Adam Smith as a pioneering labour economist
21 Jun 2014 Leave a comment
in Adam Smith, health and safety, history of economic thought, human capital, labour economics, labour supply, occupational choice Tags: Adam Smith, Alfred Marshall, compensating differences, george stigler, human capital, The wealth of nations, wage determination
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:
- 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.
- 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.
- 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.
- 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.
- 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.
Gary Becker and George Stigler on continuity in economic thinking
17 Jun 2014 Leave a comment
in Gary Becker, George Stigler, history of economic thought Tags: methodology of economics
this recession had got a lot worse, we would have seen two major changes: much more government intervention in the economy, and a lot more concentration in economics in trying to understand what went wrong.
Assuming I’m right and, fundamentally, the recession is over—a severe recession but maybe not much greater than the 1981 recession, or those in the nineteen-seventies—I think you are not going to see a huge increase in the role of government in the economy.…
Economists will be struggling to understand how this crisis happened and what you can do to head another one off in the future, but it will be nothing like the revolution in the role of government and in thinking that dominated the economics profession for decades after the Great Depression.
If the problems of economic life changed frequently and radically, and lacked a large measure of continuity in their essential nature, there could not be a science of economics.
An essential element of a science is the cumulative growth of knowledge, and that cumulative character could not arise if each generation of economists faced fundamentally new problems calling for entirely new methods of analysis…
[Economics] will continuously be confronted with new circumstances which call for more than a routine application of standard knowledge. Thus the energy crisis of the nineteen-seventies has provided much employment to economists, but it has not called for important changes in economic science…
The responsiveness of economics to environmental problems will naturally be more complete and more prompt, the more urgent the problems of the day. The response will also be more complete, the less developed the relevant body of economic analysis.
The responsiveness of macroeconomics to contemporary events is notorious. Keynes’s conquest in the nineteen-thirties was due to the fact that the neoclassical theory could not account for the persistent unemployment of that decade. A generation later, persistent inflation even with less than full employment was equally decisive in ending Keynes’s supremacy. If and when macroeconomics produces a good theory of the business cycle, its responsiveness to environmental changes will diminish sharply
Ronald Coase on blackboard economics
16 Jun 2014 Leave a comment
in history of economic thought, industrial organisation, law and economics, Ronald Coase Tags: blackboard economics, methodology of economics
This neglect of other aspects of the system has been made easier by another feature of modern economic theory – the growing abstraction of the analysis, which does not seem to call for a detailed knowledge of the actual economic system or, at any rate, has managed to proceed without it.
Holmstrom and Tirole, writing on The Theory of the Firm in the recently published Handbook of Industrial Organization, conclude at the end of their article of 63 pages that "the evidence/theory ratio… is currently very low in this field". Peltzman has written a scathing review of the Handbook in which he points out how much of the discussion in it is theory without any empirical basis.
What is studied is a system which lives in the minds of economists but not on earth.
I have called the result "blackboard economics". The firm and the market appear by name but they lack any substance. The firm in mainstream economic theory has often been described as a "black box". And so it is.
This is very extraordinary given that most resources in a modern economic system are employed within firms, with how these resources are used dependent on administrative decisions and not directly on the operation of a market.
Consequently, the efficiency of the economic system depends to a very considerable extent on how these organisations conduct their affairs, particularly, of course, the modern corporation.
Even more surprising, given their interest in the pricing system, is the neglect of the market or more specifically the institutional arrangements which govern the process of exchange.
As these institutional arrangements determine to a large extent what is produced, what we have is a very incomplete theory.
Four years before his Nobel lecture, Coase was more specific:
Marginal cost pricing is a policy is largely without merit.
How then can one explain the widespread support that it has enjoyed in the economics profession?
I believe it is the result of economists using an approach which I have termed “blackboard economics.”
The policy under consideration is one which is implemented on the blackboard. All the information needed is assumed to be available and the teacher plays all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the blackboard) to promote the general welfare.
But there is no counterpart to the teacher within the real economic system. There is no one who is entrusted with the task that is performed on the black- board.
In the back of the teacher’s mind (and sometimes in the front of it) there is, no doubt, the thought that in the real world the government would fill the role he plays. But there is no single entity within the government which regulates economic activity in detail, carefully adjusting what is done in one place to accord with what is done elsewhere.
Coase argued that marginal cost pricing is not only inefficient, but even inferior to average cost pricing due to:
(i) the fact that under marginal cost pricing, consumers are not forced to pay the full costs of the goods they purchase, leading to potentially inefficient consumption choices;
(ii) the lack of information necessary for the government to determine whether consumers would be willing to pay an amount sufficient to cover the total cost of the goods produced, and costly nature of attempts to make such estimates; and
(iii) the fact that the governmental subsidy necessary to ensure firm survival under a marginal cost pricing scheme will likely be financed through distortionary taxes, thereby creating or exacerbating a distortion in one market at the same time that it corrects a distortion in another.
Some on the Left believe the @MontPelerinSoc is the ringmaster of a vast neo-liberal conspiracy
15 Jun 2014 Leave a comment
in history of economic thought, Public Choice Tags: conspiracy theories, FA Hayek, Milton Friedman, Mont Pelerin Society, neoliberalism, vast right-wing conspiracy
 |
 |
Few had even heard of the Mont Pelerin Society until the late 1990s and the internet age. The ringmaster of the neoliberal conspiracy still has a very ordinary looking webpage.
Lead conspirator Hayek was so little known at his death in 1992 that finding extensive obituaries of him in newspapers is hard. Some may be behind pay walls. Of those that were found, they weren’t very long and forgot to mention Hayek as the leader of a global cabal that rule the waves :
When Keynesian thought prevailed and his reputation went into eclipse, Mr. Hayek turned to philosophy and psychology, which he first taught at the University of Chicago, where he wrote what many consider to be a second masterpiece, “The Constitution of Liberty “.
His son’s obituaries in 2006 were longer and more fulsome than his father’s mostly on the back of who his now famous father were:
Lawrence Hayek escaped from the formidable shadow of his father, the great economist-philosopher, Professor F. A. Hayek, into high-level medical research within the NHS, only to spend much of his final decade responding to the worldwide interest in the scholar many regard — along with Milton Friedman — as the father of Thatcherism.
Hayek, the Mont Pelerin Society’s and neoliberal conspiracy’s alleged linchpin wasn’t even able to get a job in the University of Chicago economics department. Along with Mises, their salaries were paid by a private foundation. Neither could get paid university appointments in the United States. Hayek was Keynes’s principal critic in the 1930s, and upon Keynes’s death in 1946, the most famous economist in the world at that time.
Despite being a colony of the vast neo-liberal conspiracy, mentioning Milton Friedman’s name in the 1980s at job interviews in Canberra would have been extremely career limiting. Not much better in the early 1990s.
- Back in the 1980s, the much less radical Milton Friedman was just graduating from being ‘a wild man in the wings’ to just a suspicious character in policy circles.
- If you name dropped Hayek in the 1980s and 1990s, any sign of name recognition would have indicated that you were been interviewed by educated people.
How times has changed. The reasons are well summarised by Bruce Caldwell:
But how important were [members of the Mont Pèlerin Society] in the emerging global consensus that began in the 1980s in favour of trade liberalization and privatization?
Were not, for example, the dismal performance of Keynesian demand management policies in the United States, Britain, and elsewhere in the 1970s; the heavy-handed actions of the trade unions in Britain during the “Winter of Discontent”; the sclerotic performance of countries like India who had embraced a modified version of the planning model for their own; and, of course, the patent economic and political failures of the East Bloc, far more important in turning the tide, however briefly, towards globalization?
Was not George Stigler (himself a founding member of the Society) right in his comment about economists that “our influence appears to be powerful only when we support policies ripe for adoption” (Stigler 1987, p. 11)?
see Daniel Stedman Jones (2012). Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics and P. Mirowski and D. Plehwe, eds. (2009), The Road from Mont Pelerin: The Making of the Neoliberal Thought Collective for the handbook on the cabal leading the vast right-wing conspiracy. For example,
The Road from Mont Pèlerin presents the key debates and conflicts that occurred among neoliberal scholars and their political and corporate allies regarding trade unions, development economics, antitrust policies, and the influence of philanthropy. The book captures the depth and complexity of the neoliberal “thought collective” while examining the numerous ways that neoliberal discourse has come to shape the global economy.
Masters of the Universe traces the ascendancy of neoliberalism from the academy of interwar Europe to supremacy under Reagan and Thatcher and in the decades since. Daniel Stedman Jones argues that there was nothing inevitable about the victory of free-market politics. Far from being the story of the simple triumph of right-wing ideas, the neoliberal breakthrough was contingent on the economic crises of the 1970s and the acceptance of the need for new policies by the political left.
The great enrichment – Deirdre McCloskey’s 2013 John Bonython lecture on ABC Radio
06 Jun 2014 1 Comment
in development economics, economic history, growth miracles, history of economic thought Tags: Deirdre McCloskey, The Great Enrichment, The Great Escape, The Great Fact, The Industrial Revolution
Capitalism has raised living standards worldwide by a thousand fold. Societies that respect innovation and entrepreneurship can expect more of the same.
In the space of just a couple of hundred years real incomes and living standards have risen dramatically. From peasantry to prosperity – how did it happen ?
According to McCloskey in her 2013 John Bonython lecture presented by the Centre for Independent Studies, it was ideological change, rather than saving or exploitation, that created this prosperous modern world.
McCloskey proclaims “it’s OK to be in business” and asks those critical of capitalism to re-think their opposition.
Business and enterprise, she suggests, is altruistic, cooperative and the best way to lift living standards in developing and emerging economies.
In a marvellous speech in India on the origins of economic freedom (and its subsequent fruits), Deirdre McCloskey aptly crystallizes the deeper implications of her work on bourgeois virtues and bourgeois dignity:
The leading Bollywood films changed their heroes from the 1950s to the 1980s from bureaucrats to businesspeople, and their villains from factory owners to policemen, in parallel with a similar shift in the ratio of praise for market-tested improvement and supply in the editorial pages of The Times of India…
Did the change from hatred to admiration of market-tested improvement and supply make possible the Singh Reforms after 1991?
Without some change in ideology Singh would not in a democracy have been able to liberalize the Indian economy…
…After 1991 and Singh much of the culture didn’t change, and probably won’t change much in future.
Economic growth does not need to make people European.
Unlike the British, Indians in 2030 will probably still give offerings to Lakshmi and the son of Gauri, as they did in 1947 and 1991.
Unlike the Germans, they will still play cricket, rather well.
So it’s not deep “culture.” It’s sociology, rhetoric, ethics, how people talk about each other.
Stigler’s law of textual exegesis
18 May 2014 Leave a comment
in George Stigler, history of economic thought Tags: textual exegesis
There are cottage industries of academics living of the questions such as what did Marx actually say, or what did Keynes really mean? A sign that you have really made it is people squabbling over what you really said.
Stigler’s law of textual exegesis (1965) is that because even the great and the good are human enough to contradict themselves, change their minds, and even write in vague terms from time to time and are misheard, rely on their own summaries of their own work to work out what they really think rather than hand-picked quotation. You can then check if their analytical system supports their summaries of their main work:
Let us recognize the fact that the interpretation of a man’s position –– especially if the man has a complex and subtle mind –– is a problem in inference, not to be solved by the choice of quotations.
As for why we ponder over the great texts, our goal should not be to understand what an author really believed, instead it is
…to maximize the value of a theory to the science… The man’s central theoretical position is isolated and stated in a strong form capable of contradictions by facts. The net scientific contribution, if any, of a man’s work is thus identified, amended if necessary, and rendered capable of evaluation and possible acceptance.
Minimum wage was introduced to reduce the employment of women
10 May 2014 1 Comment
in gender, history of economic thought, labour economics Tags: minimum wage, progressive era
The minimum wage is a rare policy bird. Its employment effects change at the whim of its latest proponents.
Minimum wages were initially introduced in the USA shortly after 1900 solely for women and children. The express aim was to price women out of jobs and raise men’s wages by enough so that they could provide for their families.
These days, some argue that minimum wages actually increase employment. Times change, and the slopes of supply and demand curves must change with them.
Tim Leonard in Protecting Family and Race The Progressive Case for Regulating Women’s Work showed that these women-only minimum wages were justified by political progressive including women on grounds that they would:
(1) Protect the biologically weaker sex from the hazards of market work;
(2) Protect working women from the temptation of prostitution;
(3) Protect male heads of household from the economic competition of women; and
(4) Ensure that women could better carry out their eugenic duties as “mothers of the race.”
The above photo from the Minnesota Post has the following caption:
Fuelled by the Progressive Era, Minnesota becomes one of the first dozen states to pass a law establishing work standards for women and children and established a Minimum Wage Commission.
Women-only minimum wage laws were held unconstitutional by the Supreme Court in 1923 but were upheld by a Progressive-dominated Supreme Court in 1937. In the 1930s depression, single-sex, state minimum-wage laws were revived and flourished.
Xenophobia, race prejudice, and sexism should come as no surprise to any student of left-wing politics. Progressive politics in the first half of the 20th century was infested with racism:
- The support of the Australian Labor Party (ALP), and in the USA, the Democratic Party, for vicious, state-sponsored racism is well known.
- The ALP supported the passing of the White Australia policy with glee in 1901 by the newly formed Federal Parliament.
As Tim Leonard has shown, in days gone by, budding progressives not only revelled in exposes of capitalistic barons and attacks on laissez-faire economics by muckraking journalists, they also poured over racist tracts that drew on the latest anthropology, biology, psychology, sociology, eugenics, and medical science. Social Democrat Party Sweden practised eugenics until the 1960s.
The huge differences in the coverage of government failure versus market failure in 23 leading Principles of Economics – James Gwartney and Rosemarie Fike
10 May 2014 Leave a comment
in applied welfare economics, economics, history of economic thought, Public Choice Tags: diffusion of ideas, textbook content
23 leading Principles of Economics texts reveals huge differences in the coverage of government failure versus market failure
On average, the coverage of market failure in the 23 texts is nearly six times that of government failure.
As a result of the omission of public choice, many current students of economics are presented a naïve and largely fallacious view of government and the power of economics to explain the presence of debt financing, unfunded promises, special interest spending, and the institutional environment underlying economic growth and development.
Krugman’s textbook does not mention government failure at all!
Via Economicsone
The con in econometrics
07 May 2014 Leave a comment
in econometerics, history of economic thought Tags: data mining, publication bias
A mathematician, an economist and an econometrician apply for the same job.
The interviewer calls in the mathematician and asks
What do two plus two equal?
The mathematician replies
Four.
The interviewer asks
Four, exactly?
The mathematician looks at the interviewer incredulously and says
Yes, four, exactly.
Then the interviewer calls in the economist and asks the same question
What do two plus two equal?
The economist says
On average, four – give or take ten per cent, but on average, four.
Then the interviewer calls in the econometrician and poses the same question “What do two plus two equal?”
The econometrician gets up, locks the door, closes the shade, sits down next to the interviewer and says,
What do you want it to equal?
Three econometricians went out hunting, and came across a large deer.
The first econometrician fired, but missed, by a meter to the left.
The second econometrician fired, but also missed, by a meter to the right.
The third econometrician didn’t fire, but shouted in triumph,
We got it! We got it!
Old macroeconomic fallacies never die, they just wait for the next recession
21 Apr 2014 1 Comment
in history of economic thought, macroeconomics Tags: cost-push fallacy, Murray Rothbard, Robert Barro, rules versus discretion, Thomas Humphrey, Thomas Kiuhn
Thomas Kuhn’s Structure of Scientific Revolutions showed that sciences do not march onwards and upwards towards the light. Kuhn found that once a central paradigm is selected, there is no testing or sifting, and tests of basic assumptions only take place after accumulated failures and anomalies in the ruling paradigm plunge the science into a crisis.
Scientists do not give up the failing paradigm until a new paradigm arrives, which resolves the failures and anomalies that caused the crisis. It takes a theory to beat a theory.
Murray Rothbard, when discussing Kuhn, pointed to economics is an example of a science which moves in a zigzag fashion, with old fallacies sometimes elbowing aside earlier but sounder paradigms.
Thomas Humphrey wrote an excellent 250-year long literature surveys of both the rules versus discretion debate and the cost-push theories of inflation in the 1998 and 1999 Richmond Fed Quarterly.
Humphrey wrote the reviews to see if economics was a progressive science in the sense that superior new ideas relentlessly supplant inferior old ones.
Humphrey showed that policy rules were popular in good times to contain inflation, and when unemployment was rising, discretionary policies returned to vogue. The policy debate keeps recycling because
- people forget the lessons of the past; and
- For better or worse, politicians and the public have tended to believe that central banks, the focus of his studies, have the power to boost output, employment, and growth permanently.
Mercantilists, with their fears of hoarding and scarcity of money together with their prescription of cheap (low interest rates) and plentiful cash as a stimulus to real activity, tend to gain the upper hand when unemployment is the dominant problem.
Classicals, chanting their mantra that inflation is always and everywhere a monetary phenomenon, tend to prevail when price stability is the chief policy concern.
Cost-push fallacies about inflation were even more resilient against repeated refutations.
There is nothing new under the sun in macroeconomics. The same issues that divided twentieth-century monetarists and non-monetarists as well as current macroeconomists were discussed by everyone from David Hume (1752) to Knut Wicksell (1898) and in the Bullionist-Anti-Bullionist and the Currency School-Banking School controversies:
- rules v. discretion,
- inflation as a monetary v. real cost push phenomenon,
- direct v. inverse money-to-price causality,
- central bank-determined v. market demand-determined money stocks,
- exogenous v. endogenous money, and
- backing v. supply-and-demand theories of money’s value
Current macroeconomists and monetary economists often unaware of the eighteenth and nineteenth-century origins of the ideas they employ.
Barro (1989) “New Classicals and New Keynesians, or the Good Guys and the Bad Guys”, made the point that Keynesian macroeconomics does not seek out new theoretical results for testing; rather the aim is to provide respectability for the basic viewpoints and policy stances of the old Keynesian models.
Bellante (1992) likewise, noted that the search in Keynesian economics for microeconomic foundations is to blunt criticism, rather than because it is otherwise useful. The analytical apparatus may change, but the policy conclusions remain the same.
Utopia, you are standing in it! 
Recent Comments