subjectivist economics of ignoring real economic relations between men, he also correctly asserts that this school of thought treats the economic categories of capitalism “as general praxeological categories, categories of rational human activity ...”24 Wages, capital, profit become universal categories independent of the historical shaping of society, and therefore capitalism becomes a universal requirement of rational economic activity. Lange sees that this leads to the heart of the Mises-Lange calculation controversy on whether rational economic activity requires the private ownership of the means of production.25 But then Lange can hardly be correct in charging that praxeological economics ignores concrete social and economic relations; on the contrary, his real complaint is that from these abstract, universal economic laws may be deduced the very real necessity for market capitalism in order to sustain a rational economy.
Thus, while Lange is willing to concede the universality of the economic principle, and the achievement of subjectivist economics in discovering a praxeology that can be applied to political economy and to other fields, he is of course not willing to concede that economics is exclusively praxeological. The remainder of Lange's discussion is an unsatisfactory attempt to outline what Marxism or any other economic theory might add to praxeology in the formation of economics. He mentions institutional discussions of the social organization of production, of the State, labor, national income, etc., but the unanswered question is the role of these categories in economic theory as compared to an accumulation of institutional data to which that theory can be applied. Lange also approvingly cites the attack on the subjectivist Austrian School by the Polish economist Stanislaw Brzozowski, who charged that the Austrians merely analyzed the relations between man and given things, and comprised a theory of consumption rather than a “complete theory of society.” In the first place, this contradicts Lange's previous insight that the Austrians, in contrast to Marshall and the Lausanne School, had extended their subjectivist analysis from consumption to production and the productive factors; the “given things” constituted only the first step in their complete analysis. Secondly, why should it be a defect of praxeological economics that it does not offer a “complete theory of society?” Is physics to be condemned because it is not chemistry? Has a complete and correct theory of society been offered by any sphere of economics or social science?
Lange proceeds to unworthy and rather absurd attempts to subject the Austrian School economists to a Marxian “sociology of knowledge.” The Austrian School, he asserts, is the economics of pensioners and tax officials, because it discusses only consumption and not production; and Nikolai Bukharin is cited in asserting that the Austrian School, with its concentration on consumption, is the “rentier's political economy.”26 Not only does this contradict Lange's own previous concession to the Austrian integration of production and consumption, but it also leaves us with the puzzle of how to “explain” such consumption-oriented economics as that of John A. Hobson or J.M.Keynes? Are they too to be dismissed as “rentiers”, even the Keynes who called for the “euthanasia” of that very class? Lange's second attempt is to “explain” the abstract and unrealistic Austrian methodology as the product of the professionalization of economics in the universities in the late nineteenth century, which thereupon developed in “isolation from the productive process.”27 But while the earlier classical economists may not have been as professionalized, they were also - apart from Ricardo - not businessmen, and thus were equally “cut off” from the productive process. Neither the university professor Adam Smith nor the civil servant Mill were any closer to the productive process than Menger or Böhm-Bawerk. Furthermore, a bit later in the book Lange turns around and salutes the professionalization of all scientific research in the past century as leading to an autonomy of science, a critical attitude toward the social system, and a science that “becomes independent of the social milieu which produces” it.28
Lange declares that since the bourgeoisie had to know what was actually happening in the economy, they couldn't pursue completely the Austrian path of liquidating political economy. Therefore, the more “realistic” Anglo-American neo-classicists continued to study such important economic problems as money, business cycles, growth, and international trade. What Lange ignores here is that the Austrian subjectivists have studied and come to a position on all of these important questions, so that what he sees as their abstract “isolation” applies only to the fundamental laws and not to the more developed and applied branches of the theory. One need only mention the Mises-Hayek “monetary malinvestment” theory of the business cycle to see how praxeological economics has been applied to vital and realistic economic problems. The problem, however, is that Lange cannot be very happy with the policy conclusions of the Austrians in these areas: ultra hard money, the gold standard, laissez-faire capitalism. Again, the problem is not so much the relevance of the method as the kind of conclusions that are obtained.
Lange's remarkable adoption of Misesian praxeology as the major base for economics, onto which Marxian and other approaches were then hastily grafted, met predictably mixed reaction in Marxian circles. Most striking was the laudatory critique of Lange by Ronald Meek, the distinguished English historian of economic thought.29 Professor Meek, summarizing Lange's lengthy chapter on the Principle of Economic Rationality, notes that “significantly, the references to Marx's work become purely incidental.”30
Meek considers it “interesting and paradoxical” that praxeology, which “has now become an indispensable adjunct to Marxian economics”, was the culmination of a violently anti-Marxist subjectivist trend in “bourgeois” economics.31 The paradox might well be put the other way round: that of a leading Marxian economist adopting the economics of his own and Marxism's major opponents, and then rather desperately trying to insist that there is still room for Marxian and institutional approaches in the wider rubric of political economy.
To Marxian “fundamentalists”, on the other hand, the Lange-Meek movement is seen for what it genuinely is: a massive “revisionist” retreat from Marxism. In his review of Meek, Ben Brewster despairingly writes: “... for if the relations of production is a general principle governing society the latter becomes merely the totality of human social interaction; there is no specificity of the economic level at all and the distinction between base and superstructure breaks down. The result is that in the last essay in the book (the title essay), Meek apparently falls for the most general principle of society and the most bourgeois ideology of them all, von Mises' “Praxiology” (the principle of all rational action) in Lange's purely ideological attempt to graft Marxist and Neoclassical economics.”32
And so, as Marxian economic thought joins the actual economies of Eastern Europe in a headlong flight from Marxism and socialist central planning to Western and capitalistic modes of thought and economic systems, Oskar Lange's original irony is truly beginning to boomerang: Perhaps the freemarket, capitalist economy of a future Poland will erect a statue of Lange alongside the monument to his old antagonist?Originally appeared in Toward Liberty (Menlo Park, Calif.: Institute for Humane Studies, 1971), vol. 2, pp. 307–21. Published in Economic Controversies
- 1. See Ludwig von Mises, Socialism (New Haven: Yale University Press, 1951); F.A.von Hayek, ed., Collectivist Economic Planning (London: George Routledge and Sons, 1935); and Oskar Lange and Fred M. Taylor, On the Economic Theory of Socialism (New York: McGraw-Hill, 1964). For a summary and critique of the controversy, see Trygve J.B. Hoff, Economic Calculation in the Socialist Society (London: William Hodge and Co., 1949).
Lange and Taylor, pp. 57-58
- 3. See particularly Ludwig von Mises, Human Action (New Haven: Yale University Press, 1949). For a discussion of Mises' praxeology and its relation to previous economic methodologies, see Israel M. Kirzner, The Economic Point of View (Princeton, N.J.: D. Van Nostrand, 1960).
For Mises on Kotarbinski, see Ludwig von Mises, The Ultimate Foundation of Economic Science (Princeton, N.J.: D. Van Nostrand, 1962), pp. 42, 135. Most accessible of Kotarbinski's writings is his “Idée de la methodologie genérale praxeologic,” Travaux du IXe Congres International de Philosophie (Paris, 1937), IV, 190-94.
- 5. Oskar Lange, Political Economy (New York: Macmillan, 1963).
- 6. Lange, p.148.
- 7. Lange here explicitly accepts the modern concept that the ultimate end is not cardinal or quantifiable, but rather an ordered, ordinal set of preferences. Lange, pp. 167-68.
- 8. Lange, p.176.
- 9. Kotarbinski's early work was on praxeology as applied to the theory of hostile action. See Mises, Ultimate Foundation, pp.42, 135.
- 10. In Espinas' article, “Les Origines de la technologie,” Revue Philosophique, XVth year (July-December, 1890), pp. 114-15, and in his book with the same title, published in Paris in 1897. See Mises, Human Action, p. 3n.
- 11. Eugen Slutsky, “Ein Betrag zür formalpraxeologischen Grundlegung der Oekonomik,” in Annales de la classe des sciences sociales-economiques, Academie Oukranienne des Sciences, Vol. 4 (Kiev, 1926).
- 12. On the economic vs. the technological principles, see Lionel Robbins, The Nature and Significance of Economic Science (London: Macmillan, 1935), a work heavily under the influence of Mises, Richard Strigl and others of the Austrian School; and Kirzner, pp. 108-45. Also see Rutledge Vining, Economics in the United States of America (Paris: UNESCO, 1956), pp. 1-37.
Lange, p. 190n.
- 14. Lange, pp. 229ff.
- 15. Lange, p. 236.
- 16. Croce's decidedly praxeological contributtion to economics may be found in his fascinating debate with the positivist Pareto on economic methodology, written in 1900 and 1901. See Benedetto Croce, “On the Economic Principle,” in International Economic Papers, No. 3 (1953), pp. 172-79, 197-202. For an appreciation of Croce's work, see Giorgio Tagliacozzo, “Croce and the Nature of Economic Science,” Quarterly Journal of Economics (May, 1945), and Kirzner, pp. 155ff.
Max Weber, “Die Grenznutzlehre mit das ‘psychophysische Grundgesetz,” Gesammelte Aufsätze zur Wissenschaftslehre, 2nd ed. (Tübingen: J.C.B. Mohr, 1951), pp. 364ff. On the Weber article, see Emil Kauder, A History of Marginal Utility Theory (Princeton, N.J.: Princeton University Press, 1965), pp. 116–17, 136–37.
Lange, Political Economy, p. 237
Robbins, The Nature and Significance of Economic Science. On the relationship between Robbins’s and Mises’s views on the nature of economics, which however greatly understates their similarities, see Kirzner, Economic Point of View, pp. 108–86. Bracketing them more closely is Ludwig M. Lachmann, “The Science of Human Action,” Economica (November 1951): 413.
Hans Mayer, “Untersuchungen zu dem Grundgesetz der wirtschaftlichen Wertrechnung,” Zeitschrift für Volkwirtschaft und Sozialpolitik (Vienna: Franz Deutsche, 1921), vol. 2, p. 5; Max Weber, The Theory of Social and Economic Organization (New York: Oxford University Press, 1947), pp. 162, 209. For a critique of Weber’s views on economic methodology, see Ludwig von Mises, Epistemological Problems of Economics (Princeton, N.J.: D. Van Nostrand, 1960), pp. 74–106. On Mayer, see Kauder, A History of Marginal Utility Theory, pp. 107ff.
- 21. Kirzner falls into the same error. Kirzner, Economic Point of View, p. 134.
Lange, Political Economy, p. 242.
- 23. For a slightly different translation of this passage, see Paul M. Sweezy, Böhm-Bawerk’s Criticism of Marx, in Rudolf Hilferding, eds. (New York Augustus M. Kelley, 1949), p. 196.
- 24. Lange, Political Economy, p. 298.
- 25. Ibid., p. 298n.
- 26. Lange, Political Economy, pp. 300ff. Lange himself is a bit dubious on this point, since capitalism in Austria was not as highly developed as in the other Western countries where the subjectivist, praxeological economics did not take hold.
- 27. Ibid., pp. 301–02.
- 28. Ibid., pp. 314ff.
- 29. Ronald L. Meek, Economics and Ideology and Other Essays (London: Chapman and Hall, 1967), pp. 216ff.
- 30. Ibid., p. 216.
1Ibid., p. 218.
Luxembourg citizens voted in an election last year. But as The Economist has noted, "48% of those who live there were not allowed a ballot-paper."
This is because a great many immigrants live in Luxembourg, but few of them quickly become citizens — which means few can vote.
According to the Migrant Integration Policy Index (MIPEX):
LU remains one of the most exclusive national democracies in the developed world, with the largest share of adults disenfranchised in national elections. According to 2013 OECD data, after 10+ years in the country, LU citizenship had been granted to only around 20% of the foreign-born, including among the non-EU-born, who are generally most likely to naturalise and see the benefits.
Not surprisingly, The Economist thinks this is a bad thing.
Nevertheless, few are claiming that immigrants are treated poorly in Luxembourg. Because of Luxembourg's small size and integration into the European economy, Luxembourg is quite open to migrant workers, both from neighboring countries, and from further abroad.1
Nevertheless, immigrants continue to flock to the country, and make up approximately 45 percent of the population. Moreover, 160,000 workers commute daily into Luxembourg from France, Belgium, and Germany — "Luxembourgers are only the majority in their country when the sun goes down." In recent decades, many have become permanent residents.
Aware of complaints about a lack of more widespread suffrage in Luxembourg, voters in 2015 were given an opportunity to vote on expanding voting rights to foreigners in a referendum. 80 percent rejected the idea.
It should not be surprising, though, that many Luxembourg citizens are concerned that a sizable expansion of citizenship could bring about radical changes in Luxembourg through demographic shifts. A key strategy in slowing and managing this situation — while still allowing migration — is limiting access to citizenship.A Case Study in Citizenship vs. Residency
The case of Luxembourg is helpful in illustrating how naturalization and immigration are two different phenomena. Clearly, experience suggests Luxembourgers are open to inviting in immigrants and working with them in a variety of economic ventures. Many live permanently in the country. The immigrants enjoy property rights and legal due process. A lack of access to political participation does not imply that it is legally or morally permissible in Luxembourg to treat immigrant property rights as forfeit. After all, immigrants have usually entered into legal contracts with employers and landlords to secure income, housing, and other types of property. Abolishing these legal rights could be disastrous for the local economy.
Moreover, the fact that the economy in Luxembourg depends on this openness to immigrants means the voting citizens are incentivized against enacting laws that might severely limit immigration or which would induce immigrants to avoid the country. Many Luxembourg voters likely are aware that — for practical reasons, if nothing else — it is not to their advantage to begin cutting off immigrants from their property. (It's important to note virtually no one claims this widespread denial of voting prerogatives in Luxembourg constitute any sort of humanitarian crisis.)
Nevertheless, the response to Luxembourg's practice of relatively open immigration — coupled with restricted citizenship — has some observers claiming the policy is tantamount to a violation of rights. Hence we hear charges of "taxation without representation" or the use of the often-loaded terms "disenfranchisement" and "democratic deficit."Should Citizenship Be Based on Location or Origin?
The idea that residents of a place ought to be quickly afforded full citizenship based on their current physical location, however, is far from universal.
Historically, policymakers, kings, and bureaucrats have long debated the criteria to be met in determining how quickly or how easily new residents ought to be offered naturalization.
For example, citizenship has been historically based on various criteria including residency, ancestry, promises of military service, and sworn oaths between individuals.
These criteria often fall into one of two legal traditions of naturalization: jus soli and jus sanguinis. Jus soli ("the right of soil") is the principle that naturalization ought to be based on where one is located, and this often includes "birthright citizenship." Conversely, jus sanguinis ("the right of blood") is the principle that naturalization is based on one's marriage, parentage, or origins.
Graziella Bertocchi and Chiara Strozzi have summarized the development of these two traditions in Europe and the Americas2:
In 18th century Europe jus soli was the dominant criterion, following feudal traditions which linked human beings to the lord who held the land where they were born. The French Revolution broke with this heritage and with the 1804 civil code reintroduced the ancient Roman custom of jus sanguinis. Continental modern citizenship law was subsequently built on these premises. During the 19th century the jus sanguinis principle was adopted throughout Europe and then transplanted to its colonies. ... On the other hand, the British preserved their jus soli tradition and spread it through their own colonies, starting with the United States where it was later encoded in the Constitution.
The rise of jus sanguinis in Europe, perhaps not surprisingly, coincided with the spread of ethnicity- and language-based nation states in the nineteenth century. This in turn led to greater concern over whether or not migrants could integrate into each nation's linguistic or cultural majority.
Thus, jus sanguinis requirements became an attractive means of slowing down the process of integrating new citizens and of ensuring that new migrant groups would integrate through native parentage, marriage, or through long terms of residency.Europe vs. The Americas
The situation was very different in the Americas, however. It's not a coincidence that we find the Americas to be far more reliant on the concept of jus soli.
Bertocchi and Strozzi note:
At independence, most of the incipient states [in Latin America] chose jus soli as a way to break with the colonial political order and to prevent the metropoles from making legitimate claims on citizens born in the new countries.
This is true enough. But it's also true that far lower levels of population density, coupled with perennial labor shortages, made jus soli both more practical and more attractive to states in the Americas.
As Edward Barbier illustrates in his book Scarcity and Froniers, the Americas have long been characterized by a strong need for more laborers to take advantage of the vast natural resources present across the regions often sparsely populated lands. This led to a variety of immigration policies in the Americas designed to increase immigration. Argentina and Brazil, for example, paid migrants from Italy to settle in South America. Via the Homestead Acts in the nineteenth century, the US government offered free land to new migrants. And across the Americas, of course, many laborers were imported by force via the institution of African slavery.
The most-preferred strategy, however, was often to simply offer easy citizenship to new migrants, and to guarantee citizenship for the children of migrants via jus soli provisions.
At the same time, migration across borders has often been a challenge in many areas of the Americas. Many South American states are separated by deserts, mountains, and dense jungle areas. During the nineteenth century, crossing the Andes mountains was not a simple affair. Similarly, the borderlands between the US and Mexico were largely unpopulated prior to the twentieth century. Mexico's population was concentrated in the southern regions of the country, and migration north required significant effort. It wasn't enough to simply reach the border, either. Access to jobs and capital usually required an even longer journey north or west in the American interior.
Thus, by 1929, legal scholar James Brown Scott could write: "there is no American country which accepts that principle [i.e., jus sanguinis] as the sole test of nationality." Since then, as the relative ease of migration has increased in the Americas, some regimes in the Americas — including the United States — have been pressured to pare back the dominance of jus soli provisions, although little have been done in terms of substantive change.
On the other hand, post-World-War-II Europe began to move away from jus sanguinis provisions. While Scott could conclude that just sanguinis was largely absent in the Americas, he also found "There are at present seventeen countries in Europe in which jus sanguinis is the sole test of nationality."
Part of this was due to the higher population density and geographic compactness of Europe. Moving between political jurisdictions has long been relatively easy in Europe, compared to the Americas. Since the mid-twentieth century, however, the trend has moved toward greater use of jus soli. As of 2010, according to a study by Iseult Honahan,
Ius soli citizenship is widely but by no means universally available in Europe. 19 European countries from 33 studied awarded ius soli citizenship at birth or thereafter. 10 of these countries grant ius soli citizenship at birth, and 16 after birth. ... [I]us soli in its pure (or unconditional) form is not found in Europe since its abolition in Ireland in 2004.
There are, of course, a number of conditional jus soli provisions that exist. These can include automatic birthright citizenship for foundlings and stateless children. But many states have at least some weak jus sanguinis provisions requiring birth to at least one native citizen. Naturalization can occur outside of these conditions, but these provisions often require years of permanent residency, citizenship classes, and other mandates.3
Honahan concludes that the trend in Europe "is towards the wider availability of jus soli citizenship" but with many conditions attached in most cases. Europe-wide, jus soli provisions occur across a spectrum, with more strict provisions present in Eastern Europe and Switzerland:
Returning to our Luxembourg example, we can note that Luxembourg employs a "double jus soli" standard in which children born in Luxembourg receive automatic citizenship only if one of the parents was also born in Luxembourg. Honahan thus classifies Luxembourg as a jus soli country, but as we have seen, the situation in practice is one in which citizenship remains significantly restricted.
It is important to keep in mind, moreover, that the relative restrictiveness of naturalization law does not necessary reflect the restrictiveness of immigration law.
After all, Luxembourgers are frequently outnumbered by migrants, even if citizenship is restricted. Similarly, Switzerland has one of the largest populations of foreign-born residents in the world, yet is highly restrictive in terms of naturalization. Norway is similarly restrictive, although its foreign-born population is equal to that of the United Kingdom, which employs a more liberal jus soli standard.
This mismatch between immigration policy and naturalization policy highlights for us the fact that immigration has never been merely a matter of economic relationships. For example, among laissez-faire liberals, both Ludwig von Mises and Murray Rothbard recognized that there is no economic argument against immigration. The situation is different, however, when we consider matters of citizenship and political participation. In these cases, migrants expand their role beyond the private sector and into the political sphere. As Mises noted, this fact — that fact that immigrants are not merely consumers or workers — carries with it a variety of complicating factors around the question of who shall be in control of the state. The smaller the state, the less relevant this question is. But in the presence of a robust state apparatus — especially one that controls educational institutions and social-welfare programs — this question becomes far more important.
Apparently, Luxembourgers are quite aware of these facts and have decided to maintain and expansive immigration apparatus while limiting citizenship. On the other hand, thanks to geography and the legal traditions of the New World, many Americans have a skewed view of the alleged inseparability between immigration and citizenship. This has clouded the American debate over birthright citizenship.
- 1. In Luxembourg, as in much of the EU, naturalization law is a two-tier affair. Migrants who are already EU citizens have easier access to naturalization than non-EU citizens from places like Africa and Asia.
- 2. See working paper: "The Evolution of Citizenship:Economic and Institutional Determinants" by Graziella Bertocchi and Chiara Strozzi. December 2005. (http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.540.4022&rep=rep1&type=pdf)
- 3. The extent to which jus soli provisions are adopted is not necessarily synonymous with ease of naturalization. For example, the United States could abolish birthright citizenship while also expanding naturalization through other means. On the whole, however, the degree to which jus sanguinis requirements are employed generally reflects a regime's overall openness to expanding citizenship quickly and easily. Notable exceptions exist, such as Sweden, which is restrictive in terms of just soli, but has permissive naturalization-by-application policies.
“Germany has plunged into unprecedented political chaos,” a headline dramatically proclaimed in the prestigious international Foreign Policy magazine in the wake of the German elections in fall 2017. As different parties negotiated for months to find a majority to govern, the writer of the piece, Paul Hockenos from Berlin, felt that the bad results for the conservative Christian Democratic Union (CDU) showed that “Merkel’s train wreck raises the question of her ability to lead the party and the nation.”
It is a question that even after the CDU agreed to a renewed coalition with the Social Democrats (SPD) – another “Grand Coalition” between the two grand old parties of the country, was asked again and again. An unstable government with historically low popularity numbers drifted from one crisis to another, almost collapsing seemingly every other month – like in June 2018, when the Bavarian sister party of the CDU, the CSU, threatened to end the coalition over the governments’ refugee policy. At times, Germany, of all countries, having always been immune in years past to political chaos, seemed close to getting the politics that states like Italy, Greece, or France, have had to bear with for a long time. Indeed, German society was as polarized as ever, as parties on both the far-right as well as the far-left (or, the “far-Green”) were gaining steam.
And so Merkel stepped down. After taking major beatings in state elections in Bavaria and Hesse earlier last fall, the 13-year-chancellor of Europe’s largest economy announced that she would leave her position of CDU party leader in December and would sooner than later retire as head of government as well. But as her successor, Annegret Kramp-Karrenbauer, or most often called simply “AKK,” was crowned at the party congress, one thing became ever clearer: with AKK, who is also known as “Merkel 2.0,” little would change. Instead, Germany looks into an uncertain future, which possibly has even more chaos, political disruption, and societal discord in store.
How did we get here? After all, just a few years ago, everything seemed just fine for Merkel and her left-wing conservatism that AKK wants to adopt, too. In contrast to most other European countries, Germany escaped the economic crisis of 2008 and the subsequent euro crisis of 2012 relatively unscathed, instead scoring solid economic growth and decreasing unemployment numbers ever since. On the world stage, Germany became a voice again that others listened to, both economically – as the home of industry and as export champion, as well as socially, being open to outsiders, and politically, as a defender of the liberal democratic order. No one has forgotten when Merkel proclaimed in 2015 that “Wir schaffen das” (“We can do it”), as refugees from the Arab world were rushing in in (hundreds of) thousands. No one will either forget when in the wake of the U.S. Presidential elections in 2016, some dubbed the chancellor as the new leader of the free world.
Much was deceiving, though. Economically, for instance, it is tough to praise Merkel for Germany’s success, considering it was the important reforms of her predecessor, the Social Democrat Gerhard Schröder, which put the country back on the path of success. Schröder – not Merkel, received the “Ludwig Erhard Prize” in 2016 for the pro-market policies he implemented, like his tax cuts both on corporate as well as income taxes, reductions in unemployment benefits as well as a decrease in pension benefits. When Merkel succeeded him in 2005, Germany was finally competitive again in Europe when it comes to labor costs.
Merkel, meanwhile, did very little for the German economy – except making it tougher to do business as well as find a job. Instead of lowering taxes even further like she promised, the German government introduced a minimum wage (and has increased it several times since), even decreased the pension age despite the system being in trouble already and the redistribution from the young to old having been in earnest for way too long, and conducted a costly energy transition – deciding to slowly pull out of nuclear energy production for massive subsidies in renewable energies. Electricity prices for households doubled from 2000 to 2017, and in total, the “Energiewende” could cost the country up to 1.1 trillion euros until 2050. And, perhaps most significantly, Merkel was the conductor of the drama which saw Germany bail out Greece at the height of the euro crisis, regardless of how much the population rebelled.
One can say then that Angela Merkel has become Germany’s economically most left-wing chancellor in post-war history. And as the now 64-year-old pursued this path, she alienated the business community and a big chunk of her supposedly conservative party with every day. In the battle of who would replace her, Friedrich Merz eventually came in second after AKK, only closely losing by 52 to 48 percent. The success of Merz, a strong pro-market voice who has been active in the financial industry for over a decade and even co-founded a think tank promoting the market economy, showed the split that is going through the CDU on where the biggest party of the country should head.
While the economy is one of the main reasons why the CDU is split, there is little doubt that cultural issues are the decisive factor in the increasing polarization in German society. Here also Merkel’s decisions are mainly responsible. It is, after all, her refugee policy which has caused so much dismay among voters and the rise of the first solidly right-wing party since World War II. The Alternative for Germany (AfD), which at this point is most often polling above 15 percent (sometimes closing in on twenty), has overtaken the Social Democrats and is battling with the Greens for the second spot behind the weakened CDU.
While the AfD was originally founded as a party rebuking Merkel’s economic policy and the euro as a currency in principle, it has shifted farther to the right continuously since the refugee crisis began in 2015. Germans, of course, are also enraged about the economic consequences of the refugee crisis, which will cost, as some estimates put it, $86 billion only from 2016 to 2020. Not only that, though, as the incentives for incoming refugees are particularly macabre, as they are forbidden to work until their refugee request is approved, which can take years in extreme cases. Instead, they have to spend day-in, day-out in refugee centers in boredom, meanwhile taking in large amounts of money from German taxpayers.
There is little doubt, however, that the main issue German voters see in the refugee crisis is a cultural one. With more than one million Arabs and North Africans entering the country in 2015 alone (and many more, though less quick, ever since), the cultural change has been as disruptive and rapid as ever before. Far-right voices from the AfD to the anti-immigrant Pegida, a group which has been protesting the refugee policy especially in the Eastern German city Dresden ever since the crisis commenced, often focus on the phenomenon of the so-called “Rapefugees,” i.e. higher crime rates and especially rapes by refugees. It is a phenomenon which seems to be more of a populist invention than reality outside of the shocking incident in Cologne, when mass sexual assaults by Arabs occurred on New Year’s Eve 2015.
In general, the anger of many Germans seems to stem more from the deep cultural change Germany has experienced in a matter of less than five years, with (much) more to come (refugees in general have more children than German citizens). Some call it “Islamization,” which is exaggerated, and headline producing cases like the small village of Sumte, which had one hundred inhabitants until 700 refugees where moved there, are extreme and rare. Nonetheless, there are new challenges Germans have to deal with. People who have lived in their community for decades are suddenly confronted with many newcomers whom they do not know, whose culture they have never been in contact with and which they often see as dangerous, all the while those very newcomers are not very well integrated yet.
But the debate goes deeper than that: it is a debate on the very core of both liberalism as well as the nation that is called Germany itself. It is a debate on how open or closed the country should be. What is more important? Having a cosmopolitan society or finding one’s identity? And finding one’s identity it truly is in the German case, as today’s Germans never had the same sense of national identity as almost any other nation on this planet. Rather, Germans, due to the country’s dark past, have had to deal with what went down as “German guilt,” and were never allowed to develop their own national identity and culture, in fear that the ghosts of the 1930s would come back to haunt them. In this sense, today’s debate goes to the heart of what it means to be German.
Merkel’s policy then has brought a discussion to the forefront which was brewing underneath the surface ever since the great wars of the last century. But by ignoring – or sometimes even ridiculing, and more often bedeviling, one side of the debate, the chancellor might have created exactly what she was so determined to prevent: the revival of the far-right. This might be Merkel’s biggest contribution in the end. The “leader of the free world,” who has been horrific on economics, who bailed out other countries on the back of her own, who led a monumentally expensive energy transition, and who failed to follow her predecessor in liberating the German economy, was close to fall many times over the years – and for those very reasons.
What would ultimately lead to her downfall, however, was that she – as almost everyone else in the political establishment – did not give a fair hearing to those that those that did not necessarily wanted everything to stay the same it had been, but those who simply did not want their entire surrounding to change from one day to another by the government’s hand. And to those who, regardless of whether rightfully or not, were alienated by the multiculturalism and political correctness that dominated German society – a society in which, for instance, flying a German flag outside your house could easily lead to you being deemed a fascist.
Her successor, Kramp-Karrenbauer, will in all likelihood find no solution to this. She, who is called “Mini-Merkel,” will provide more of the same. More of the same is the least anyone wants right now. And so Germany is looking into a future in which two visions – “open” versus “closed,” multiculturalists versus localists, “anywheres” vs “somewheres,” are pitted against each other, one side accusing the other of bigoted nationalism, and the other side accusing the one of cultural suicide. The only thing that is sure about this future is that it will be one of uncertainty, of chaos, and ever greater polarization.
There are some economic principles that can help entrepreneurs in their business-building endeavors. One is the understanding of ends and means. What ends (goals, objectives) are your customers pursuing, and how do they choose the means to achieve those ends? The customer is in charge of choosing ends, and the entrepreneur takes charge of offering the most attractive and valuable means. How do entrepreneurs solve that equation? We asked Peter Klein. Peter is Professor of Entrepreneurship at Baylor University’s Hankamer School of Business. He is also Senior Research Fellow at Baylor's Baugh Center for Entrepreneurship and Free Enterprise and Adjunct Professor of Strategy and Management at the Norwegian School of Economics. He knows ends and means.Show Notes
Economics helps entrepreneurs in a very practical sense by shining a very bright light on human motivation. In economic terms, people act. They do things. And when they do things, they always have purpose in mind. They are goal oriented. The entrepreneur’s job is to figure out how to help customers achieve a goal that they already have in mind.
Thinking about this principle in simple terms helps entrepreneurs develop a deep understanding of customer value chains. Why for example, do people choose to drink coffee? It doesn’t just happen. People raise a coffee cup to their lips because they want to enjoy the taste. Or maybe to give themselves a caffeine boost. Or perhaps they are drinking coffee in a social context and they want to enjoy the shared experience. Economists are always thinking about the customer’s goal in taking a certain action — and entrepreneurs can benefit from thinking the same way.
How and why do people decide on their ends? Economists — and entrepreneurs — don’t judge. We just want to find out what ends the customer is pursuing. And how behavior might change if circumstances change — for example, if prices rise, the customer might buy less or stop buying altogether.
How can entrepreneurs find out about what motivates customers to pursue certain ends and use certain means? By immersing themselves in a market — like the consumer market for coffee as a beverage — and thinking about it from all angles: psychology, economics, history, culture, fashion, supply chain, marketing. Like Howard Schultz observing coffee shop behavior in Milan as a precursor to launching Starbucks in the US. He deduced from his observations what Americans might derive from a similar experience if he provided it.
How do entrepreneurs develop the appropriate skills and knowledge? Not from reading books, that’s for sure. It’s instinct plus tools. The tool discussed in this episode is the Means-Ends Chain. It’s the tool that helps entrepreneurs understand that they are not selling — and the customer is not buying — coffee, but an experience.
The skillful entrepreneur links the proximate product — the coffee — to the desired experience — the “third place” experience as Starbucks calls it — in a convincing and persuasive manner. This requires exploration and experiment to get it right. It’s never obvious.
That’s why economists refer to uncertainty — it’s the situation all entrepreneurs face. You never know the future outcome until you try. The entrepreneur must be flexible in exploring the customer’s ends and means. Uncertainty rules.
Entrepreneurs exercise judgment, and try to develop insights, but can never achieve certainty. Data might help but it’s not infallible. Eventually, the entrepreneur must decide to “go for it” without certainty of being right. It’s the “plunge” decision. Learning, big data, and surveys are inputs, but they can’t make the decision; only a human can.
Experience can help. In the US, the average age of the first-time entrepreneur is mid to late 40s. Experience in an industry and lived experience are helpful. And intergenerational sharing of experience — like finding a mentor — can also contribute the experience you don’t have.
Entrepreneurship is not rocket science. Know your market, know your customers, and trust your judgment and your instincts.
Thousands of people are killed or seriously injured on Canadian roads and highways every year. Traffic congestion is common. Perpetual road construction/repairs. Cars lined up at a red light while non-existent cross traffic faces a green light. Idling cars, frayed nerves, road rage. If this was the performance record of private firms who owned and managed the roads, politicians would go ballistic and seize control of the roads in order to “ensure consumer safety.”
However, as we know, it is the politicians and bureaucrats who are responsible for this dismal, and deadly, performance record, so they unleash their propaganda: “Citizens have to be more patient”, “Commuters should car pool”, “Drivers have to slow down”, “More people should take public transit, or cycle, or walk”, “Employers should offer staggered shifts and allow some employees to work from home”, “Higher taxes will solve the problem”, and, my personal favourite, “We need more traffic laws. No, no, we are sincerely concerned for your safety, not our revenue.”
Whenever the government attempts to provide a service, service is severed from payment, which means taxation guarantees the salaries of politicians and bureaucrats without incentivizing them to provide the services most highly preferred by taxpayers. A visible example of this in London are the many miles of empty cycling lanes adjacent to congested car lanes. For every cyclist, there are at least a thousand motorists. So much for majority rule. And, for a city government professing deep concern for the environment, this is indeed a curious outcome: environmental resources are wasted on the construction of largely vacant cycling lanes, which in turn increases the environmental impact of internal combustion engines due to increased traffic congestion directly attributable to less road space for cars.Private Road Management
In contrast, private road companies do not have the powers of taxation and expropriation. Therefore, unlike the government, they are highly incentivized to minimize costs by allocating resources efficiently in order to satisfy consumers’ preferences to the fullest possible extent because that is the only way to earn revenue. In turn, the market’s price system allows consumers to express their preferences. If people don’t like a particular service, they don’t pay for it, and if enough people don’t pay for it, the service will disappear, or improve, or the price will drop. Moreover, if demand is insufficient to justify the cost of providing a particular service, then the service will not be provided, thereby conserving resources, which minimizes waste. Not to put too fine a point on it, but a constant reminder of municipal government waste are those miles of empty cycling lanes, a project unlikely to be duplicated in the private sector unless cyclists are willing to pay for it. And that is our lesson: when service is linked to payment, waste is minimized because resources are allocated according to consumers’ preferences, not according to arbitrary political edicts.
There are many examples today of efficient road management by the private sector . And if we are alert, we can always identify real world events which clearly illustrate the contrasting incentives of the public versus the private sector. In 2014, Mike Watts, a private citizen in the U.K., frustrated by the economic consequences of a lengthy detour because of government delayed road repairs, built his own bypass toll road which attracted many commuters and embarrassed the government. Read about it here , here , and here .
The 2014 U.K. example reminds us that inefficient transportation hinders economic growth, as it has throughout history. As Murray Rothbard wrote:
In England before the eighteenth century, for example, roads, invariably owned and operated by local governments, were badly constructed and even more badly maintained. These public roads could never have supported the mighty Industrial Revolution that England experienced in the eighteenth century, the “revolution” that ushered in the modern age. The vital task of improving the almost impassable English roads was performed by private turnpike companies, which, beginning in 1706, organized and established the great network of roads which made England the envy of the world.1
The owners of these private turnpike companies were generally landowners, merchants, and industrialists in the area being served by the road, and they recouped their costs by charging tolls at selected tollgates. Often the collection of tolls was leased out for a year or more to individuals selected by competitive bids at auction. It was these private roads that developed an internal market in England, and that greatly lowered the costs of transport of coal and other bulky material. And since it was mutually beneficial for them to do so, the turnpike companies linked up with each other to form an interconnected road network throughout the land — all a result of private enterprise in action.2
Rothbard described similar circumstances in the United States in the early nineteenth century, where “Once again, private enterprise proved superior in road building and ownership to the backward operations of government.”3Conclusion
Professor Walter Block wrote, “In advocating a free market in roads … we shall be merely arguing that there is nothing unique about transportation; that the economic principles we accept as a matter of course in practically every other arena of human experience are applicable here too.”4
In all likelihood, London’s traffic problems are a direct result of unavoidable planning errors at City Hall, due to the perverse incentives inherent to the government system. It is time to give private enterprise a chance. The likely result would be a more efficient transportation network, at lower cost, with less wasting of resources, thereby paving the way for lower taxes, a smaller government, and increased economic prosperity.
- 1. Chapter 11, For A New Liberty https://mises.org/library/new-liberty-libertarian-manifesto
- 2. Murray N. Rothbard For a New Liberty (Ludwig von Mises Institute, Auburn, Alabama, 2006) p 264 [additional source provided by Rothbard: T. S. Ashton An Economic History of England: The 18th Century (New York: Barnes and Noble, 1955), pp 78 – 90. See the same source, pp 72 – 90, for the mighty network of private canals built throughout England during the same period.]
- 3. Ibid., p 265 [additional sources provided by Rothbard: George Rogers Taylor, The Transportation Revolution, 1815 – 1860 (New York: Rinehart, 1951), pp 22 – 28; W. C. Wooldridge, Uncle Sam the Monopoly Man, pp 128 – 36
- 4. Walter Block The Privatization of Roads & Highways – Human and Economic Factors (Ludwig von Mises Institute, 2009) p 11
What is the real state of life in America? Why are we so divided, politically and otherwise? How fragile is the economy, and how much longer can debt and deficits go unaddressed? Will culture wars destroy any remaining sense of a shared American vision? Is a cold civil war—or worse—inevitable? Recorded at "The Mises Institute in Orlando: The Real State of the Union" on February 16, 2018.
What is the real state of life in America? Why are we so divided, politically and otherwise? How fragile is the economy, and how much longer can debt and deficits go unaddressed? Will culture wars destroy any remaining sense of a shared American vision? Is a cold civil war—or worse—inevitable? Recorded at "The Mises Institute in Orlando: The Real State of the Union" on February 16, 2018.
What is the real state of life in America? Why are we so divided, politically and otherwise? How fragile is the economy, and how much longer can debt and deficits go unaddressed? Will culture wars destroy any remaining sense of a shared American vision? Is a cold civil war—or worse—inevitable? Recorded at "The Mises Institute in Orlando: The Real State of the Union" on February 16, 2018.
[First published as "Our Greatest Presidents?" in the Libertarian Review, 1977. An MP3 audio file of this article, read by Steven Ng, is available for download.]
It was as if, for 25 years, time had stopped. As if the author serenely expected that we would suddenly unlearn everything the past decade had taught us about the uses of power at the highest levels of government. As if we had not, by 1977, reached the point where even a perennial sycophant of state power like Arthur Schlesinger, Jr., has ended by bemoaning "the Imperial Presidency."
There it was again — as dated as a double-breasted suit — an article on "Our Greatest Presidents," and written by none other than Henry Steele Commager himself!
A quick background briefing for those too young to remember. In the 1940s and early '50s, a school of establishment historians existed who made it their business to act as a sort of intellectual Secret Service for the American presidency. Close upon every great public rape of the Constitution by a president — for instance, when Harry Truman seized the steel mills, or when he began to wage war on North Korea and China without a declaration of war by Congress — these historians would rush into print with learned accounts of the 129 times the Constitution had been similarly raped in the past, under dire necessity and with no ill effects to the body politic — quite the contrary, actually: she never felt better in her life.
The most outstanding among this school were Allan Nevins of Columbia University, Arthur Schlesinger, Jr., of Harvard, Eric Goldman of Princeton, and — topping them all — Henry Steele Commager of Amherst College. When they were in a classy, quasi-philosophy-of-history frame of mind, these men would sometimes rationalize the power moves of the chief executive through an eye-catching gimmick. The public would be presented with the answer to a question nobody had asked, now just who were the really Great Presidents?
This was a favorite game of around 1950 for Nevins, Commager, and the rest, and the lists were always the same. Washington, Lincoln, and another one or two of the earlier presidents would be thrown in to give a tone of objectivity and sageness. The point of the whole enterprise, however, would come with the Great (or Near-Great) Presidents of the 20th century.
Then it would be given out, as the conclusion of historical science, that — taking the good with the bad, of course — the one indisputable Great in our own time was Franklin D. Roosevelt, and the indisputable Near-Greats were Theodore Roosevelt, Woodrow Wilson, and Harry Truman. Surprise! Surprise!
Those were halcyon days for the mystique of the presidency, such that one could find this childishly transparent attempt to turn a bit of liberal politicking into the Verdict of History in the pages of Life, Look, and the New York Times Magazine. But now the great interventionist picture books are gone, and there are smart New Left revisionist sharks roaming about on Sunday morning who would like nothing better than to pounce on such grade-school stuff — to remind everyone, for instance, of what Jackson did to the Cherokees, of what Truman did to the civilians at Hiroshima and Nagasaki, and that Theodore Roosevelt was a racist in practically the Nazi sense.
Thus, poor Professor Commager is reduced to publishing in Parade, the mass-Sunday-newspaper-supplement semithrowaway. It was there, on May 8, after the third cup of coffee, that one found his nostalgia-awakening article, "Our Greatest Presidents."
In case you were wondering, the outstandingly Great Presidents according to Commager (and to a poll of historians at one hundred colleges and universities that he reports on) are Lincoln, Washington, and Franklin D. Roosevelt. They are closely followed by Theodore Roosevelt, Jefferson, Wilson, Jackson, and — a little behind — Harry Truman.
Surprise! Surprise! What are the criteria of greatness in a president?
First, all were what we must call "strong" Presidents. All believed the President should be both a symbol and a leader …. Second, all ranged themselves on the side of the people, of an enlarged scope for government.
(Nobody here but us objective historians!)
The third criterion, being a good administrator and politician, is not, it turns out, a necessary condition according to Commager (the contradiction is his). But the fourth may be found in all of these leaders. It is, "quite simply, wisdom, sagacity, intelligence." (This of Franklin Roosevelt — of Wilson!) Finally,
There is one essential common denominator that transcends all others: all the great Presidents were men of principle, prepared to sacrifice popularity to what they thought was right.
And so it goes. It is clear that Commager's favorite is FDR. Here are some of History's conclusions about FDR: Among his qualities were
honesty, resolution, fortitude, compassion, a sense of justice …. How right Franklin Roosevelt was when he said: "The Presidency is preeminently a place of moral leadership."
Roosevelt was "prepared to put principle above politics — and above popularity." The way Commager phrases the outstanding example of Roosevelt's loyalty to "principle" is interesting: he "risked the loss of the 1940 election by stretching the Constitution to its permissible limits in order to aid beleaguered Britain" against Germany (emphasis added). "History," Commager adds, "has vindicated him well."
This is the famous historian's little way of getting around a fact that, since the golden age of presidential glorification, has become common knowledge: namely, that Roosevelt committed the United States to war against Germany — through his promises to foreign leaders and his directives to the American armed forces — in 1940 (at the latest), without even the knowledge of Congress, and in direct contravention of his assurances to the American people, whom he treated as fools. By now, this much is established: as C. Boothe Luce put it for all time, "he lied us into war."
For sure — honesty, as Commager assures us, was one of FDR's great virtues. And Eleanor's mind was a model of Cartesian clarity. But what is the use? Commager's out-of-date nonsense, masquerading as historical wisdom, is what they are going to teach little children in the government's schools. After Vietnam and Nixon, the professional custodians of the tarnished symbols of the American state are panicky. They do what they can to patch things over — old pimps to an old whore dressed up as history. But how much longer?
In a very limited sense, there is private education in the developed world, but almost always private schools are heavily regulated by the government. There is also the issue of compulsory attendance laws. Competition in schooling that is unapproved by government bureaucrats is prohibited since attendance does not qualify as actual “education” in the eyes of the government. We, therefore, lack the means to compare an actual free market in education with government schooling.
In underdeveloped nations, however, because society is much poorer, governments lack the resources to crack down on underground private schools. In his book The Beautiful Tree, James Tooley explored and researched numerous poor countries including India, Nigeria, Ghana, Kenya, and China. He describes a recurring theme of government education officials not even being aware of private schools for the poor. Usually, they balked at the idea. Private schooling is generally regarded as a luxury for the rich. In cases where government agents did know of the schools, regulation was rarely enforced. Officials did not always visit schools in poor areas, and when they did, a bribe was enough to get them to leave.
Tooley’s research showed low-cost private, usually unregulated schooling to be a thriving market in many areas. In Nigeria for instance: “…we’d found 32 private schools in the shantytown of Makoko, none recognized by the government, and estimated that around 70 percent of schoolchildren in Makoko went to private school. In the poor areas of Lagos State more generally, we’d estimated that 75 percent of all schoolchildren were in private schools, of which only some were registered with the government.” Writing of a visit to India, he commented: “Everywhere among the little stores and workshops were little private schools! I could see handwritten signs pointing to them even here on the edge of the slums.” In rural Gansu, China Tooley’s team located 586 private schools in the villages. “Officially”, there were only 26 schools in Gansu all of which were government schools in the larger towns. It was a matter of policy in China to deny these private schools existed. After all, China had already declared universal public primary school had been achieved. Tooley’s research, therefore, provides a unique insight into comparing government schooling with private alternatives.Private Schools vs. Government Schools Teacher absenteeism in government schools is probably the most blatant issue. While visiting a government school in India, Tooley observed 130 students cramped together in 1 room. The head of the school mentioned that the other teachers were absent that day, so they were teaching them all together. “They’ll be absent every day.” he was told by the deputy district education officer. Transparency International has estimated government teacher absenteeism in the developing world ranges from 11-30%.1 Conversely, Tooley reported that when he visited private schools unannounced, it was rare to find teachers not teaching, and in those instances, the principal had taken over the class for the day.
The absence of teachers is not the only problem. In 2003 Kenya introduced free primary education. Many parents who transferred their children from private schools to the new government schools, soon reversed their decision. Tooley’s team interviewed parents from four different schools who had tried the government schools. He reports that every parent interviewed commented on how the private schools were of higher quality. He encountered quotes like this: “[Public education] may be free, but children do not learn. This makes the quality of the education poor and that is why many parents have brought their children back.” A father commented: “While most of the teachers in government school are just resting and doing their own things, in private school our teachers are very much busy doing their best because they know we pay them by ourselves.”
While interviewing mothers in India who sent their children to low-cost private schools, all were very open about why they chose private over government. One mother, when asked about government teachers being well-trained replied: “They might be very good at studying, but they are not very good at teaching.” Another commented: “They even beat the children very badly, treat them as slaves.” This was of course if the teachers showed up.
Tooley encountered similar stories everywhere he went. A man in Nigeria commented: “We pass the public schools many days and see the children outside all of the time, doing nothing. But in the private schools, we see them every day working hard.”
Even though these schools serve some of the poorest people on the planet, they still take in enough in fees to be able to stay open. They do so by hiring and personally training teachers who do not demand high wages due to being extensively trained in universities (education of many teachers tends to be at about a high school graduate level). Low-cost schools also invest significantly less in buildings and playgrounds. Though the fees are low enough to be manageable for most parents in poor areas, many of the schools Tooley visited were also providing free education to orphans, as well as families who were exceptionally poor. In some cases, 20% of the students were receiving free education.Key Findings
The studies that Tooley organized in India, Nigeria, Ghana, and China comparing government schools with both private recognized and unrecognized schools confirmed his experiences on the ground interacting with parents and teachers. Below is his summary of the results.
-Class sizes were smaller in both types of private schools than in public schools
-Both types of private schools had higher teacher commitment – in the percentage of teachers teaching when our researchers called unannounced.
-Only on one quality input – the provision of playgrounds – were government schools superior to both types of private schools across all studies.
-Children in both types of private schools, in general, scored higher on standardized tests in key curriculum subjects than did children in government schools.
-The higher standards in private schools were usually maintained for a small fraction of the per-pupil teacher cost in government schools.
In addition, he noted: “Controlling for the range of background variables, including education and wealth of parents, student’s IQs, and peer-group effects, the differences were usually slightly reduced but generally still large and still favored both types of private schools in each study.”
The success of entrepreneurs in developing countries at meeting the demand for education is quite impressive. Especially, when compared to the failures of the government alternative. The myth that education cannot possibly be provided to the poor through non-governmental means is shattered. In fact, it may be the only effective way for them to receive a quality education. One wonders what could be achieved if educators were completely freed from the threat of regulation, the corruption of government agents, and the crowding out effects from massive subsidization of poor-performing government schooling.
- 1. Also see the World Bank on teacher absenteeism: http://blogs.worldbank.org/education/hidden-cost-corruption-teacher-absenteeism-and-loss-schools
The golden rule—“Do to others as you would have them do to you” being the most common variant I have heard--may be the most common ethical touchstone for human interactions. After all, Simon Blackburn wrote in his 2001 book, Ethics, that the Golden Rule is “found in some form in almost every ethical tradition.” I doubt there is anyone I know who has not heard of it. And I have often heard it used as the gold standard for behavior, applied to individuals, groups and governments.
However, fewer seem familiar with the silver rule, which is the converse of the golden rule—“do not do unto others what you would not have them do unto you”—even though it has been expressed in far more ways in various religious and ethical traditions. What it instructs us not to do has included “what you would not choose for yourself,” “what you do not want to happen to you,” what would anger if done to you by others,” “what you yourself dislike,” “that which is hateful to you,” “that which one regards as injurious to oneself,” and “that which is unfavorable to us,” among others, presenting a more thorough delineation of what not to do than the golden rule provides for what to do.
The silver rule follows the traditional definition of justice—giving each his own. It is reflected by Adam Smith, in his Theory of Moral Sentiments, where he writes “We can often fulfill all the rules of justice by sitting still and doing nothing.” That leaves it below the golden rule on most people’s ethical medal stands, because it seems to hold us to a higher standard. That is true when we are talking about individuals and voluntary associations but when we are talking about governments, the silver rule takes the gold.
When we are considering individuals, the golden rule need not conflict with the silver rule. You and I are each free to go beyond doing nothing harmful to others and do as much good unto them as we choose, using our own resources.
The same is true for individuals who voluntarily associated into groups. You and I together can agree to go beyond doing nothing harmful to others and do as much good unto them as we choose, using our own resources.
When we come to government, however, the golden rule, as commonly understood, conflicts with the silver rule. Say a government decision maker determines to do good, as they see it, unto others. The problem is that government has no resources of its own; only what it commandeers from citizens. Without unanimous consent (which happens how often in government, where control only requires 50%-plus-one consent for most decisions?), resources will necessarily be taken for that purpose against the will of some, and often many. That violates the supposedly less demanding silver rule. That is why Grover Cleveland could say that the U.S. government is “pledged to do equal and exact justice to all men,” without contradicting himself when he said that “though the people support the Government, Government should not support the people.”
The problem arises in such cases because focusing on the golden rule can lead people to perceive someone’s needs or wants, decide that someone should do something about it, and so volunteer the government for the task. But that leaves out a central part of the story. They could have sought to ameliorate the problem in a manner that would not violate the silver rule--doing something about it as an individual or as a voluntary association—but instead decided to employ government’s coercive power to force a substantial part of the tab for their ethical concerns onto others who don’t share their opinions or conclusions.
Another way of saying this is comes from what Adam Smith wrote just before his quote above: “The man who barely abstains from violating either the person, or the estate, or the reputation of his neighbors…does everything which his equals can with propriety force him to do, or which they can punish him for not doing.” That is, government is to be our protector against invasions from outsiders and neighbors. Laws, like the Bill of Rights, should focus on applying “thou shalt nots,” as Justice Hugo Black once put it, against violators of our rights. When it goes further, it treats some citizens as a predator rather than a protector, undermining its central purpose.
Fortunately, there is a form of the golden rule that can reconcile government with the silver rule as well as a truncated view of the golden rule that ignores where the resources must come from. It comes from the hadith, collected accounts of Muhammad and his teachings: “Prophet said: ‘As you would have people do to you, do so to them; and what you dislike to be done to you, don’t do to them.’” In other words, “do only those things under the golden rule that do not violate the silver rule.
The Federal Reserve’s doors have been open for “business” for one hundred years. In explaining the creation of this money-making machine (pun intended — the Fed remits nearly $100 bn. in profits each year to Congress) most people fall into one of two camps.
Those inclined to view the Fed as a helpful institution, fostering financial stability in a world of error-prone capitalists, explain the creation of the Fed as a natural and healthy outgrowth of the troubled National Banking System. How helpful the Fed has been is questionable at best, and in a recent book edited by Joe Salerno and me — The Fed at One Hundred — various contributors outline many (though by no means all) of the Fed’s shortcomings over the past century.
Others, mostly those with a skeptical view of the Fed, treat its creation as an exercise in secretive government meddling (as in G. Edward Griffin’s The Creature from Jekyll Island) or crony capitalism run amok (as in Murray Rothbard’s The Case Against the Fed).
In my own chapter in The Fed at One Hundred I find sympathies with both groups (you can download the chapter pdf here). The actual creation of the Fed is a tragically beautiful case study in closed-door Congressional deals and big banking’s ultimate victory over the American public. Neither of these facts emerged from nowhere, however. The fateful events that transpired in 1910 on Jekyll Island were the evolutionary outcome of over fifty years of government meddling in money. As such, the Fed is a natural (though terribly unfortunate) outgrowth of an ever more flawed and repressive monetary system.Before the Fed
Allow me to give a brief reverse biographical sketch of the events leading up to the creation of a monster in 1914.
Unlike many controversial laws and policies of the American government — such as the Affordable Care Act, the Troubled Asset Relief Program, or the War on Terror — the Federal Reserve Act passed with very little public outcry. Also strange for an industry effectively cartelized, the banking establishment welcomed the Fed with open arms. What gives?
By the early twentieth century, America’s banking system was in a shambles. Fractional-reserve banks faced with “runs” (which didn’t have to be runs with the pandemonium that usually accompanies them, but rather just banks having insufficient cash to meet daily withdrawal requests) frequently suspended cash redemptions or issued claims to “clearinghouse certificates.” These certificates were a money substitute making use of the whole banking system’s reserves held by large clearinghouses.
Both of these “solutions” to the common bank run were illegal as they allowed a bank to redefine the terms of the original deposit contract. This fact notwithstanding, the US government turned a blind eye as the alternative (widespread bank failures) was perceived to be far worse.
The creation of the Fed, the ensuing centralization of reserves, and the creation of a more elastic money supply was welcomed by the government as a way to eliminate those pesky and illegal (yet permitted) banking activities of redemption suspensions and the issuance of clearinghouse certificates. The Fed returned legitimacy to the laws of the land. That is, it addressed the government’s fear that non-enforcement of a law would raise broader questions about the general rule of law.
The Fed provided a quick fix to depositors by reducing cases of suspensions of their accounts. And the banking industry saw the Fed as a way to serve clients better without incurring a cost (fewer bank runs) and at the same time coordinate their activities to expand credit in unison and maximize their own profits.
In short, the Federal Reserve Act had a solution for everyone.
Taking a central role in this story are the private clearinghouses which provided for many of the Fed’s roles before 1914. Indeed, America’s private clearinghouses were viewed as having as many powers as European central banks of the day, and the creation of the Fed was really just an effort to make the illegal practices of the clearinghouses legal by government institutionalization.Why Did Clearinghouses Have So Much Power?
Throughout the late nineteenth century, clearinghouses used each new banking crisis to introduce a new type of policy, bringing them ever closer in appearance to a central bank. I wouldn’t go so far as to say these are examples of power grabs by the clearinghouses, but rather rational responses to fundamental problems in a troubled American banking system.
When bank runs occurred, the clearinghouse certificate came into use, first in 1857, but confined to the interbank market to economize on reserves. Transactions could be cleared in specie, but lacking sufficient reserves, a troubled bank could make use of the certificates. These certificates were jointly guaranteed by all banks in the clearinghouse system through their pooled reserves. This joint guarantee was welcomed by unstable banks with poor reserve positions, and imposed a cost on more prudently managed banks (as is the case today with deposit insurance). A prudent bank could complain, but if it wanted to use a clearinghouse’s services and reap the cost advantages it had to comply with the reserve-pooling policy.
As the magnitude of the banking crisis intensified, clearinghouses started permitting banks to issue the certificates directly to the public (starting with the Panic of 1873) to further stymie reserve drains. (These issues to the general public amounted to illegal money substitutes, though they were tolerated, as noted above.)Fractional-Reserve Free Banking and Bust
The year 1857 is a somewhat strange one for these clearinghouse certificates to make their first appearance. It was, after all, a full twenty years into America’s experiment with fractional-reserve free banking. This banking system was able to function stably, especially compared to more regulated periods or central banking regimes. However, the dislocation between deposit and lending activities set in motion a credit-fueled boom that culminated in the Panic of 1857.
This boom and panic has all the makings of an Austrian business cycle. Banks overextended themselves to finance the booming industries during America’s westward advance, primarily the railways. Land speculation was rampant. As realized profits came in under expectations, investors got skittish and withdrew money from banks. Troubled banks turned to the recently established New York Clearing House to promote stability. Certain rights were voluntarily abrogated in return for a guarantee on their solvency.
The original sin of the free-banking period was its fractional-reserve foundation. Without the ability to fund lending activity with their deposit base, banks never would have financed the boom to the extent that it became a destabilizing factor. Westward expansion and investment would still have occurred, though it would have occurred in a sustainable way funded through equity investments and loans. (These types of financing were used, though as is the case today, this occurred less than would be the case given the fractional-reserve banking system’s essentially cost-free funding source: the deposit base.)
In conclusion, the Fed was not birthed from nothing in 1913. The monster was the natural outgrowth of an increasingly troubled banking system. In searching for the original problem that set in motion the events culminating in the creation of the Fed, one must draw attention to the Panic of 1857 as the spark that set in motion ever more destabilizing policies. The Panic itself is a textbook example of an Austrian business cycle, caused by the lending activities of fractional-reserve banks. This original sin of the banking system concluded with the birth of a monster in 1914: The Federal Reserve.
Image source: flickr: https://www.flickr.com/photos/37815348@N00/6682415005/sizes/l