Friday, September 10, 2004

What should economists do? 

Economists reading that title will recognize it as the title of a book by James Buchanan which has borne up well from repeated reading over the years. The title was the title as well of a lecture he gave to the Southern Economics Association in November 1963 (and reprinted in the Southern Economic Journal, Jan 1964). From that lecture there is this passage:
What is the sophomore, who has completed his "principles," expected to reply to the question: What is the difference between an economic and a technological problem? He might respond with something like the following: "An economic problem arises when mutually conflicting ends are present, when choices must be made among them. A technological problem, by comparison, is characterized by the fact that there is only one end to be maximized. There is a single best or optimal solution." We conclude that the sophomore has read the standard textbooks. We then proceed to ask that he give us practical examples. He might then say: "The consumer finds that she has only $10 to spend in the supermarket; she confronts an economic problem in choosing among the many competing products that are available for meeting diverse ends and objectives. By contrast, the construction engineer has $1,000,000 allotted to build a dam to certain specifications. There is only one bet way to do this; locaiting this way constitutes the technological problem." Most of us would, I suspect, be inclined to give this student good grades for such answers until another, erratic and eccentric, student on the back row says: "But there is really no difference."

And there's not. Both are optimizing subject to constraints; the only difference is that the constraint is better specified for the engineer than the consumer. Over time, some economists have tried to make the consumer's problem look more like the engineer's, because that problem is tractable; you can see yourself grinding out a mechanical solution. There's no choosing.

This type of criticism of economics has been around for a long time -- Buchanan understood it forty years ago. He later said in The Limits of Liberty:
If something is wrong, have government regulate it. If the regulators fail, regulate them, and so on down the line. In part this is the inevitable result of public failure to understand the simple principle of laissez-faire, the principle that results which emerge from the interactions of persons left alone may be, and often are, superior to those results that emerge from overt political interference. There has been a loss of wisdom in this respect, a loss from eighteenth-century levels, and the message of Adam Smith requires reiteration with each generation. (Modern economics must stand condemned in its failure to accomplish this simple task, the performance of which is, at base, the discipline's primary reason for claiming public support.) (Emphasis added.)

You might by now wonder why I bring this up (if you haven't already left). A couple of days ago Edward Lotterman published an article that started nicely enough discussing "social capital":

To some, that is simply stating the obvious, but Harvard Professor Robert Putnam has gained considerable fame with these assertions. For more than a decade, he has tried to measure such "social capital" and determine the degree to which it influences various social and economic outcomes. A talk he gave Wednesday in Minneapolis prompts insights on the limitations of current economic research.

It also raises questions about what, if anything, a community or nation can do to raise the level of civic engagement if such engagement in fact makes society better off.

Putnam spoke to a meeting of the Great North Alliance, an organization of leaders from business, labor, government and academia dedicated to improving the competitiveness and quality of life in the Twin Cities.

I highlight the identification of the group because it's telling. (The links are also my insertions, just in case you want to research this.) One wonders how these people thinkg they can "improve competitiveness". I'll come back to that, because I have another ax to grind first with Mr. Lotterman first.

Many economists are not convinced, largely because their discipline long has scorned consideration of such subjective factors as "social capital" or "civic engagement" in their theorizing. Their tepid response to scholars such as Putnam says more about the limitations of contemporary economic theorizing than about the validity of his ideas.

From the discipline's inception two centuries ago, economists have assumed that economic resources are divisible into land, labor and capital, and that humans are rational beings who make conscious choices so as to maximize the satisfaction they get out of life. Implicitly, most agree with former British Prime Minister Margaret Thatcher who said, "There is no such thing as society; there are individual men and women and there are families."

A bit more than a century ago, three British economists � F.Y. Edgeworth, William Jevons and Alfred Marshall � transformed economics by introducing mathematics as the language of economic reasoning and discourse. After World War II, U.S. economists such as Paul Samuelson boosted use of mathematics to a still-higher level.

The concept of "social capital" though has been researched a great deal by economists. We spend a large amount of time figuring out why some countries are rich and others poor, as Lotterman later says. That discussion has focused not nearly so much on the amount of labor and capital countries have -- because the ratios of inputs held by rich and poor countries cannot possibly explain the differences in living standards -- but on why some countries are so much more productive. Read the work of researchers at the World Bank, or of IRIS (Mancur Olson's legacy). This isn't new work. And we've understood the bad as well as the good of Edgeworth, Jevons and Marshall, as Buchanan noted forty years ago (and, many will argue, Mises and Hayek well before then.) Lotterman isn't just erecting a strawman -- he's trying to rescue one that's been knocked down for decades. And meanwhile, he's rebuilding leftism:
If social capital, culture and institutions are important, can a society do anything to consciously transform itself? Can failing Bolivia transform itself in the image of successful Chile? Could corrupt and ineffective Romania become a bustling Switzerland on the Danube?

But the point is, if you believe competition is the way these countries can become rich, gathering people in some alliance (even NARN) isn't how it's done. Buchanan had that wired forty years ago as well.
A market is not competitive by assumption or by construction. A market becomes competitive, and competitive rules come to be established as institutions emerge to place limits on individual behavior patterns. It is this becoming process, brought about by the continuous pressure of human behavior in exchange, that is the central part our discipline, if we have one, not the dry rot of postulated perfection. ... A general solution, if there is one emerges as a result of a whole network of evolving exchanges, bargains, trades, side payments, agreements, contracts which, finally at some point, ceases to renew itself. At each stage in this evolution toward solution there are gains to be made, there are exchanges possible... (italics in original)

You cannot will social capital. When Putnam notes on his site that "Joining one group cuts in half your odds of dying next year," that isn't cause-and-effect (I'm sure Putnam would agree.) Countries in which people join groups more readily have progressed through these emergences to a place where life expectancy is higher. It's hubris to think we can force these emergences, and economists that do aren't doing their jobs.