Index

Political Doctrine vs. Science in Economics

Keith Wilde

A professor of political philosophy1 recently assigned graduate students to make a seminar presentation about the bearing of philosophy on a specialist discipline of their choice. After a particularly lucid and complete exposition on the "dismal science" the professor exclaimed dismissively that "economics is just the logical implications of a selected set of postulates and therefore can be no nearer to truth and beneficial application than the accuracy of the postulates. This makes it identical in form to philosophical systems generally, of which there have been many in the tradition of European thought."2

The suggestion that economic theory is a philosophical system, constructed by logic on a foundation of selected premises, casts doubt on its claim to be scientific. A recent paper by Michael Hudson3 points out that contemporary mainstream economists "identify scientific theory with timeless generalities. The basic attitude is that logical consistency is the most important feature of economics, even when the underlying assumptions have little relation to empirical reality." The subject of his paper, Simon Patten,4 examined systems of economic thought, particularly those of David Ricardo, Karl Marx and Henry George, with the intent "to show through his study that the premises on which each of these systems was based were only of transient validity." A few years later this transient feature of systems of economic thought was explicitly adopted and expanded by Edwin R.A. Seligman, a Harvard professor. In a brief chapter of his Principles of Economics (7th ed., 1916) Seligman showed how the economic thinking of major epochs in European history, beginning with the Greeks, reflects the physical and social circumstances of the times. Features of economic thought that were later considered to be essential and even obvious did not show up until changed circumstances made previous theories obsolete, redundant and inadequate to explain new conditions of life.

Patten’s particular interest in this theme appears to have been its probable application to the new approach to economic reasoning that was becoming fashionable in the late 19th century (emergent neoclassicism). His contribution engages the attention of Michael Hudson through its implications for the history and functioning of monetary and financial institutions. That is the orientation that gives a unique flavour and emphasis to Hudson’s perspective on the history of thought. His focus in the Patten paper is on important transformations in economic doctrine since Adam Smith. The core issue is unearned incomes, which turn-of-the-century commentators like Patten noted to be increasingly concentrated in the financial sector. An important emphasis in Hudson’s applied work is that the FIRE (finance, insurance, real estate) sectors now overshadow the real economy, incorporating many tollgate features. The themes of transition and method in economics are enlightening background for that judgment and are illustrated with the concept of rent that is developed by Hudson in this Patten paper.

The thread begins with David Ricardo and continues through John Stuart Mill to Karl Marx and Henry George, then concentrates at the end on the marginalist revolution with John Bates Clark in particular and his intellectual opponents among the American Institutionalists (Patten especially). The seed for analysis of unearned incomes was planted by Ricardo. He was active in Britain when the industrial revolution was heating up. At that time and place it seemed natural (cf. Seligman) to assume that labourers were paid just enough to keep them alive and sufficiently healthy to work and reproduce. In that era, the most serious (or obvious) class conflict was between landlords and captains of industry. Ricardo reasoned that the value of goods should be the cost of what went into producing them. That was mainly labour (including the labour embodied in the capital used up in production) and therefore should equal the sum of subsistence wages paid. If the price of goods were higher than this "value," which was normally the case, Ricardo identified the excess as (mostly) a return to property – meaning land. He called this margin economic rent, and described it as accruing to owners of the most fertile soils. The rental element in price was a consequence of population growth and the need to use less fertile soils to produce crops. The price of grain had to cover costs on the least productive soils, so the common price created a premium for owners of the best fields. As population expanded, therefore, so did the average cost of keeping it fed. This meant that the costs of labour for the new industrial enterprises had to go up, making their products more difficult to sell in international markets. Furthermore, increasing prices for inputs to manufacturing, whether due to real scarcity of natural resources or artificially contrived monopolies (tollgates), would further erode profits, bringing investment and economic growth to a halt. The response by Ricardo to this dismal forecast was to urge free trade so that Britain could buy cheaper food abroad, while opening foreign markets to its manufactures. Its agricultural tariffs, the Corn Laws, were duly repealed in 1846.

While international free trade seems "fair" on the surface, it was actually a self-interested policy for Britain, as explained in Ricardo’s analysis based on the assumptions described above, of decreasing returns to agriculture, increasing returns to industry, which were threatened by static productivity of labor combined with higher costs for its subsistence and increasing cost of inputs due to depleting natural resources and monopoly power over their prices.

It was also consistent with the laissez faire tradition following Adam Smith, which urged governments to stand aside on the premise that market forces by themselves would produce the most efficient outcomes.

This "classical" analysis became uncomfortable, first because of further thought about the implications of its assumptions and then, by some thinkers, replacement of those assumptions by more accurate revisions. Discomfort began within the classical school itself. As economists from David Ricardo through John Stuart Mill analyzed British land ownership and protective agricultural tariffs they concluded that groundrent and rising land prices were payments to landlords that were an "unearned increment" – unearned because they occurred without property owners having to expend any effort of their own. Prices rose due to economy-wide forces. This became an argument for nationalizing the land, or at least its rental income. Rentier income was a class phenomenon in Britain and other European countries. Most rent was taken by the landed aristocracy, the heirs to the original military appropriators and their legacy of feudal economic structures. This made the fight against rentier income largely a class issue. Hudson illuminates this point with a (1908) quotation from Patten:

The older thought assumed that for each kind of income there was a social class which was interested in its defense. The social condition of England at the time economic theory was formulated favoured this concept. The aristocracy held the land, the so-called middle or industrial class owned the capital, while the great mass of unskilled and politically unprotected labourers did the work. The essence of the Ricardian economics was an opposition to the aristocratic landlords, and it succeeded so well that an imputation of being unearned was put upon their income.

The Spread of the Rent Concept

Reformers subsequent to Mill took the idea of rent much further. Karl Marx identified another source of unearned income stemming from a power (tollgate) position. Acknowledging and endorsing the labour theory of value, he contrasted the subsistence wage paid to workers to the prices of the products sold by their employers. The difference or profit margin became an index of the degree to which wage-labour was exploited simply by being hired. (In Ricardo’s analysis, workers generally were paid a subsistence wage, and some few lucky landowners captured the rent in the price of their crops. In Marx’ analysis, the workers still received only a subsistence wage, and the profits were garnered by well-positioned or cagey industrialists – again a relative few, depending on the degree of tollgate power they had in setting the prices of their products.)

By the 1870s the combination of depicting groundrent and profits as being exploitative (especially monopoly profits, which technically were a form of economic rent) turned classical economics into an ideological threat to landlords and capitalists alike. Much to the embarrassment of economists, classical economics was being used to attack rather than promote society’s vested interests. "If this new group of thinkers called themselves sociologists or historians they might be disregarded," Patten observed. But the social reformers "openly claim to be economists, and the worst of the matter is, they have…the mass of the older economists on their side. Nothing pleases a socialist or a single taxer better than to quote authorities and to use the well-known economic theories to prove his case."

This prompted a new school of economists to take a second look at the logic of classical value theory. They "soon realized that their favourite authors were not so perfect as they supposed, and that economic doctrine must be recast" to exclude logic that implied an exploitative character of industrial profit and the "unearned increment" that landowners obtained in the form of rent and rising property prices. A marginal-utility school arose to focus on the psychology of consumers, while attributing all income to the supposedly productive contribution made by its recipients rather than deeming any form of income to be unearned or exploitative. This new generation of economists stopped talking about property and its income, shifting the focus to consumer utility and depicting "time" rather than labour as the exploited factor in production. A related shift was to focus only on marginal changes, taking the existing distribution of property and organization of markets for granted rather than as subject to change. Public policy was left out of the analysis, exiled to the realm of political philosophy. Government was viewed as a deadweight burden draining the economy with taxes, as if these simply disappeared. Mainstream economists turned their eyes within, to become marginal utility theorists and even to mathematize marginal utility to an unparalleled degree.

The approach just described became "neoclassical" economics and originated with the "marginal revolution" led by the Englishman Jevons and the Austrian Menger. Different approaches to the "dismal science" implications of the classical analysis were taken by the German Historical School of economists, and following them, by a school called American Institutionalism. The historical approach emphasized dynamism in economic activity, implying development over time, as contrasted to the static assumptions that underlay Ricardian free-trade theory and laissez faire generally. These economists laid out the conditions for promoting industrial and agricultural technology rather than relying on virgin soil fertility and labour productivity as inevitable elements of increasing cost. This technological approach drew on the chemical view of soil fertility…to increase agricultural productivity, while introducing power driven capital to increase industrial productivity. The result was an analysis of potential costs under conditions of increasing returns in place of the more static Ricardian analysis based on diminishing returns at any given point in time. And in contrast to the laissez-faire doctrine, these economists argued that conditions outside of Britain were so different that government should take the lead in industrializing their nation. (Britain had a head start at industrializing, and its doctrine was a means to preserve and exploit it. This is explained fully in a 1992 book by Hudson on the history of theories about international trade.)

Simon Patten and other young Americans studied in Germany and were strongly influenced by the historical approach. Patten sought an even more far-reaching refutation of British economic thought by widening the range of economic analysis to provide a framework in which Britain and its economic categories appeared merely as a transition phase in a broader evolutionary logic of development. His framework depicted America not simply as an exception to the British rule but as part of the new dynamic of future evolution. Britain and the rest of Europe were invited to catch up to America by moving beyond their "pain-deficit" organization of class conflict into a "pleasure-surplus" economy under more democratic and forward-looking economic regimes. Rejecting the "one size fits all" outlook that assumed universal validity for British free-market economics, Patten saw that economies could organize their legal and tax systems, educational and social policy in a wide variety of ways. The upshot was a broader and more complex view than that which characterized anti-government free-market economics, especially the marginal-utility school that was replacing classical political economy.

But the "Free Market" is a Myth

Protectionist ideas in America had long controverted some fundamental assumptions of Ricardian economics, starting with that of the soil having "original and indestructible powers." Whereas Ricardo assumed fertility differences to be immutable facts of nature, the protectionists saw how the South’s plantation crop exports depleted the soil, while the catch-up costs of introducing industrial technology rose as Britain extended its leadership as workshop of the world thanks to increasing returns in manufacturing. Rather than specializing and becoming monocultures, countries needed balanced industrial and agricultural growth. The Institutionalists used this observation to argue that it was British free-trade theory that was unscientific. It lacked empirical verification with regard to presumably fixed soil and labour productivity, and assumed as universal the sharp class divisions and subsistence wage levels that characterized 19th-century Britain. Furthermore, the foundation of the free trade doctrine was itself flimsy. British political economy urged governments to stand aside, on the premise that market forces by themselves would produce the most efficient outcomes. But what are markets, the institutionalists asked, if not carefully constructed arrangements that differ from one nation to the next and one time period to the next, shaped by tax laws, government subsidies, educational systems and the cost of public infrastructure. There is no such thing as a "free market."

Hudson notes that the logical consistency emphasis in mainstream economics depicts theories that endorse protectionist policies, government regulation or planning as "uneconomic" and even unscientific, simply by narrowing the scope of economics to universals. These timeless and "one-size-fits all" assumptions are hardly a guide for policy of specific countries at given points in time. Attempts to deal with countries abstractly are bound to strip away everything political, and hence are implicitly laissez faire. Recognition of the role played by institutional characteristics can hardly be dismissed as anti-intellectual merely on the grounds that it does not oversimplify by stripping away historical considerations and other elements of empirical reality.

Keith Wilde

1. Dr. N. Schwartz-Morgan, Royal Military College of Canada.

2. This judgement illuminates the lecture notes of Jose Ortega y Gasset (The Origin of Philosophy) that philosophical systems are subject to corrections over time, as the truthfulness of their premises is thrown into doubt by the march of human experience, including deliberate efforts of scientific investigation. Elements of persisting value are nonetheless incorporated in the new system that is emerging from the ashes of the old.

3. Dr. Michael Hudson, Distinguished Research Professor of Economics, Universities of Missouri at Kansas City and of Latvia in Riga, and policy adviser to the Government of Latvia.

4. Simon Patten, Rent Theory and the Rise of American Institutionalism (not yet published). Except for obvious editorial commentary, this article is excerpted from the paper with Dr. Hudson’s permission.

– from Economic Reform, November 2006

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