Tuesday, September 21, 2010


Does "homo economicus" exist?

The idea that market players are the dominant actors that drive and shape society, and should be left alone to pursue their ends because their activities lead to better societal outcomes, has it's roots in the 18th century. But the idea persists to this day. There are many reasons for this. All too often people will believe something simply because it's convenient, or because it's what they were told growing up. Worse, they may not know any better.

This is one of the reasons why I wrote The Myth of the Free Market: The Role of the State in a Capitalist Economy. In my book I take a look at the idea that market players should be left to pursue their own ends. Specifically, I review the arguments made by one of the economic icons of market capitalism, Milton Friedman. What follows below are some of the issues that I discuss in my book, and some of the concepts we will be discussing in class this week (I've listed page numbers where the topic can be found in my book throughout the text below).

Did Milton Friedman "Get it Wrong"?
In my book I begin my discussion of market capitalism by taking a look at the arguments made by economist Milton Friedman. I make it very clear that I think he not only got some very basic assumptions wrong, but that his approach to economics has caused some real damage to our society because of how his arguments have encouraged many people to believe that people in the pursuit of profit become rational and virtuous in a market setting.

To understand how Nobel Laureate Milton Friedman got it wrong I start by looking at what Adam Smith, the patron saint of modern capitalism, said about markets and trade in 1776. Adam Smith made it clear that a level playing field, or what he called the "laws of justice" should not be undermined. Custom, tradition, privilege, market conspiracies, favorable legislation, and affronts to human dignity (e.g. the violation of individual rights) all work to undermine the market's playing field by shifting resources to those that don't necessarily work for their reward (15-17, 26).

The interesting thing is that Adam Smith wasn't the only one who saw how the laws of justice could be violated in 1776. James Madison and the Founding Fathers spoke about the need to reign in merchants and other "factions" because the "most common and durable source of factions has been the various and unequal distribution of property" (17-19).

These considerations, according to the Founding Fathers, inflamed "passions" in post-revolutionary America to such a degree that they threatened to tear apart the new union. Worse, according to Madison, is how "the latent causes of factions are thus sown in the nature of man." Simply put, we're not necessarily good people, especially in a trading environment. Madison understood this and wrote: "If men were angels, no government would be necessary."

Guess what? We're not angels. So we can't trust one another, even in a market setting.

This is why we ditched the Articles of Confederation, which gave market players at the time free rein, and created a Constitution that gave the federal government broad authority in the market (see especially Art. I, Section 8). The fact that we can't trust one another in a market setting (see this) is why we create laws and regulations. Human nature demands it.

Friedman's Unicorn View of Human Nature
All of this is something Milton Friedman passed over, or simply got wrong, when he discussed the power of "the market" to transform the passions of merchants. More specifically, Friedman placed so much faith in people doing the right thing in a market setting that he virtually ignored what the Founding Fathers, and Adam Smith, said about the human condition.

The Founding Fathers, in particular, had seen in real time what a weak central government could produce, and did not want to re-visit the Articles of Confederation. Like it or not, they believed merchants can't always be trusted in a market setting. For his part, Adam Smith believed that merchants, left to their own devices, would work against the interests of the consumer, and would use the state to secure their positions if necessary. If  Adam Smith, James Madison, and the Founding Fathers understood this, why not Friedman?

Part of Milton Friedman's problem can be traced to his position on freedom, and how he assumes liberty is kind of like air ... it's just there for everyone. This is why he suggests an "umpire model" for society. Let the state call balls and strikes in the market, and leave it at that.

What Friedman ignored is how umpires call games differently (ideological extremism can get in the way). He also ignored how strike zones can be changed (deregulation & favorable legislation). Worse, he ignored how some people never get to the plate (women and people of color). Finally, he ignored how umpires can get dirt thrown in their faces (yes, market players can and will collude with government regulators and members of Congress ... as Wall Street in 2008, and a trail of bailouts illustrate).

The Moral Justification of Capitalism
All of this can undermine our level playing field. It can also destroy the moral justification of capitalism. We need to remember that the moral justification of capitalism, which is the cornerstone of our market economy, rests on one simple principle: If you work hard you will get ahead.

Personal responsibility and a strong set of moral obligation for middle America has grown out of this simple principle.

Once you undermine the conditions that make the moral justification of capitalism work we're all in trouble. Stagnating incomes, record bankruptcies, and homeowners walking away from their mortgages, among others, are not good signs today.

Still, in spite of crashing our market in 2008, market players on Wall Street continue to invoke what Adam Smith referred to as our system of "natural liberty" to pursue their own selfish ends. Ironically, while they channel the spirit of Adam Smith to justify their efforts in the market, their activities not only undermine the laws of justice (by influencing how reward and resources are distributed) but violate what Adam Smith called "the order of nature and reason" (which leads to market imbalances and societal disconnect; 37-45).

Because of his belief that market players will do the right thing in a market setting was so strong Milton Friedman grafted his assumptions on to his policy analysis, and his policy prescriptions. This is where he got it wrong, big time.

Men aren't angels. Men pursuing profits and wealth aren't much better. To believe otherwise is to embrace Unicorn theories of the human condition.

Embracing the Unicorn
Milton Friedman didn't simply get the human condition wrong. He embraced the Unicorn.

Specifically, he went beyond promoting an umpire model of markets (i.e. we can be trusted in a market setting while we're pursuing profits) by deliberately distorting the debate, and the facts. While there are many things that Milton Friedman missed when it came to understanding human nature, below is a partial list of what Milton Friedman got wrong, ignored, or misrepresented in his work(s) (which I discuss in chapter 2 of my book).

FALSE DICHOTOMY: Throughout his writings Friedman consistently warns about the collectivist tendencies he saw in western democracies. Seeing socialist ghosts in every corner, Friedman constantly warned about creeping socialism, and how market capitalism was threatened by a state that promoted civil liberties and civil rights.

What Friedman ignored is that markets aren't an either/or proposition. A state can't embrace either complete freedom for all, or be on the march to socialism. This is a false dichotomy (10). Saying you either do it my way or we're going down a socialist rat hole does not represent what happens in the real world, and is not sound analysis (especially for jump starting a debate).

IGNORES ECONOMIC GROWTH: For all of Milton Friedman's dire warnings about America, and the west, going to hell in a hand basket because of the creeping socialism, Friedman missed one important fact: Post-war America and the west experienced the greatest, and widest, degree of economic growth and prosperity in human history (5-13). We avoided the threat of major market collapse, or economic depression too.

Warning about the dire effects of an evolving "collectivist" regime when growth and stability are high and widespread is simple fear-mongering. Global confidence in the sturdiness of the world's financial center, New York, evolved for one simple reason: Transparency was at the heart of sensible regulations, which were tethered to a viable system of justice (something to think about today).

PLAYING POLITICAL GAMES: One of Milton Friedman's key assets (and problems) is that he understood he could ride on the back of the field of economics, which maintains an elevated - but undeserved - position in the political world, and in the social sciences. This position was a powerful tool politically. Milton Friedman understood this and deliberately sought to discredit his opponent's arguments by:

(1) Conflating government regulations and the push for civil liberty protections with socialism and collectivism (his influence is so great that those in the Tea Party movement today still don't seem to understand the difference between these categories),

(2) Marginalizing the efforts and duties of government as wasteful, when we all know that state functions are distinct from those performed by the market,

(3) Derisively dismissing other, competing, disciplines as "speculative philosophical discourse" that are less rigorous than economics (which studies homo economicus), and

(4) Denigrating his opponents arguments by making references to the "bubbly emotionalism" of their position(s).

To be sure, all intellectual battles require that you distort, marginalize, dismiss, and deride the efforts of your opponents if you can't defeat them on the merits. But think about it. How many professional economists saw the market collapse coming in 2008? (I'll try and link a short list here later.) How many understand it's roots today? (And, no, it's not Fannie Mae's fault, or the fault of all those people who took out loans they couldn't afford, or the fault of government spending alone ...)

Milton Friedman understood the political climate of the day, and took advantage of it to irresponsibly push a world view that does not adequately capture the human condition (see esp. the intro to Ch. 4).

DOWNPLAYS DEMANDS OF MODERN WORLD: If you create an automobile we know that we need the DMV, the CHP, the DOT, and ... the list goes on. Or do you trust other motorists to do the right thing? Do you trust the states to build and maintain highways?

Similarly, do you trust Wall Street to do the right thing now that the overly dramatic fears of the economic crisis of 2008 have passed (for now)? Do you really trust that British Petroleum will make things whole in the Gulf of Mexico? Do you care if your medical doctor is certified? Complex industrial societies require rules and regulations. As Hernan de Soto would argue, unlocking the mystery of capital demands it.

Milton Friedman, however, seemed to believe that creating a complex and interdependent society across a continent is it's own achievement. It's not. You might want the government off of your back, but I can assure you that you want the government on your neighbor's back.

DOWNPLAYS HISTORIC ROLE OF THE STATE: Manifest Destiny ... Land grant colleges ... Our Indian land policy (someone had to kick them off for you to invest in it) ... Land acquisition policies (war/purchase) ... Market subsidies ... Mass market purchases (starting with the Civil War) ... Infrastructures (Erie Canal, RR, etc.) ... The creation of America's middle-class (yeoman farmer, blue collar workforce, and the social wage earner) ... Education policies ... Tariff policies ... Civil Rights legislation ... All of these developments make it clear that the state has had a dominant role in creating the conditions for freedom and liberty to prosper, and for wealth to grow in America (30-35, plus Ch. 6). There are no invisible hands here.

IGNORES WHAT MAKES MORAL JUSTIFICATION OF CAPITALISM TICK: Work hard and get ahead? Not if you were a woman, black, or even white male without land (initially). The state has worked hard to open and guarantee opportunities for those who were once relegated to second class status in America. Access wasn't provided by enlightened market players. There was too much money to be made keeping the field tilted in their favor. It was fought for and taken by those who were excluded from the liberties and freedoms granted by the Constitution.

Later, when child labor laws, family wage laws, and Jim Crow/Civil Rights's laws were required, the state once again stepped in. Industry, for the most part, fought the state every step of the way. Markets didn't magically open up opportunities for everyone in America. It was democracy in action. It was people making demands on the state, and then having the state act. Political movements and the state made the moral justification of capitalism work in America, not market players.

There's more, but this is enough (for now).

- Mark

NOTE: I presented an earlier version of this for another class five months ago.

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