The Economics of the Hispanic Scholastics

Economics, as a branch of knowledge concerned with human wellbeing, is somewhat like Jenga. The structure cannot hold if certain pieces, such as Adam Smith’s classical school, are removed. 

In Economics: An Introductory Analysis, Paul Samuelson presents a “family tree of economics” noting the contribution of Aristotle, Aquinas, and medieval Schoolmen to the history of economic thought. This may have been a nod to his dissertation advisor, Joseph Schumpeter, who believed that the 16th century development of natural law theory created a framework for economics as an independent discipline. This natural law tradition was subsequently passed on to Adam Smith at the University of Glasgow. 

An intense modern-day look at the economic contributions of late Hispanic Scholastic thought began with Marjorie Grice-Hutchinson (The School of Salamanca, 1952). It continued with Alejandro Chafuen (Faith and Liberty, 2003 and Raices de la Economia de Mercado en la Escolastica Catolica, 2nd Ed., 2017). 

The Hispanic Scholastics were the first to formulate a quantity theory of money and purchasing power parity, foundational in the canon of economics. However, it is worthwhile to consider how their methodology employed natural law, civil law, and revelation to explore a subjective theory of value, the moral neutrality of market transactions, and personal consent. 

The Hispanic Scholastics’ subjective (not to be confused with relativistic) theory of value applies to all goods, including money. Viewing consumption as the end of all economic activity implies that value is subjective, based on people’s needs and wants, even when those needs and wants are foolish. These ideas persisted on the European Continent with the ordinary person seen as a consumer rather than a producer.

In the 18th century, classical economists stressed production, inputs, and cost, even to the extent of holding to a labor theory of value. Measuring hours of labor and other inputs is relatively straightforward; whereas subjective satisfaction or utility is incapable of measurement. A theory of behavior describing how consumers reveal preferences was needed. The time had not yet come to advance theories of value into a coherent synthesis, combining subjective and objective elements. 

In the 1870s, Carl Menger in Austria defined the value of an economic good in essentially Hispanic Scholastic terms, i.e. its ability to satisfy a human need. Leon Walras, a French land reformer, modeled money into ratios of exchange between goods. William Stanley Jevons, a British economist departing somewhat from Smith, derived the value of goods from revealed intensities of satisfaction. Within four years of each other Menger, Walras, and Jevons independently set the precedent for marginal supply and demand analysis for understanding market prices.

Economics, within the tradition of classical liberalism, is perceived by some to be excessively individualistic and dismissive of national sovereignty. Multigenerational poverty and the hollowing out of employment in certain sectors are serious economic issues. However, sound economic principles formulated over time by those seeking truths about the human condition and the wealth of nations are essential building blocks. There is no need for future generations to bear the economic consequences of ignoring these relatively absolute absolutes. 

My recent essay at AdamSmithWorks provides a fuller summary of some of the most important ideas of the Hispanic Scholastics.

 


Maryann Keating O. is a research fellow at the Indiana Policy Review Foundation. She edited Paul Samuelson’s essays on Economics from the Heart (Thomas Horton and Daughters) and had co-authored several articles and books, including Microeconomics for Public Managers (Wiley-Blackwell).

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Impoverishing Economic Illiteracy

Last week, for the Nth time, the Wall Street Journal had a story about shortages of Covid-19 tests ( “Covid-19 Testing Is Hampered by Shortages of Critical Ingredient,” September 25). An important topic. The journalist notes:

According to a survey last month by the American Association for Clinical Chemistry, which represents commercial, hospital and public-health laboratories, 67% of labs are having issues getting both reagents and test kits—the highest level since the group started querying labs in May.

Shortages of test kits have persisted for seven months. And there is apparently no explanation in sight. The president of the Riverside Health System in Virginia, Dr. Michael Dicey, echoes the general puzzlement:

This is a big country, and we still haven’t been able to settle the testing issue. It doesn’t make any sense.

In fact, it makes a lot of sense for anybody who knows something about economics—and does not push it under the rug for ideological reasons. During these seven months, prices of most goods produced in America have been under the legal threat of states’ “price gouging” laws and of the federal Defense Production Act. The latter does not formally control the prices of testing supplies, but the federal government has been doing it indirectly through the FDA, the CDC, and a few commissars who control the allocation of many Covid-19 related products. Among them are Peter Navarro, the so-called “equipment czar” (“‘This Is War’: President’s Equipment Czar to Use Full Powers to Fight Coronavirus,” Wall Street Journal, March 28, 2020), Admiral Brett Giroir, the “testing czar” (“Trump’s Covid-19 Testing Czar Claims Administration Is Doing ‘Everything That We Can Do’ to Increase Testing Capacity,” CNN, August 14, 2020), and Moncef Slaoui, the “vaccine czar” (“Trump Vaccine Czar Will Not Be Required to Disclose Pharma Ties, IG Rules,” The Hill, July 17, 2020).

The Soviet Union was also a big country and they too were unable to settle similar issues, such as shortage of automobiles, pharmaceutical products, or bread. It took between 8 and 12 years for an ordinary citizen to take delivery of a car after he ordered it. Shortages also hit pharmaceutical products; a New York Times story of 1977 (“Soviet Medicine Mixes Inconsistency with Diversity”) gives many examples. Another New York Times story, published a few years later, focussed on food shortages (“Soviet Food Shortages: Grumbling and Excuses,” January 15, 1982; OCR errors corrected):

The situation in late summer looked so bleak that the Kremlin began a nationwide campaign for the conservation of bread, and there are many cities and towns where bread purchases are restricted. …

In Moscow there is de facto rationing, limits set by store managers on the quantities that shoppers can buy. …

For years, top Soviet officials have attributed the nation’s poor agricultural performance to bad weather, and the leadership’s official New Year greeting to the people this year again stressed the climatic blight.

Legion of examples are available.

Strangely—for those who ignore standard price theory—shortages persisted until the whole system crashed. It was not because of a lack of commissars. Could the situation, by any chance, have something to do with the substitution of government allocation for free-market prices? And is it possible that what does not work in the United States right now is also, on a lower scale, the consequence of government interference in prices and allocation? Economic theory and observations strongly point to a positive answer.

The efficiency of decentralized markets and free prices in the allocation of resources was first clearly demonstrated by Adam Smith in his 1776 classic The Wealth of Nations. The invisible hand of voluntary cooperation works better than the visible fist of the state. (The featured image of this post shows Smith’s statue in Edinburgh.)

The well-known story reported by Philip Coggan in his recent book More (which I review in the current issue of Regulation) illustrates the incapacity of the collectivist mind to understand or to acknowledge that decentralized and free markets are more efficient than government price controls and allocation:

In the aftermath of the Soviet Union’s break-up, the economist Paul Seabright was contacted by a Russian official who was keen to learn about the workings of the markets. “Tell me, for example,” he asked “Who is in charge of the supply of bread to the population of London?”

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Concise Encyclopedia Biography of Kirzner

Steve Horwitz’s recent post, “Marginal Revolutionaries: Kirzner and the Modern Austrians,” August 19, 2020, references the bio of Israel Kirzner in The Concise Encyclopedia of Economics. I finished the bio a couple of months ago and it was posted last month. Steve’s post reminded me that I had forgotten to call attention to it.

In researching the bio, I read Kirzner’s 1973 book, Competition and Entrepreneurship much more carefully than I had in 1973 at the behest of one of my UCLA professors, Ben Klein. Ben was rare in that he came out of the University of Chicago but was his own man from the get-go. He found a lot of value in Kirzner’s book and recommended that his UCLA Ph.D. students buy it. I did so and enjoyed it, but my mind at age 69 is better at nuances than my mind at one third that age.

Here’s a highlight of the bio:

The main difference between Kirzner’s entrepreneur and Schumpeter’s is that Schumpeter’s entrepreneur upsets an existing equilibrium by introducing a new product or a new production technique, while for Kirzner, the entrepreneur “has an equilibrating influence.” Kirzner writes, “For me the important feature of entrepreneurship is not so much the ability to break away from routine as the ability to perceive new opportunities which others have not yet noticed.”

Read the whole thing.

Thanks to Richard Ebeling for reading the bio carefully and giving me suggestions, especially about  finders-keepers.

 

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Marginal Revolutionaries: Kirzner and the Modern Austrians

3rd and final in a series of posts on Janek Wasserman’s The Marginal RevolutionariesRead the previous two posts here and here.

 

The weakest part of the book comes in the final two chapters where he addresses the revival of Austrian economics since the mid-1970s. In particular, he dramatically underplays the importance of Israel Kirzner for the Austrian economics of the 21st century, both in the substance of his thought and as a role model for scholarly activity. One reason for this neglect is that Kirzner, and the later “Kirznerians,” create a complication for his narrative. Wasserman wants to argue that Austrian economics was always in service of the powerful and that therefore ideology eventually would triumph over serious scholarship, making it unsurprising that the Rothbardians would play footsie with the alt-right. Kirzner doesn’t fit that story. Not only did he, and most of those who followed up on his work, remain committed liberals, Kirzner was the very model of scholarly engagement and that branch of the modern Austrian school has continued to follow that path.

I write about these issues with some trepidation as I have not only lived through the events Wasserman describes, I have committed my career to the Kirzner side of this divide and am cited for that view in the book. So readers should take my own biases into account in what follows.

 

Wasserman is correct to identify the two wings of modern Austrian economics as being between a broadly Kirznerian wing associated with George Mason University and a Rothbardian wing associated with the Ludwig von Mises Institute. The problem with his presentation is that he fails to distinguish the important differences between how Kirzner and Rothbard, and their followers, approached the relationship between scholarship and ideology, and how they interacted with the scientific community of economists. The differences between these two wings is largely portrayed as a clash between what one might call “liberal libertarians” and “paleo-libertarians.” Much of the chapter on these differences relies on debates that took place in the blogs and other informal sources.

What Wasserman does not do is to discuss the ways in which the two wings have interacted with the larger economics discipline. Wasserman held up early 20th century Vienna as a model to be emulated in the ways that Austrians were in the middle of important conversations in the social sciences. Through his career, and especially starting with Competition and Entrepreneurship, Kirzner attempted to engage the questions that the mainstream of the discipline thought were important. Although his contributions to professional journals were limited, his students and their students in the GMU wing have published widely in professional journals. They have incorporated ideas from related areas in economics, such as public choice, and the Bloomington school of political science associated with Elinor and Vincent Ostrom, to create an interdisciplinary approach to political economy. Members of that wing have also published books with major university presses and have taken on leadership roles in professional organizations beyond the ones directly associated with Austrian economics. The dozen or so panels of the Society for the Development of Austrian Economics (also never mentioned in his account) continue to be the most well-attended at the Southern Economic Association meetings.

The emphasis on scholarly contributions on the part of the Kirznerian wing is substantially due to Kirzner’s influence not necessarily as a direct mentor, but as a role model of scholarly engagement. , Their focus steers clear of narrow policy advocacy or equating Austrian economics with libertarian ideology; it is not the Kirznerians who refer to themselves as “Austro-libertarians.” In a more complete account of where Austrian economics is today, Kirzner would have been featured much more prominently. In addition to serving as a role model, the substance of his contributions has been fundamental for the path that the GMU-related wing has taken, even where there have been plenty of disagreements with the details. Giving Kirzner his due in this way would also have enabled Wasserman to more accurately frame the current divisions among Austrians as being less about libertarianism or even the specifics of Austrian economics, but instead about the relative roles of scholarship and politics and the resulting relationship between Austrians and the rest of the economics profession. The Kirznerians have done more to recapture the intellectual spirit of Vienna than Wasserman gives them credit for, and he thereby overlooks the ways in which that spirit has been productive in giving Austrian economics a seat at the table in economics in ways that they haven’t had since the interwar years.

Unfortunately for Wasserman, acknowledging that reality poses a major problem for his overarching narrative. If the majority of 21st century Austrian school economists are engaging with the profession, contributing to its top presses and journals, and being elected to leadership roles, all while sustaining a commitment to scholarship over ideology, it undermines his claim that there is something about the Austrian school that inherently led it to give up its scholarly roots and find alliances with the worst sort of defenders of privilege and power. As a claim about modern Austrian economics it’s just not true. There was a far more interesting concluding chapter that Wasserman could have written that explored what I think are the real differences between the Kirznerians and Rothbardians, but he chose the one that looks more like a prizefight.

Despite its flaws, Wasserman’s book is well worth reading for those interested in the Austrian school or the history of economics more generally. Future work on the history of Austrian economics will not only have to tangle with Wasserman’s book, it will be better for having done so.

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Power, Privilege, and Liberalism

Read Part 1.

Getting the facts largely right is a necessary condition for writing good history, but it is not a sufficient one. Historians inevitably have to make choices about which facts to include and exclude. More fundamentally, their own intellectual and ideological frameworks will guide them to look at some things and not others. Good histories are narratives and how a historian links together the facts to tell an overarching story is just as important as the facts themselves. It is here that Wasserman’s book is at its most frustrating, especially to those who are sympathetic to the Austrians. One of the implicit themes of the book, demonstrated by everything from the historical events and connections he focuses on, to his choice of adjectives, to what he leaves out of his account of modern Austrian economics, is that the classical liberalism of the Austrians serves the interests of capital and the powerful more generally. In that way, it is inherently conservative and the more recent strong rightward drift of the Rothbardian wing of the school is something of a logical outcome.

Consistent with much left-wing thinking, Wasserman appears to believe that a capitalist market economy primarily serves the well-being and interests of the capitalists rather than the population as a whole. When Austrian economists offer arguments for liberalism and the market economy, they are, perhaps unwittingly but perhaps not, doing the bidding of those with economic power and influence. Because he also appears to view economies as something akin to zero-sum games, the fact that those at the top gain from the system is an explanation for the poverty of the rest. Therefore, when Austrians accepted funding from wealthy businessmen to support their research, they were not engaged in a scientific enterprise but an ideological one. Compared to their predecessors in Vienna, the American Austrians who struck up many such arrangements had sold their soul to the powerful. Again, this argument is never made explicitly, but it permeates Wasserman’s word choices and emphases throughout the book.

As one somewhat small example, consider his description of the headquarters of the Foundation for Economic Education as an “opulent estate” in a “wealthy suburb” (212). Why is it relevant to the work that FEE was doing and the ideas it was promoting that it was headquartered in a mansion or in a wealthy suburb? (And it’s worth noting that Wasserman could not have ever been to FEE because, for all of the positive memories I have of that place, it was far from “opulent.”) It can only be relevant if you want to suggest that it’s not the ideas that matter but the class interests of those promoting them. This strategy also becomes a way to indicate that the Austrians ideas were wrong without ever having to confront them directly. The claim by the Austrians that the market order would lead to prosperity and progress for all is reduced to ideological cover for the interests of the powerful.

There are two problems with Wasserman’s view of these issues. First, is it really true that the market predominantly serves the interests of capital? And second, the Austrians of the 20th century were very clear about their opposition to privilege and their belief that the market order predominantly served the interests of the populace as a whole.

With respect to the first question, there is a large empirical literature demonstrating the ways in which the market economy has dramatically raised the living standards of both the average and poorest households in the advanced economies. Recent data on the reduction in global poverty provides evidence about the rest of the world. One need only consider Nordhaus’s famous study showing that innovators capture only about 2 percent of the total value they create to see that the benefits of markets are spread wide and far.

Although not as clear in the work of the early Austrians, the 20th century Austrians were also quite clear in differentiating “free markets” from “what was good for business people.” Mises’s emphasis on “consumer sovereignty” demonstrates who he thought were the primary beneficiaries of the market economy and he consistently opposed what he (and early liberals) termed the “privileges” sought after by private owners wishing to use the state to limit competition. In Hayek, we see a similar argument about who the real beneficiaries of markets are. He too explicitly opposes privileges that serve the interests of capital. In Law, Legislation, and Liberty Vol. 1 (62), he wrote:  “[The term] ‘capitalism’ is…always misleading because it suggests a system which mainly benefits the capitalists, when in fact it is a system which imposes upon enterprise a discipline under which the managers chafe and which each endeavors to escape.” Similar arguments can be found in modern Austrian work as well.

One hypothesis that Wasserman does not entertain is that the business people who backed the Austrians genuinely believed that freer markets would make the world a better place independently of what it would do for them personally. After all, if they were simply interested in lining their own pockets, seeking after government privileges, such as subsidies, monopolies, or costs imposed on their competition, would seem to be a much more effective short-run strategy. This whole set of problems with Wasserman’s argument is ironic in that he ends up doing precisely what he criticizes the Austrians of doing: abandoning more objective arguments in favor of ideology.

 


Steven Horwitz is Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University in Muncie, IN. He is also an Affiliated Senior Scholar at the Mercatus Center in Arlington, VA, and a Senior Fellow at the Fraser Institute of Canada. 

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The Marginal Revolutionaries: Wasserman’s Value Added

In the world since the 2017 publication of Democracy in Chains, Nancy MacLean’s near-slanderous “history” of public choice economics and the contributions of James Buchanan, it is understandable that a reader sympathetic to Austrian economics might approach Janek Wasserman’s 2019 history of that school of thought with some trepidation. The good news is that Wasserman’s book is a far better effort than MacLean’s, as he suffers from none of her problems with accuracy of source material and he understands the economic ideas he’s working with well enough to convey them accurately to a general reader. His careful work with archival sources provides a richly detailed account that adds to our understanding of the Austrian school’s evolution and the roles its members played in influencing 20th century economic policy. The book is not without its flaws, however. In much the same way that MacLean starts with the assumption that classical liberal ideas are racist and otherwise evil (rather than attempting to provide evidence for that claim), Wasserman’s progressivism affects his broader narrative, though in much more subtle ways than MacLean’s. In particular, he assumes that the liberalism of the Austrians was simply ideological cover for defending the power and privileges of the elite. As a result, his history of the school’s evolution in the 20th century tells an incomplete tale.

 

The Marginal Revolutionaries tells the story of the evolution of the Austrian school, focusing on both the way in which its emphases changed over the 20th century and the related role its members took on as influencers in the worlds of ideas and public policy. The thesis, or at least the narrative arc, of the book is that the Austrian school was once a vibrant, diverse, and scientific approach to economics that was deeply embedded in the world of ideas of its time, particularly early 20th century Vienna. As it migrated to the United States, it lost that identity and became more ideological and less scientific, culminating in the flirtation of the modern-day Rothbardian wing with the seedier sections of the political right. For Wasserman, it’s no surprise that a version of Austrian economics became attractive to people he sees as quasi-fascists. In his view, Austrian economics in the 20th century was always about trying to preserve the power of the elite, so the dalliance with the worst of the right wing was a logical outcome of that evolution.

Before turning to the problems with that narrative, there are several strengths of the book worthy of further discussion. Wasserman’s history of the first generation or two of the Austrian school provides some valuable historical detail on the prominent contributors, such as Menger, Bohm-Bawerk, and Wieser, as well as the various institutions they created in their attempt to establish a true school of thought. His more limited discussion of some of the other less well-known figures of the first and second generation of the school is also useful, as the usual narrative leaves them out. He documents the relationship between all of these early Austrians and those with economic and political power in turn-of-the-century Vienna. That is worthwhile historical context, but it also serves his larger narrative in several ways.

One of the other themes of the book is about the attempt to re-create Vienna. Wasserman persuasively documents the fantastic intellectual environment that surrounded the Austrian school in early 20th century Vienna. Much of this history is known, but Wasserman ties it to the influence that the early Austrians had and their commitment to developing a scientific research program untainted by ideology. After that community was destroyed during World War II, Wasserman sees much of what the Austrian school emigres tried to do in the US and elsewhere as an attempt to re-create the atmosphere of Vienna. None of those attempts succeeded, and he at least implies that it was due to the increasing role that ideology was playing in their self-understanding, especially for Mises and Hayek.

One other strength of the book is its serious treatment of what we might call the “extended” Austrian school. In prior histories of the school, such as Karen Vaughn’s Austrian Economics in America, people like Fritz Machlup, Gottfried Haberler, Oskar Morganstern, and even Joseph Schumpeter are relegated to cameos in favor of a Mises-Hayek-Kirzner centered narrative. No doubt those three are the core of the modern Austrian school, but Wasserman’s more extensive treatment of these other scholars offers some important history of their interactions with people like Mises and Hayek, but also their important roles in the economics profession and the world of public policy. This conception of who was in the Austrian school might strike some as overly broad, but part of Wasserman’s point was that the school was in fact broad enough to encompass them in a meaningful way.

Wasserman also gets much of the later 20th century and early 21st century history right, at least on the facts. His description of the migration of the Austrians to the US, and Hayek’s eventual return to Europe, provides important details that have not always been emphasized. In both cases, however, the tone surrounding Wasserman’s description of the outside funding of their positions, particularly Mises’s, matches his larger narrative of them being beholden to the interests of capital. The implication, of course, is that Mises (and to a lesser extent Hayek) had abandoned serious scholarship for being a lackey for the capitalist class. This ignores a couple of important facts. One is that whatever the nature of his position at NYU, Mises was still allowed to oversee PhD dissertations, so clearly his NYU colleagues thought he was a serious scholar worthy of doing that work. The other is that he was named a Distinguished Fellow of the American Economic Association in 1969, which has often been a precursor to a Nobel Prize. This fact is not mentioned by Wasserman, even though the somewhat more praiseworthy (in Wasserman’s view) Fritz Machlup was named a Distinguished Fellow two years earlier, as was Oskar Morgenstern in 1976.

Overall, though, Wasserman’s facility with the archival material and other primary sources has enabled him to provide important new details to the early and more recent history of the Austrian school. In this way, it’s an excellent complement to both Vaughn’s book and Bruce Caldwell’s Hayek’s Challenge.

 


Steven Horwitz is Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University in Muncie, IN. He is also an Affiliated Senior Scholar at the Mercatus Center in Arlington, VA, and a Senior Fellow at the Fraser Institute of Canada. 


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Sowell on Writing

Today is Thomas Sowell’s 90th birthday. I am sure many celebrations of Sowell will be published. Not in Europe, I am afraid: in spite of his renown in America, Sowell is virtually unknown in Europe. I suspect this is at least partially due to his choice to concentrate on writing and to eschew conferences and public gatherings. He never got on the conference circuit, so to say.

It is a pity. Sowell is admirable for a number of reasons. His courage. His productivity. His work.

Knowledge and Decisions is my favorite book of his. F. A. Hayek’s insights on the role of knowledge in society are developed splendidly and presented in a scintillating and clear style.

Style is another thing to admire Sowell for. He strove for it and told his experience with writings in a little essay, a few years ago. Here are a few passages:

Learning to write by trial and error not only calls for patience on the writer’s part, it also taxes the patience of wives, landlords, and creditors. Whenever someone, especially a young person, tells me of an ambition to become a writer, my heart goes out to him or her immediately—and my spirits sink. There is seldom a pot of gold at the end of the rainbow, even for those who become established writers eventually—and a lot can happen between now and eventually, like broken marriages, eviction for non-payment of rent, and the like.

Even the mechanics or logistics of writing can be a challenge to figure out. Some of the most productive writers have followed the disciplined practice of sitting down at fixed times each day and turning out the words. Anthony Trollope followed this regimen in the nineteenth century and Paul Johnson with equal (or greater) success in the twentieth century. Alas, however, human beings differ and some of us are never going to be Anthony Trollope or Paul Johnson, in this respect or any other.

Instead of trying to be someone that you are not, be the best at what you are. My own writing practices are the direct opposite of that followed by these prolific and renowned writers. I write only when I have something to say. The big disadvantage of this is that it can mean a lot of down time. There are manuscripts of mine that sat around gathering dust for years without a word being added to them. …

The big advantage of this off-beat way of working is that what I write is written when I am full of ideas and enthusiasm about the subject—even if these periods occur only at intervals, with months or even years in between for a given book. Some of my favorite books came from manuscripts that I thought would never get finished.

Now, I do not think that Sowell’s essay on writing – particularly his rant at copy-editors – will do particularly well for younger writers. But I read it as delivering three key messages: (a) writing is work, not a gift. This is clear to most people who somehow write for a living, but is typically unclear to everybody else. People tend to believe you are “good” at writing, as it is some sort of natural magic.

Yet, as virtually everything else in life, it needs exercises and constant practice. Sowell’s way of working is different than Ian Fleming, who purportedly wrote every day between 9 am and noon, in his Jamaican villa. Sowell’s way of practicing is certainly different than the one which may suit most of us, far less talented than he is: but even somebody as obviously talented need to practice and to work a modus operandi out; (b) finding your own voice is not easy. It may take years to finish a manuscript as you wanted or envisioned it. It may take more rewriting than writing. Your voice does not simply “come out;” (c) it is painful. Success in writing is a very relative thing (success for economic/political bloggers is different than success for novelists) but, with the exception of a few superstars (John Le Carré, J.K. Rowling, Paul Krugman…), you hardly find the golden pot at the end of the rainbow. If you really want to make writing (part of) your profession, start by forgetting that writing is easy.

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Transaction Costs are the Costs of Engaging in Economic Calculation

This year marks the 100th anniversary of the publication of Ludwig von Mises’s seminal article, “Economic Calculation in the Socialist Commonwealth,” which marked the first salvo in what later became the socialist calculation debate. Though the contributions of F.A. Hayek to that debate, and to economic science more broadly, have been well recognized, what is somewhat forgotten today is that the fundamental contributions of another economist were also born out of the socialist calculation debate. I am referring to none other than Ronald Coase.

 

As Coase outlines in his Nobel Prize Address, he had been a student of Arnold Plant in the Department of Commerce at the LSE, who introduced him to Adam Smith’s invisible hand, and the role that the price system plays in coordinating the allocation of resources to their most valued uses without central direction. The insights of Coase, like Mises, were both motivated from the attempt by the Bolsheviks to implement central planning in Soviet Russia. As Coase writes, “Lenin had said that the economic system in Russia would be run as one big factory. However, many economists in the West maintained that this was an impossibility,” a claim first put forth by Mises in his 1920 article. “And yet there were factories in the West, and some of them were extremely large. How did one reconcile the views expressed by economists on the role of the pricing system and the impossibility of successful central economic planning with the existence of management and of these apparently planned societies, firms, operating within our own economy?” The answer put forth to this puzzle was what Coase referred to as the “costs of using the price mechanism,” (Coase 1992, 715). This concept, which later came to be known as “transaction costs,” was first expounded in his seminal article, “The Nature of the Firm” (1937) and later developed in subsequent articles, “The Federal Communications Commission” (1959) and “The Problem of Social Cost” (1960). But, it is interesting to note that Coase also states that “a large part of what we think of as economic activity is designed to accomplish what high transaction costs would otherwise prevent or to reduce transaction costs so that individuals can freely negotiate and we can take advantage of that diffused knowledge of which Hayek has told us” (1992: 716).

My point here is not to trace the historical origins of the parallel insights drawn by Mises and Coase, or other economists working in the Austrian tradition and the transaction-cost tradition for that matter. Rather what I wish to suggest here is that what Coase (not just Hayek) had been stressing in his insights learned from the socialist calculation debate cannot be fully appreciated without placing his contributions in the context of what Mises had claimed regarding the problem of economic calculation. Reframed within this context, I would argue that the concept of transaction costs can also be understood as the costs of engaging in economic calculation. However controversial my claim may seem, this reframing of transaction costs as the costs of associated with economic calculation has a precedent that can be found not only in Coase, but also in more recent insights made by economists working in the Austrian tradition (see Baird 2000; Piano and Rouanet 2018).

How do transaction costs relate to the problem of economic calculation? According to Coase, the most “obvious” transaction cost is “that of discovering what the relevant prices are” (1937: 390). The costs of pricing a good (i.e. transaction costs) are based, fundamentally, on the costs of defining and enforcing property rights in order to create the institutional conditions necessary for establishing exchange ratios, hence prices, in the first place. This also entails not only cost of negotiation and drawing up contracts between trading partners, but also discovering who are the relevant traders partners are, as well as discovering what are the actual attributes, such as quality, of the good or service being exchanged.

Carl Dalhman (1979) argues that all such transaction costs can be subsumed under the umbrella of information costs, but the nature of such information is not one that can be obtained only through active search per se, as if all such information is already “out there” and therefore acontextual. Rather, the very nature of such information is not just tacit and dispersed (Hayek 1945), but contextual (see Boettke 1998). The discovery of relevant trading partners, the valuable attributes of a good being exchanged, and the price to which trading partners agree, emerges only within a context of exchangeable and enforceable private property rights. This last point is precisely the argument that Ludwig von Mises had meant in his claim that economic calculation under socialism is impossible! Outside the context of private property, subjectively held knowledge cannot be communicated as publicly held information without first establishing the terms of exchange in money prices to allocate resources to their most valued uses.

In his Presidential Address to the Society for the Development of Austrian Economics, published in The Review of Austrian Economics as “Alchian and Menger on Money,” Charles Baird (2000) best illustrates the point I’m making here. Carl Menger (1892) and Armen Alchian (1977) had made distinct, though complementary stories as to why money emerges spontaneously, namely to reduce transaction costs. Menger argued that money emerges to avoid the costs associated with the double coincidence of wants between exchange partners. On the other hand, Alchian emphasized that money emerges to reduce the costs of calculating and pricing the value of the various attributes of a good, such as in comparing the quality of different diamonds. Money prices reduce the costs of pricing the quality of diamonds, thereby providing information, discovered by middlemen, to non-specialists about what kind of diamond they are purchasing (i.e. higher quality or lower quality). As Baird writes, “Menger’s story is incomplete. But so, too, is Alchian’s. On the other hand, both stories are complete on their own terms. Clearly what is needed is someone to put these two stories together” (2000: 119). Thus, reframing transaction costs from an Austrian perspective, money, firms and other institutional arrangements emerge to reduce the costs associated with economic calculation.

In a lecture written to honor F.A. Hayek in 1979, later published posthumously in The Review of Austrian Economics, James Buchanan boldly declared the following: “The diverse approaches of the intersecting schools [of economics] must be the bases for conciliation, not conflict. We must marry the property-rights, law-and-economics, public-choice, Austrian subjectivist approaches” (Buchanan 2015: 260). The link that “marries” these distinct schools, including the Austrian School, is the notion of transaction costs. However, this underlying link cannot be understood without first reframing, I would argue, the concept of transaction costs as the costs of engaging in economic calculation. The “marriage” of these intersecting schools, as Buchanan and others have suggested, highlights distinct aspects of the economic forces at work in the market process, as well as the alternative institutional arrangements that emerge to reduce the cost of transacting and thereby exploit the gains from productive specialization and exchange.

 

 


Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and Associate Director of Academic and Student Programs  at the Mercatus Center at George Mason University

 

 

References

Alchian, Armen A. 1977. “Why Money?” Journal of Money, Credit and Banking 9(1): 133–140.

 

Boettke, Peter J. 1998. “Economic Calculation: The Austrian Contribution to Political Economy.”  Advances in Austrian Economics 5: 131–158.

Buchanan, James M. 2015. “NOTES ON HAYEK–Miami, 15 February, 1979.” The Review of         Austrian Economics 28(3): 257–260.

Coase, Ronald H. 1937. “The Nature of the Firm.” Economica 4(16): 386–405.

Coase, Ronald H. 1959. “The Federal Communications Commission.” The Journal of Law & Economics 2: 1–40.

Coase, Ronald H. 1960. “The Problem of Social Cost.” The Journal of Law & Economics 3: 1–44

Dahlman, Carl J. 1979. “The Problem of Externality.” The Journal of Law & Economics 22(1): 141–162.

Hayek, F.A. 1945. “The Use of Knowledge in Society.”

Menger, Karl. 1892. “On the Origin of Money.” The Economic Journal 2(6): 239–255.

Mises, Ludwig von. [1920] 1975. “Economic Calculation in the Socialist Commonwealth.” In F.A.     Hayek  (Ed.), Collectivist Economic Planning (pp. 87–130). Clifton, NJ: August M. Kelley.

Piano, Ennio E., and Louis Rouanet. 2018. “Economic Calculation and the Organization of     Markets.” The Review of Austrian Economics, https://doi.org/10.1007/s11138-018-0425-4

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