The Corrs – Unplugged

A Brief History of the Efficient Markets Hypothesis by Eugene Fama


Adam Smith as a pioneering labour economist

Adam Smith anticipated much of labour economics by basing it on his principle that individuals invest resources to earn the highest possible return. All uses of a resource must yield an equal rate of return adjusted for relative riskiness for otherwise reallocation would result.

The whole of the advantages and disadvantages of the different employments of labour and stock must, in the same neighbourhood, be either perfectly equal or continually tending to equality.

If in the same neighbourhood, there was any employment evidently either more or less advantageous than the rest, so many people would crowd into it in the one case, and so many would desert it in the other, that its advantages would soon return to the level of other employments.

Smith used this insight on  be equality of returns to explain why wage rates differed. Workers care about the whole aspects of the job, not only the cash wage payment: it is the “whole advantages and disadvantages” of the job that is equated across jobs in a competitive market, not wage alone. Smith set out criteria that determined how wages compensated or were discounted for the different characteristics of specific jobs:

  1. the agreeableness or disagreeableness of the employments themselves: better for more enjoyable working conditions will lead an individual to accept lower wages for their labour. Likewise, unpleasant work will have a higher wage. Wages vary with the ease or hardship, the cleanliness or dirtiness, the honourableness or dishonourableness of a job.
  2. The easiness and cheapness, or the difficulty and expense of learning them: jobs that are difficult or time-intensive to learn will pay more. Those who invest the time are being compensated for their additional effort with higher wages. The opportunity cost of forgoing the time-spent in training will be compensated for through higher wages. The difference between the wages of skilled labour and common labour is founded upon this principle.
  3. The constancy or inconstancy of employment: workers who face only partial or inconsistent employment throughout the course of the year, such as seasonal workers of agriculture, must be paid more for their labour. Their wages carry them not only during times of employment, but also during times of unemployment.
  4. The small or great trust which must be reposed in those who exercise them: individuals who have high levels of responsibility  in their jobs will be compensated with higher wages.
  5. The probability or improbability of success: this is an entrepreneurial element in wages. Employment where the chance of success is high will be paid lower than those who take more risks. If individuals were not compensated for risk, there would lack an incentive to seek employment that may not be successful.

The supply and demand for labour in different industries  determines relative wages and the relative numbers of employees in different occupations. Individuals are willing to make a trade-off between less desirable occupations and increased income. Smith spoke of how these five circumstances  listed above  lead to considerable inequalities in the wages and profits.

George Stigler thought that the second greatest triumph of Adam Smith in his Wealth of Nations was his famous list of cost factors that generate apparent but not real differences in rates of wages and profits because of training, hardships, unemployment, risk and trust. This list was quoted almost verbatim by his successors  down to this day and is the direct ancestor of both Alfred Marshall’s famous chapters on wages and of the modern theory of human capital.

Clintons seek to avoid a tax they once supported

Costs do not determine prices!

The misconception that costs determined prices prevented economists for a long time from recognizing that it was prices which operated as the indispensable signals telling producers what costs it was worth expending on the production of the various commodities and services, and not the other way around. It was the costs which they had expended which determined the prices of things produced.

FA Hayek

The entrepreneur forecasts whether consumers are willing to pay enough to justify him bringing his product to the market.  If consumers are unwilling to pay enough for him to make a profit, he will not supply in the first place.

The Simple Case for Laissez-Faire

The discussion so far suggests a simple solution to the problem of creating efficient legal rules – private property plus freedom of exchange.

Everything belongs to someone. Everyone is free to buy or sell on any terms mutually acceptable to buyer and seller… Any new good belongs to whoever produced it.

So if the cost of producing a good, the summed cost of all the necessary inputs, is less than its value to whoever values it most, it will pay someone to buy the inputs, produce the good, and sell it to the highest bidder.

Not only do all goods end up in their highest valued uses, but all goods are produced if and only if their value to whoever values them most is greater than their cost to whoever can produce them most easily

H.L Mencken on meddlesome preferences

Puritanism: The haunting fear that someone, somewhere, may be happy.  - H. L. Mencken


Murray Rothbard on the European Union

The Union will increase pressures  for high taxes and higher inflation.

The order brought about by the mutual adjustment of many individuals in a market

Virtue is more to be feared than vice, because its excesses are not subject to the regulation of conscience. - Adam Smith

Pete Boettke has written extensively about how The Wealth of Nations is about social order among strangers. The market is a social order much larger than our span of moral sympathy.

In civilized society [man] stands at all times in need of the co-operation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons. In almost every other race of animals each individual, when it is grown up to maturity, is entirely independent, and in its natural state has occasion for the assistance of no other living creature.

But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them.

Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of.

To realize this social cooperation, Boettke argues that social institutions must be in place such as private property, keeping promises through contract, and the acceptance of the legitimacy of the transfer of property by consent. The division of labour is the key to the ability of the market system to produce social cooperation among distant and different anonymous actors.

The civilising influence of commerce is well-known as is it as the key to peace. We fear neither Russia nor China because of extensive economic interdependencies makes war pointless for all. The common market ended war in Western Europe.

The co-operation and peace is a spontaneous product of Hayek’s concept of catallaxy which is

the order brought about by the mutual adjustment of many individual economies in a market

The youtube clip is Milton Friedman’s discussion of the famous essay I, Pencil  and how strangers cooperated in peace and harmony in the market even though they might hate each other if they ever met. I, Pencil details the complexity of its own creation and the numerous people involved is the absence of a master mind, of anyone dictating or forcibly directing these countless actions. Instead, we find the invisible hand at work.

Capitalism is a system which enables cooperation between millions of strangers so that they may jointly pursue their diverse goals.

Machiavelli, Mises, Milton Friedman, W.H. Hutt and Walsingham’s Manual on practical public policy advising

File:Santi di Tito - Niccolo Machiavelli's portrait headcrop.jpg

Ludwig Von Mises worked as an economic-policy advisor to the Vienna Chamber of Commerce from 1909 to 1934. As Richard Ebeling notes:

What comes out from reading Mises’s policy writings from this period of his European career is that if you had asked him a fiscal, or monetary, or regulatory-policy question in the context of his role as analyst at the Chamber of Commerce, he would not have said, and did not simply say, "laissez-faire" — abolish the central bank, deregulate the economy, and eliminate taxes.

Mises accepted the context of which his policy options must be worked out. Ebeling went on to note that Mises seemed to think in three policy horizons:

  1. The most optimal institutional and policy arrangements in society for the fostering of the classical-liberal ideal of freedom and prosperity, based on the knowledge that he thought sound economic theory could provide;
  2. the actual circumstances of the present, but focused on the intermediary goals that would be leading in the direction of that more distant, "optimal" horizon; and
  3. current situation and the immediate future

In the 1970s, Rothbard criticised Milton Friedman for advocating indexation of prices and wages as a method to reduce some of the negative effects from an on-going inflation. Rothbard regarded this as a sell-out.

Richard Nixon’s responses to Milton Friedman were rather more flattering in terms of his policy purity:

I don’t care what Milton Friedman says, he’s not running for re-election.

In 1922, during the worsening Great Austrian Inflation, Mises proposed indexation of wages and prices. Ebeling explained Mises as follows:

  • what was inefficient and unnecessary in the three-tiered Austrian bureaucratic system of federal, provincial, and municipal regulators and taxing authorities;
  • what specific reforms should be introduced, how they could be experimented with in smaller regions of Austria; and
  • how best to overcome the resistance of those in the bureaucracy fearful of losing their jobs

Milton Friedman was purer than this – always the first best advice:

The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in the light of what can be done, politics aside, and not to predict what is ‘politically feasible’ and then recommend it.

Little wonder that Friedman had little time for those economists who promised more than they could deliver and warned less than they should of the hazards and difficulties that may lie ahead the particular policies that were being considered:

A major problem of our time is that people have come to expect policies to produce results that they are incapable of producing. …

we economists in recent years have done vast harm—to society at large and to our profession in particular—by claiming more than we can deliver.

We have thereby encouraged politicians to make extravagant promises, inculcate unrealistic expectations in the public at large, and promote discontent with reasonably satisfactory results because they fall short of the economists’ promised land.

W.H. Hutt steered the middle course that I favour:

In our judgment, the best you will be able to get away with is programme A along the following lines; but if you could find a convincing way of really explaining the issue to the electorate, our advice would have to be quite different.

We should have to recommend programme B, along the following lines.

James Buchanan emphases political realities in a similar way:

We start from here, from where we are, and not from some idealized world peopled by beings with a different history and with utopian institutions. Some appreciation of the status quo is essential before discussion can begin about prospects for improvement.

Ebeling ends by saying:

Even as that uncompromising and principled proponent of individual liberty and the free market, Mises was called upon in his role as policy analyst and advocate to sometimes devise "second-" and "third-best" policy proposals in an imperfect world dominated by collectivist and interventionist ideas and practices.

for those who have sometimes asked, "Well, but how do you apply Austrian Economics to the ‘real world’ of public policy?" here is the answer by the economist who has been considered the most original, thoroughgoing, and uncompromising member of the Austrian School over the last one hundred years! His policy analyses provide us with warning signs and guideposts to assist us in thinking about and designing better policies for our own time.

In The Prince, Machiavelli said in a chapter on how to choose wise advisors and avoid flatterers.

Therefore a wise prince ought to hold a third course by choosing the wise men in his state, and giving to them only the liberty of speaking the truth to him, and then only of those things of which he inquires, and of none others; but he ought to question them upon everything, and listen to their opinions, and afterwards form his own conclusions.

With these councillors, separately and collectively, he ought to carry himself in such a way that each of them should know that, the more freely he shall speak, the more he shall be preferred; outside of these, he should listen to no one, pursue the thing resolved on, and be steadfast in his resolutions. He who does otherwise is either overthrown by flatterers, or is so often changed by varying opinions that he falls into contempt…

A prince, therefore, ought always to take counsel, but only when he wishes and not when others wish; he ought rather to discourage every one from offering advice unless he asks it; but, however, he ought to be a constant inquirer, and afterwards a patient listener concerning the things of which he inquired; also, on learning that any one, on any consideration, has not told him the truth, he should let his anger be felt.

I think Mises read less of Machiavelli and more of the now 400 year old book written by an French courter called  not to A Practical Guide for Ambitious Politicians, or Walsingham’s Manual which Gordon Tullock republished in 1961.

I have a copy of this rare book republished in 1961 which was translated again in 2007 under the title Treatise on the Court. The Early Modern Management Classic on Organizational Behaviour.

For Mises to survive and prosper as a policy advisor as he struggled for position within a small elite group amidst fierce competition, he had to know how organisations worked, how to find the levers of power and press them. That is why is pitched his advice in light of the immediate,medium term or long term policy horizon horizon as set out in the dot points above.

Walsingham’s Manual has a whole chapter on when the courtier should warn of the hazards and difficulties that may lay ahead and when he should humour the prince in his inclinations that mesh well with what Mises did. There is another chapter on how to deal with rival courtiers that made Sir Humphrey proud:

Those who feel compelled to compete with you will not be won over by shows of respect or veneration. You can, however, coax them onto a different path by

  • encouraging them to aim for a goal more ambitious than yours,
  • helping them achieve this goal,
  • offering to help advance their ambitions, and
  • playing down your own goal as being too insignificant for them to aspire to.

Imply that you have no choice but to pursue your goal because you aren’t capable of competing (as they are) for any­thing better. By way of contrast, praise your competitors’ reputation, power, abilities and merit: suggest that they can do far better than you and should set their sights higher.

If ever you come to fear that a competitor may get ahead of you, raise doubts and insecurities in his mind about what he wants to do. Discuss the pros and cons of the matter, but always in a way that reinforces why he should give up and look elsewhere.

Your best and quickest course, though, is to disguise or hide your objective until it’s too late for anyone to compete with you or block you.

Pushing an ambitious plan too openly may repel the very people who would have helped you if you’d been more discreet, making your task more difficult and damaging your chances of success.

Then, if you do prevail, you’ll attract more envy than you would have otherwise, and if you fail, you’ll look that much more foolish. Your safest course is to do as rowers do, turning your back on your objective and showing every sign of having some other destination.

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