New York Review of Books How to Understand the Economy
By Robert M. Solow, Nov. 16, 2006 Issue Adams Fallacy: A guide to economic theology By Duncan K. Foley (Belknap Press/Harvard University Press, 265 pp., $25.95). Economic theology masquerading as economics is not anyones exclusive property, right or left. Foley is right to insist on that, and it is a useful lesson for educated general readers. But relegating modern mainstream economics to the margins is not a favor to his audience because they are deprived of some interesting intellectual machinery that can help them to understand the economics of everyday life. The allocation of fifty pages instead of twenty-three would have given him the opportunity to sketch a validly agnostic reading of some modern economic theory. Instead one finds a casual brush-off, often so casual as to be a misleading distortion. I will mention one minor example, because it points to a bad habit in mainstream economics that bugs me even more than it does Foley. He remarks, quite correctly, that the mainstream (marginalist) project of tracking equilibrium prices and quantities is intrinsically complex and difficult because the buyers and sellers (agents) in an economy differ substantially in their interests, tastes, capacities, information, and social positions. Foley writes: One short-cut, which neoclassical economists frequently take, is to assume that all individuals in society are exactly alike, so that they can be reduced to a representative agent, and then to work out how the representative agent would allocate the existing stock of commodities, and what marginal utilities (whose ratios will be interpreted as market prices) will result. He then points out that this device is very likely to give wrong answers (and, he might have added, more emollient, Panglossian answers.) This is fine as far as Foley goes, but it does not go very far; I think it is basically uninformative to a non-specialist. It would have taken only a couple of pages to explain that the representative-agent device is far from universal in mainstream economics; it appears mainly in a few sub-areas of the discipline, but one of these is important. The representative-agent device has been adopted by a significant, perhaps dominant, school of thought known as real business cycle theory, and it is applied to a problem of everyday life where it can do a lot of damage: the theory of those irregularly alternating states of affairs we call prosperity and recessions. The representative-agent device, by simply assuming away the more or less obvious differences in desires, expectations, and beliefs among groups of consumers, investors, workers and business firms, manages to convert the business cycle from a (large or small) pathology of the economic system into a sort of optimal adaptation to unforeseeable disturbances. Thus, a recession is seen as the rational, even inevitable, market response to an unforeseen event, not a possibly preventable reaction to excessive capital investment or financial speculation. Here and elsewhere, Foley misses an opportunity to teach useful lessons about both economic theology and economic analysis. With this background, we can turn to the major theme of Adams Fallacy (The Adam in question is Smith, of course, but the reminder of the First Man is surely intended.) Here is Foleys first extended statement of what he means: For me the fallacy lies in the idea that it is possible to separate an economic sphere of life, in which the pursuit of self-interest is guided by objective laws to a socially beneficent outcome, from the rest of social life in which the pursuit of self-interest is morally problematic and has to be weighed against other ends. This separation of an economic sphere, with its presumed specific principles of organization, from the much messier, less determinate, and morally more problematic problems of politics, social conflict and values is the foundation of political economy and economics as an intellectual discipline. Elsewhere in the book there are many references to Adams Fallacy in specific contexts, some of which do not seem to me to fit the basic definition. The moral fallacy of Smiths position, writes Foley, is that it urges us to accept direct and concrete evil in order that indirect and abstract good may come of it. But is this a fallacy? Consider one of Foley s examples: >From Malthuss perspective, charity to the poor was self-defeating or, even worse, exacerbated the problem of poverty: charity or the dole allows workers to reproduce even when they have no employment. Thus subsidizing the poor pushes down the wage and standard of living at which population stabilizes This kind of reasoning is characteristic of Adams Fallacy. Its method lies in contrasting the immediate effects of action (charity relieving the suffering of the poor) with indirect, systemic effects (charity expanding the population and lowering the standard of living of the poor). Its burden is the moral necessity of resisting moral impulse . Now Malthus may have been wrong. Certainly no one in Britain today would think of appealing to the Iron Law of Wages, which holds that wages will be drive down to subsistence levels. But if Malthus was right in 18th century Britain or in some poor country now, then I do not see that his argument involves any separation of an objective sphere of economics from a broader moral sphere. He is claiming that, in this case, the pursuit of short-run moral benefits (money for charity) will, through the working-out of certain empirically valid patterns of human behavior (Foley calls them objective laws), result in long-run moral costs that outweigh the sought-for benefits. If your oncologist tells you that this course of chemotherapy will be exceedingly painful but will lead to an enduring improvement in quality of life, you hope she is right, but you do not suspect a fallacious separation of an objective medical sphere from a broader moral sphere. Similarly, refusing charity to the poor may be painful for them in the short run but may have broad beneficial effects over time. Of course, the modern successors of Malthus, who have sometimes argued that the relief of poverty through public assistance actually creates and prolongs poverty, may drastically overstate the case. The reach of Adams Fallacy may thus be a little less than Duncan Foley suggests. But the original statement of it is interesting and important. Someone like me, who adopts the mechanics-eye view of economics, has to deal with it. Students of economics are indeed taught to make a clear distinction between positive statements (this is how this piece of the world works) and normative statements (some states of the world are better than others). They are taught that no ought follows from an is, except with the addition of a clearly defined ethical criterion. And then they are taught a very stringent criterion of betterness, devised in the early 20th century by the Italian economist Vilfredo Pareto: a state of the world A is Pareto-better, or more Pareto-efficient, than state of the world B, if and only if every person is better off in his or her own estimation in state A than he or she is in state B. There are three important things to say about that criterion. First, it is totally individualistic; no persons well-being can legitimately be traded off against any other persons. Second, for that very reason, it is almost impossible to satisfy in practice; not many policy moves that are of benefit to many will be costly to no one, and certainly not redistributive moves. Third, for that very reason, there is a temptation to violate the Pareto rule in practice; but it serves the purpose of reminding the violator to be clear about the welfare criterion being appealed to. There is a common, theologically fraught pitfall here. We are all familiar with statutory regulations that are said to distort economic decisions, and prevent resources from being allocated to their socially most productive use. Presumably they are enacted for some worthy purpose. Rent control is an example: large rent-controlled apartments may house small families who cannot afford to leave, while larger families pay higher uncontrolled rents for smaller spaces. (Leave aside any effect on new construction.) An end to rent control would allow an increase in efficiency, in the precise sense that everyone cold be better off; those who gain from decontrol could in principle compensate perhaps through state-imposed taxes and transfers 0 those who lose, and have something left over to share around. But that never happens: instead, the rise in rents following decontrol amounts to a transfer of wealth from tenants to landlords. The Pareto criterion is not satisfied in practice. But acolytes of the free market focus on the gain in efficiency and tend to neglect the equity or distributional consequences. This is, just as Foley says, an illegitimate separation of economic from moral considerations, an example of Adams Fallacy. But it is not intrinsic to marginalist or neoclassical economics. In fact the analysis of the effects of abolishing rent control that I just sketched is neoclassical economics. The trouble is neoclassical economics is amazingly good at teasing out the last detail about efficiency gains and losses, but it has no special tools for analyzing equity considerations. So there is a tendency to marshal economics on behalf of free marketeerings, knee-deep in Adams Fallacy. The remedy, it seems to me, is to show where the applications have gone wrong rather than to abandon the theory in favor of some inferior mode of thinking. Foley is deeply skeptical about the ability to correct misguided applications of neoclassical economics. In its sophisticated form, he writes, neoclassical economics finesses the question of morality through a version of pragmatism. But are there really any significant instances where the economic and the moral are so inextricably intertwined that careful analysis and fact-finding cannot succeed in elucidating the issues? The only cases I can think of are those where the economic act itself is felt as immoral, for example, we do not allow the voluntary sale of body organs for transplant. Even so, we mechanics would opt for sticking to those problems of which there are many where one can figure out (a) how the systems works, and (b) exactly what moral issues are implicated. These might include, for example, the price of oil, the control of population, the inequality of wages, the persistence of unemployment, and the necessity of some public investment. Render unto Marshall. My tentative view is that Adams Fallacy is better regarded as a bad habit that certain ways of thinking about economics may encourage, though not necessarily imply. Maybe it should be called Duncans Temptation. Infatuation with the remarkable properties of decentralized markets, and with the capacity of modern economic analysis to sort them out, does not provide a free pass to leave it to the market regardless of distributional and other ethical considerations. This conclusion is worth some emphasis. Foley reflects on Adam Smiths claim that unfettered competitive markets guide the consequences of self-interest to a socially beneficent outcome. Modern students learn that this beneficence has to be carefully interpreted. The economy starts with a set of participants, each endowed with a certain bundle of resources, property and capacities. According to the remarkable First Theorem of Welfare Economics (conceived by Kenneth Arrow, among others), a perfect free market system and months of study go into the precise meaning of perfect here will achieve a Pareto-optimal outcome. No feasible reallocation can make anyone better off without making someone else worse off. That might be described as a certain kind of beneficence. But if the initial endowments of each participant in the economy had been different, a different Pareto-efficient outcome would have come about, and very likely those individuals whose endowments of wealth and skills had been improved would fare better in the outcome. So the free market outcome is not better that its starting distribution of wealth. It can be described as socially desirable only if the allocation of initial endowments was socially desirable. The theological free marketeer likes to omit that proviso. A good student should not. Toward the end of Foleys short book, there is another short chapter about four maverick early 20th century economists. John Maynard Keynes, Thorstein Veblen (a favorite of mine, too), Frederich Hayek, and Joseph Schumpeter. Keynes is the most important of these, and Foley does well by him, though I would have like more attention to the uses that mechanics have made of Keyness ideas in analyzing the day-to-day operation of the economic system as a whole. This is especially important when there is excess unemployment and idle capacity, and the beautiful neoclassical rules do not apply. The space available for Veblen is not nearly enough to allow a discussion of the variety of his offbeat insights, but I am glad that Foley included him. He is also good on Hayek, especially at drawing a line between Hayeks essential contribution about the informational content of decentralized markets and his purely ideological utterances. I was especially delighted to hear that Duncan Foley finds Hayeks book on business cycles as incomprehensible today as I found it as a student sixty years ago. I am less of an admirer of Schumpeters Capitalism, Socialism, and Democracy, and a little more about his earlier Theory of Economic Development, with its focus on entrepreneurial innovation as the driving force of economic progress. Anyway, the best these short vignettes can do is to induce some readers to go further. So what would I tell an educated general reader who is looking for a book on economics? Duncan Foley could not fail to have written a book with spark and depth. He has done that, and it ranks right up there with Heilbroners classic. Heilbroner has more to say about the political and economic setting in which each of his worldly philosophers emerged; but Foley gets deeper into the analytical content of major schools of thought. Still, Adams Fallacy is not the book I would have wished for. That would have been more of a Popular Mechanics; this is what they say about the exchange value of the dollar; this is what they say about the combination of recession and inflation; this is what they say about the estate tax; and this is how they tie these things together. Yet another take will be available next spring when Oxford University Press publishes Partha Dasguptas Economics: A very short introduction, which is more about the institutional infrastructure required for a well-functioning market economy. Maybe the best thing to tell the educated general reader now is: you know you could read two books. http://www.nybooks.com/articles/article-preview?article_id=19602 <http://www.nybooks.com/articles/article-preview?article_id=19602> please contact me if you would like a single reader friendly copy.
|
Duncan Foley’s Adam’s Fallacy reviewed 7 |
_______________________________________________ Futurework mailing list Futurework@fes.uwaterloo.ca http://fes.uwaterloo.ca/mailman/listinfo/futurework
