Chapter V: Equilibrium, or The Tao of Economics

Open any standard economics textbook, and before you have gotten too far into it, you will see a chart that looks like this:

The vertical axis represents price for any commodity and the horizontal axis indicates quantity of that commodity. Within the chart there are two lines that cross, “S” for supply and “D” for demand. The supply curve indicates the amount of any commodity that producers are willing to supply at a given price, while the demand curve indicates the amount of that commodity that consumers are willing to buy at a given price. The point where the two lines cross, labeled “E” is called the equilibrium point, while “Q₁” and “$₁” represent the quantity and price at the equilibrium point. The chart is based on an intuitively obvious idea, namely that buyers want to spend as little as they can and suppliers want to get as much as they are able. Hence, the lower the price of something, the more consumers are willing to buy of that product, while the higher the price, the more suppliers are willing to produce. The equilibrium point represents the balance between supply and demand, the point where buyers are willing to buy the exact amount that producers are willing to supply at that price.

This deceptively simple chart is an extremely powerful tool, and economists put it through all sorts of permutations to arrive at all sorts of conclusions. None of that need concern us here; at this point we are mainly interested in understanding the idea of equilibrium, and how societies get to that point. . It is no exaggeration to say that the entire structure of modern, neoclassical economics is built on this chart. Therefore, some comments on the chart are in order. The first thing that we must note is that this is an idealized representation; it represents equilibrium in a static moment, but an actual economy is dynamic; prices change from day to day and even from hour to hour. Because it is an idealized portrait, it shows equilibrium as a precise and knowable point that is actually reached. In a real economy and for any real product, the equilibrium point is rarely known with any precision, but forms an attractor point around which prices and quantities fluctuate. And it should be noted that while we call them “supply” and “demand” curves, they are really both demand curves, since the supply curve represents the producers’ demand for the commodity known as “money.” This would be self-evident in a barter economy. If someone were trading shoes for fish, we would place fish on one axis (it doesn’t matter which one) and shoes on the other, and both parties would be simultaneously “demanders” and “suppliers.” It is only in a money economy, where goods and services are measured in terms of one special commodity that we can strictly separate “suppliers” from “demanders.” It is important to remember this, because in a money economy, most people become demanders only after first being suppliers, usually by supplying to the market the commodity known as labor.

The Demand Curve

Demand is affected by the consumer’s income level, his needs, tastes, and preferences, the prices of other goods, and his expectations of any changes in price levels. If a consumer’s income increases, some portion of the increase will contribute to an overall increase in demand. So, for example, an increase in the minimum wage might raise overall demand and affect the equilibrium point. What the equilibrium point really measures in not overall demand, but effective demand, by which we mean both the desire for the product and the ability to pay for it. Note that in a market system, the equilibrium point will always be less than total demand, usually substantially less. Hence, certain common goods, such as police or schools or roads are not normally provided as market goods (or some would receive none of them) but as socialized goods.

Needs, tastes, and preferences are often regarded as “individual choices”; however the truth is much more complex. While these always appear as personal actions, they are actually socially influenced. In fact, a lot of what we are has little to do with “individual choice.” For example, most readers of these words speak English not as an individual choice, but as a social gift; we were given the English language long before we realized that we might have some choice in the matter. Our preferences are heavily influenced by such things as fashion, advertising, work-place dress codes, and social conventions. Even those who wish to escape the conventional most often do so by substituting other conventions. For example, a teen-ager objecting to conventional styles may adopt “goth” styles, a social “sub-group.” Examples of a “pure” individual choice are hard to come by. Economists tend to model demand as the aggregate of purely individual choices, but this may not be the best model of what humans actually do.

Prices of other goods affect demand because we must make choices; to purchase a quantity of commodity A precludes us from using the same money to purchase B. Further, many products have substitutes. For example, if the price of beef increases relative to the price of pork, many people will substitute pork for beef in their diets. Hence a producer competes not only against others producing the same product, but against those producing products that can be substituted for his.

Another thing we may note about demand is its elasticity. Elasticity measures how much a change in price is required to change the volume purchased. Some products are highly elastic; a small change in price will lead to large increases or decreases in what is purchased. Other products are inelastic; it takes a large change in price to change buying behavior. For example, most of us must use a certain amount of gasoline to get to work, and have difficulty finding an alternate means of transportation. Therefore, we are likely to pay whatever the market demands for gas, making gas an inelastic commodity.

The idea that as a commodity's price falls people will tend to purchase more of that commodity is called The Law of Demand. However, it is not really a law in the way that gravity is a law, always and everywhere operative. Rather, it is a tendency, and as such there are many exceptions. Some products actually depend on the price being unreasonably high. A Ford will get you where you are going as well as will a Jaguar, but a Jaguar will display your wealth along the way. If the price of Jaguars were lowered to that of Fords, it is likely they would, after a time, sell less of them, not more. A more common example is athletic shoes. A $130 pair of Nike’s may or may not be any better than the $30 no-name pair that comes out of the same shoe factory in Vietnam. But by placing the “swoosh” on the shoe, the seller can get a large premium, a premium which contributes to the product’s image and exclusivity. Again if he lowered the price to $30, there would be nothing to distinguish it, and sales might actually fall. Nevertheless, and even with all these caveats, the law of demand is still a useful concept, even if it isn’t really a law.

Taking all these things together, we note that the deceptively simple supply curve encodes a tremendous amount of information. Any change in the factors making up the supply curve can have large consequences on the shape of the curve and hence on the equilibrium point. Moreover, this encoded information is largely social. Our actions are influenced by others and, in turn, influence others. For example, when we choose to buy a giant Hummer, we increase the demand for gasoline, and thus affect the price that everyone else pays for it, even those who have no interest in monster-sized cars.

The Supply Curve

As complex as the demand curve is, the supply curve presents even more challenges. In the standard, neoclassical theory of economics, it is relatively straightforward: firms supply product to the market until marginal revenue equals marginal costs; this is called marginal cost pricing. “Marginal” here means the cost or revenue for the last unit produced. Marginal revenue is simply the price of the product. Marginal cost, however, is highly complex. In general, we know that with a given amount of equipment and labor, we can produce one more unit of a product for a low additional cost, up to a point. Beyond that point, costs per unit will actually start to rise. It will cost more to make the last unit than the product actually sells for; hence there is no reason to produce past this point. Firms will produce product up to the point that marginal costs equal marginal revenues. Under conditions of perfect competition, this will provide the greatest possible amount of goods to the market at the lowest practical price. Society will benefit, and the firm will make a reasonable, but not outrageous, profit.

The theory is sound; however, actual practice diverges from this theory more often than not. In the first place, knowing the “marginal revenue” means knowing what the demand curve will be, and this is generally just a guess, for all the reasons we have already mentioned. But it is the marginal cost that is most problematic. When an economist thinks of costs, he thinks of all the resources that were consumed in making the product. The businessman, however, only thinks of the costs he actually has to pay. Other costs may be externalized, that is, placed upon third parties who are not necessarily purchasers of the product. For example, the owners may get the government to build them roads, finance their facilities, pay part of their work force (with food stamps or housing vouchers, for example), give them tax rebates, etc. The most obvious example of an externalized cost is pollution. A manufacturing process may dump highly toxic chemicals into the air, the land, or the water, causing health problems for everybody else. This is a real cost, but one that does not show up in the business owner's calculations. But even considering just internal costs, these turn out to be complex and difficult to measure, and few companies actually undertake such an analysis. Rather, they depend on strategies other than marginal cost pricing.

If a company has a patent on a product for which there are no substitutes, it may engage in monopoly pricing. This is especially the case in the drug industry, where patent protection allows the drug companies to charge $10’s or $100’s of dollars for a pill that may cost pennies to manufacture, even considering research costs. If there are a few companies in the same business, they may engage in a similar practice, oligopoly pricing. They may use package pricing, relying on the reputation or packaging of the product to obtain a higher price, as in the Nike example above. Or they may use predatory pricing to price the product below cost and force a weaker competitor out of business. Or, they may use discrimination pricing, which sells the same product to different markets at different prices. For example, the same seat on an airplane may cost a different amount depending upon whether the passenger is a business traveler, a leisure traveler, bought the ticket the day of flight or three weeks in advance, is staying over a weekend, etc. These and many other pricing strategies are a long distance from the marginal cost pricing of the standard theory.

Having drawn all of these caveats around the supply and demand curves, have we not then shown that the “Magic Chart” is not really valid? Well, perhaps, but I don’t think so. All we have shown is that the standard tools of neoclassical analysis may not be the best way to understand equilibrium. The theoretical model may be insufficiently “scientific,” that is, not really well-related to the way things really work. The truth is that all successful economies reach equilibrium, more or less. But the problem (and the analytical challenge) comes in the fact that they reach it through both economic and non-economic means. It is the means by which equilibrium is reached that must be correctly analyzed.

Economic Equilibrium

When people come together in families or firms to produce things, they add wealth to the economy; in fact, this is the only economic way to add wealth.[1] If they get an equitable share of the output, or the wealth they create, there will be enough purchasing power in the economy to buy all the things they produce. This is the much-maligned “Say’s Law of markets,” which states that “supply creates its own demand.” When there is an excess of goods supplied to the economy, we have a recession, or worse. Say’s Law is much criticized because if you examine it closely, it says that recessions are impossible; there will always be enough purchasing power to clear the markets. Clearly, we purchase things in terms of other things. If, for example, you are a fisherman and you want some shoes, you catch some fish and trade them with the cobbler (in a barter economy). The total number of things created equals the total number of things that can be used for purchasing the other things. The two quantities are in fact the same quantity, so that there can never be a shortage of purchasing power in the economy. Granted, there may be a temporary disequilibrium in any particular market. The fisherman may catch more fish than people really want to eat; the cobbler may make too few shoes. But such a situation will normally not persist. A fisherman who cannot sell all of his fish will cut back on the time spent fishing and devote himself to other things. Perhaps leisure, or perhaps he will take up cobbling, thereby adding to the supply of shoes. But in any case, a recession in these circumstances cannot be of long duration or great importance. And yet, recessions do happen, quite obviously. Long ones. Deep ones. Serious ones. So what is wrong with Say’s “Law”?

To understand the problem, we have to look at the sources of demand in a money economy. And these sources are two: wages, and interest or profit.[2] Wages are, of course, the rewards of labor, and profit the reward of capital. In another sense, however, these are the same rewards since capital is merely “stored-up” labor, or things produced in one period to be used to continue production in the next period. For example, if a farmer wishes to have a crop next year, he must save some seed-corn from this year’s crop. Now, the corn he consumes and the corn he saves are the same corn from the same crop. But by saving some corn for seed, it becomes “capital.” Hence, the return on this capital is really a return on his prior-period labor, just as his wages are a return to current-period labor. Clearly the returns to capital and labor, interest and wages, spring from the same source (labor). Capital, then, ought to have roughly the same rewards as labor, plus some premium for saving. Or, to put it in “eco-speak,” the returns to capital and labor should be “normalized” to each other. This normalization of incomes from capital and labor is the condition of equity in an economy. That is, the same kind and quality of labor, whether in its original or “stored-up” form of capital, should produce roughly the same return.

Interest (or profit) and labor constitute the economic sources of demand, and if they are normalized to each other, economic recessions are unlikely.[3] There will be enough purchasing power distributed equitably to clear the markets. In capitalist economies, the vast majority of men are not capitalists; that is, they do not have sufficient capital to make their own livings, either alone or in cooperation with their neighbors, but must work for wages in order to live. And since the vast majority of men and women work for wages, then the vast majority of goods will have to be distributed through wages. In conditions of equity, this will not be a problem; so long as there is equity, there is likely to be equilibrium, and periods of disequilibrium are likely to be brief. But it may happen, and quite often does, that interest and wages are not normalized to each other. In almost all cases (although there are exceptions), this means that capital gets an inordinate share of the rewards of production. This, in turn, means that the vast majority of men and women will not have sufficient purchasing power to clear the markets, and the result will be a disequilibrium condition, that is, a recession. When this happens, governments and societies often look to non-economic ways of restoring equilibrium.

Non-Economic Equilibrium

The major non-economic means of restoring equilibrium are charity, welfare and government spending, and consumer credit (usury). Each of these methods transfers purchasing power from one group, which presumably has an excess, to another which has a deficit. The first method, charity, will always be necessary to some degree. This is because even in the most equitable and well-run economies, there will always be people who are incapable of making a decent living, perhaps because of mental impairment, moral deficiency, or physical handicap. One hopes that there is enough generosity and benevolence in society to voluntarily cover the needs of these people. However, when low wages become widespread, and when self-interest becomes the dominant motivation in society, it is likely that charity will be insufficient, and other means must be used.

The second non-economic means is welfare and government spending in general. By these means, the government seeks to re-establish equilibrium conditions either by supplementing the income of some portion of the population, or simply by increasing its spending to create more jobs and thus add more purchasing power to the economy. This strategy is at the heart of Keynesian economics. The “market” economy is allowed to continue to produce inequitable (and therefore disequilibrium) conditions, but the government will tax and redistribute the excess incomes in an amount sufficient to restore equilibrium. For a while, this method worked fairly well. However, it created some problems. In the first place, it created entitlements. Unlike charity, which depends on the benevolence of the donors and may evoke gratitude on the part of the recipients, welfare depends on the police powers of government and is more likely to evoke resentment on the part of both the recipients and the “donors.” Further, these re-distributions require increasingly intrusive bureaucracies to collect and disburse the funds. The recipients, no less than the donors, find that every aspect of their life is subject to government review and control, and this is never a comfortable feeling for either.

Despite the fact that Keynesian transfers now consume a huge portion of the federal and state budgets, these transfers have been, for some years now, insufficient to balance supply and demand, and for some time now the economy has depended chiefly on the third method, usury or consumer credit. Here we must distinguish between lending for investment and usury. Investment means giving money to firms and entrepreneurs in order to expand production and increase the wealth of society. In this case, interest is merely the investor’s participation in the profits; it is the “wage” of the capital supplied, and the one who supplies it is entitled in justice to that wage. Usury, on the other hand, is lending money at interest to increase consumption. Nothing is added to the wealth of society, however much may be added to the wealth of the lender. Since nothing is produced, there is no valid claim to profit; interest payments in this case merely constitute a transfer of wealth from the borrower to the lender, but no net increase in the social stock of wealth. In fact, wealth is actually “used up” in this process without making a contribution to production, hence the name “usury.”

This is the plastic economy, an economy based on credit cards. And to the extent than an economy depends on consumer credit, it is, quite literally, a house of cards, and will be as unstable as those structures usually are. In fact, usury is the most destructive way of increasing demand. Usury actually delays the problem, postpones the crisis to a future period. This is because a borrowed dollar used to increase demand today must be paid back tomorrow and hence decrease demand in a future period by that same dollar—plus interest. This requires more borrowing, which of course only makes the problem worse. Eventually, the system falls of its own weight, as credit is extended to an increasingly weakened consumer, and a credit crisis results.

Non-economic equilibrium provides us with a measure of just how well an economy is doing in economic terms. If the economy has a high dependence on non-economic means, we may assume that there are serious problems in the economy itself. This is an important point. Those who wish to scale back the extent of government involvement in the economy must first analyze the failures in the economy that make heavy government involvement necessary. Those who would effect a cure, must first analyze the cause. And the cause is always and everywhere the same: a lack of justice.

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[1] There are non-economic ways to add wealth to a nation, such as plundering other countries.

[2] There is actually a third source of income, economic rent, or an amount paid beyond what it takes to keep an asset in productive use. Economic rent introduces some serious complications, and will be dealt with in a later chapter.

[3] However, there may be “non-economic” or “exogenous” causes for a particular recession, such as flood, famine, or plague.

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Eyes on the Prize

It is, of course, the silly season, or rather the silly year. That is, leap year, when the presidential campaigns make the year seem longer than the one extra day might otherwise indicate. It is a year when candidates try to display their care and concern for whatever concerns the public at that particular moment. They advance “ideas” (I use the term advisedly) whose purpose is not so much to be serious policy proposals as to be markers for their empathy with the voters. Most of these “ideas” do not survive until inauguration day, and that's probably for the best, at least in most cases. The “ideas” were only campaign ploys and most do not—and should not—survive the campaign. Since the major concern du jour is gas prices, candidates have to come up with something that indicates their solidarity with the suffering public, even if the idea makes no sense. Certainly, Obama's support of ethanol falls in this category, although it also has to do with his pandering to corn state voters. McCain's “gas tax holiday” is a bit of silliness designed mainly to use a few billion dollars of public money to buy votes, with no discernible benefit to the public.

But occasionally, candidates come up with something that actually could be a good idea and do touch on real issues. This is probably accidental, nevertheless, we take good ideas where we find them. And McCain's proposal for a $300 million prize for a new auto-battery could be a good idea, depending on what McCain actually means. Now, it is likely that the candidate has no idea of what he means; it was likely just a publicity stunt to begin with. In its present undefined form it is somewhat useless. Whoever comes up with such a battery will get a patent that will be worth a lot of money, maybe even $300M. In that case, the “prize” is of no effect whatever, and will just be an additional payment for what somebody was going to do anyway. There is a tremendous amount of research in this area, and pretty soon someone will break the code and find the answer, regardless of what the govmint does.

However, if McCain means that the government will buy the patent for the new battery in behalf of the people of the United States, this could be a very good idea indeed. The whole idea of a patent is to ensure that those who come up with new ideas will reap an economic reward. The theory is that this will both encourage and fund new research, to the betterment of all. The problem with patents, however, is that they create monopolies and spread economic inefficiency throughout the economy. Further, they are not necessary for funding new inventions. They could easily be replaced with licenses. Inventors could be required to license their ideas to however can pay the license fee and meet the manufacturing standards required for the product. This means that the inventor will receive a proper revenue stream to fund new discoveries, while providing multiple firms the right to make the product and thereby eliminate monopoly pricing while encouraging competition.

We see the effects of monopoly pricing most prominently in drug prices, where products that cost a few cents to manufacture cost $10's, or $100's, or even $1000's per dosage, depending on what the market will bear. Big pharma claims they need these high prices to pay the costs of research, but the claim is dubious. Actually the high prices mostly fund high marketing expenses. A good portion of our health care problems can be traced to the current system of patents. But the problem is not just with drugs; patents spread monopoly pricing throughout the economy in many areas. Wherever you see a product with a patent, you are probably looking at at least some economic inefficiency in the pricing of that product.

Now, if McCain wants to buy the patent and license it to firms making both the battery and the car on American soil with American workers, this could be a very good idea, and $300M would be a small price to pay. If he merely means to give an additional wad of taxpayer money to a monopolist, then it is just a publicity stunt, and an extra expense for the taxpayers. We will just have to see what McCain means. Most likely, McCain will have to see what McCain means. I suspect he has not thought this thing through and hasn't the faintest idea of the relationship between patents and monopolies. It is not one of the things he seems to think much about. But I am willing to give him the benefit of the doubt and see how this plays out.

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Chapter IV: The Purpose of an Economy

What Must an Economy Do?

The indispensible requirement for any economic system is that it must provide the material basis for life for a sufficient number of its citizens so that society can continue for another season. In addition, it must provide a sufficient surplus so that society can be re-populated and continue for another generation. If either of these conditions is not met, then society simply disappears and further discussion is unnecessary.

But in addition to the few things that an economy must do, there is a longer list of things it ought to do. For example, an economy ought to provide the material basis of life for as many members of society as possible, and ideally for all members. It ought to provide for a certain level of material comfort and security; it ought to reward work, ingenuity, thrift, and inventiveness; it ought to supply sufficient excess to fund common goods such as the national defense, religious works, education, etc.; it ought to provide the ground for liberty; it ought to provide the ground for social harmony, that is, each citizen ought to be able to believe that his efforts are fairly rewarded, and that no one lives off of the efforts of another.

Having a list of things an economy should do implies another list of things it should not do. For example, it should not depend on slavery; it should not deprive work (including the “stored-up” work known as “capital”) of its just rewards; it should not reward sloth, that is, create wealth without work, wealth not based on some productive endeavor; it must not weaken social bounds or encourage class warfare, and so forth. Taken together, these lists of what an economy must do, what it ought to do, and what it ought not to do, provide us with a set of criteria upon which we may make firm judgments about the success or failure of any particular economy, most particularly our own. Granted that these judgments can never be precise. We can always point to some wealth without work, some work not fairly compensated, some shortfall in the material provisioning of society. But what we must really judge is whether these things are endemic to the society, or merely limited failures, failures which, in an imperfect world, we must expect in any system.

The Economic Problem

What is Economics? “Economics is about social provisioning, or how societies provide for their material reproduction.”[1] This definition deals with a more basic problem than do the more common definitions of economics, which generally involve “the allocation of scarce resources among alternate uses.” Resources must be allocated, but such definitions leave out the purpose of these allocations. Further, the neoclassical definition biases the conversation in favor of scarcity rather than abundance; but the whole purpose of resource allocations—the whole reason for economizing—is to allow for a relative abundance. It is the means (resources) which may be scarce, but not necessarily the ends. Therefore, the more fundamental economic question involves social provisioning. In answering this question, we must deal with three further questions: What to produce? How to produce it? To whom should the benefits be distributed?[2]

What to produce? What a society produces is a direct reflection of its dominant values, or at least of the values of those who dominate society. It would seem that some things need to be produced and are therefore natural and beyond cultural considerations. But while things like food, clothing, and shelter are necessary, the form they actually take is always cultural. For example, we must eat to live regardless of what language we speak, but what we actually eat—spaghetti or egg foo young or hamburgers—is always a cultural product.

How to produce it? This is a question both of human technology and abilities. There must be a means of assigning tasks, something which normally has a large social content. For example, tasks will be assigned at least partially on the basis of education, but who gets educated and who doesn’t is largely a social decision.

To whom should we distribute the product? This question has both discretionary and necessary aspects. Certainly the product must be divided so that enough members of society can subsist and reproduce the next group of workers. Beyond that, distribution has strong discretionary elements. Normally, the actual distributions will depend on the values of the society at large, or perhaps will reflect the values only of the ruling class. The solution is largely a matter of power relationships rather than of some “pure” economics.[3]

Solutions: Tradition, Command, and Market

The answers to the questions of social provisioning can come from three sources: tradition, command, or the market.[4]

Tradition: The past guides the present: What to produce this year is guided by what was produced last year; sons follow their fathers’ professions. There is little change and less freedom. All three questions are answered, but answered, as it were, “in advance” and with little option for growth and change.

Command: Command economies rely on some central authority to provide all the answers. While this ensures that all the questions are answered, the quality of such answers may be open to some doubt, especially if the values of the planners are at odds with the values of society at large. The planners can be seeking either the interests of the common good or their own interests. Nevertheless, economies heavily dependent on command have functioned successfully and left behind great monuments such as the pyramids or the medieval cathedrals.

Market: The forces of supply and demand dictate the answers, with each individual responding to price signals in order to maximize utility. In this way, it is believed, the market is self-organizing and capable of creating order out of chaos. But as Charles Clark has noted:

This is the myth of the market. Markets are not natural phenomenon, but are socially created. In the real world the market mechanism is best at dealing with small changes to an already existing economic order, providing the signaling function of adjusting relative prices so that a small number of market participants can adjust their behaviour. Markets, however, cannot generate this order. All markets are social institutions, embedded in particular societies and in history. They have rules of behaviour, laws and customs. These come from tradition. Also they have property rights and methods for enforcing these rules and customs. These come from command. Without the proper context, markets are inefficient and chaotic, as Russia is currently demonstrating to the world.[5]

Clearly, the markets do not generate order, but are based on a pre-existing social order which they then help direct. But they can also help to destroy that order. Indeed, the assumption that all things can be based on self-interest destroys the very basis of virtue which is presumed by the market. A pure market system has never been attempted, because it cannot be attempted. Markets require fully socialized and ethical participants in order to function, but an attempt to establish a pure market system displaces these traditional sources of economic order, that is, families and shared political values. It is no accident that as the force of custom and virtue diminishes, the role of law—and lawyers—increases. So too does the role of politics and bureaucracies; Force, legal or political, must replace the virtues that a “pure” market system helps to undermine.

Economics and the Family

If economics requires fully socialized participants, and if economics is about social provisioning, then the question of the family cannot be divorced from economic questions. For the economic actors, producers and consumers, are “produced” and socialized within the confines of the family, and without the family there will be no next generation and hence no future for the economists to worry about. Therefore, it is the family that is the basic economic unit as well as the basic social unit. Modern economics tends to ignore the role of the family completely to focus on the individual. However, the individual, by himself, is sterile and not a self-sustaining entity. Neoclassical economics thus has no way to explain how new workers come into the economy, and hence it has no way to explain growth. John Mueller has characterized these shortcomings in economics as “The Economic Stork Theory.” In the Stork Theory, workers arrive in the economy fully grown, fully trained, and fully socialized. These stork-borne workers are a “given”; that is, there is no way to explain the growth in workers or their level of training and socialization, and hence little reason to support them with political or fiscal policies. Mueller describes the theory as follows:

I call this the Stork Assumption, since it literally means that adult workers spring from nowhere, as if brought by a large Economic Stork. Under the Stork Assumption, the accumulation of workers’ tools—buildings and machines—is the only possible source of economic growth that can be affected by policymakers. Moreover, under these assumptions the total tax burden not only should, but inevitably must, fall entirely upon the incomes of workers (who by assumption cannot avoid such taxes by having fewer or less-educated children, though property owners are assumed able to avoid taxes on property income by investing less in property). The Stork Assumption, not economic theory, underlies the perennial proposals to abolish taxes on property income, which are advocated by a cottage industry of (mostly my fellow Republican) economists centered in Washington, D.C.[6]

It is an oddity of modern economics that it depends on treating the worker as just another commodity (labor) for purposes of pricing that labor, but treats the production cost of that “commodity” as something beyond the price system. If we take any other commodity, say a bar of pig-iron, it is assumed that the price must cover the cost of production, maintenance, and depreciation, or the product will be withdrawn from the market. But in regards to labor, this assumption is never examined. For labor has its own “production cost” (the family) and its own “maintenance” costs (subsistence and health-care) and its own “depreciation” costs (sickness and old age). Labor cannot simply be withdrawn from the market when these requirements are not met. Therefore, labor—and the family—does not even gain the dignity of a bar of pig-iron in modern economic theory.

Scarcity, or “Can there ever be enough to go around?”

Scarcity is the most obvious and self-evident economic principle because we live in a finite world. Indeed, scarcity is what makes economizing necessary.[7] However, when ends and means are confused, scarcity itself becomes not something self-evident, but something evidently false. Let me illustrate with an anecdote. When I was a boy in New York City, we lived in an old brownstone apartment on Manhattan’s west side. We did not have a car; nobody on our street did. However, for 15 cents we could buy a subway token, and for that fee the cultural and recreational wealth of New York City was ours, even as small children. My brother and I loved to go to the American Museum of Natural History to see the great skeleton of Tyrannosaurus Rex that dominated the lobby, or the great blue whale that hung in the basement. Or we would go to the Metropolitan Museum of Art and see the armor exhibit, with knights in shining armor mounted on steeds covered in steel plate, lances lowered so that, when you entered the room, they looked like they were charging directly at you. Or for the same fee, we could go to the beaches at Coney Island or Far Rockaway. We were indeed men of the world at the age of seven. But mostly, we were independent; we were free. It was a poor neighborhood, but we were rich in cultural and recreational resources. By contrast, my children grew up in an affluent suburb in Texas. Everybody on the street had at least two cars, but my children had very little transportation. The means of transport were not available to them independently, and hence parents and children were bound together in a relationship similar to that of a lord and his chauffeur; both children and parents lost some of their freedom. It was perhaps good that there were so few places to go, and that the major cultural resources were the mall and the movie theater.

In one case, there was a scarcity of means and an abundance of ends (transportation), and in the other an abundance of means and a scarcity of ends. In one case, cars were scarce and transportation abundant, and in the other cars were abundant and transportation scarce. Properly considered, scarcity should apply to means, not ends. If we reverse the terms, we end up manufacturing our way into scarcity, and an expensive scarcity at that. In place of robust systems designed according to some notion of the common good, we have narrow systems designed from the premises of individualism which always make the ends, transportation in this case, more problematic. And they are even more problematic the more you invest in them: we spend huge sums of public money on systems that limit access rather than expand it. This same pattern of spending ourselves into scarcity can be seen education, health care, the military, etc. Expenditures for higher education increase while access to college declines, for example. What is lacking is a purpose, a telos, that is to say, a vision of the common good, and a proper distribution function informed by that vision.

Summary

Let us now summarize our conclusions about the purpose of an economy:

· The subject of Political Economy is the material provisioning of society.

· An economic system must answer three questions: What to produce? How to produce it? And To whom do we distribute the output?

· The answers to these questions will come from a combination of tradition, command, and market forces.

· In order to accomplish the material provisioning of society, the economy must provide for the material provision of the family, because the family is the basis of both the social and economic orders; it is the reason for having an economy and the indispensable condition of an economy.

· The economy must provide for a relative abundance of ends using relatively scarce means.

· It must accomplish all of these tasks in ways that advance freedom

Taken together, these give us a teleology for the economy; they define the ends and purposes of any actual economy and give us a set of criteria to make reasonable judgments about that economy, to say whether or not the economy is fulfilling its proper functions. However, they say nothing about the means by which an economy reaches its natural ends. Now, the primary means by which an economy fulfills its goals is by achieving a balance between supply and demand, a state called equilibrium. There are various paths to achieving this balance, some of them manifestly better than others. These will be the subject of the next chapter.

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[1] Charles M.A. Clark, "Catholic Social Thought and the Economic Problem," Oikonomia, no. 1 (2005), http://www.pust.edu/oikonomia/pages/febb2000/Clark.htm.

[2] Ibid., no.

[3] Ibid., no.

[4] Robert L. Heilbroner, and William Milberg, The Making of Economic Society, Eleventh ed. (New Jersey: Prentice Hall, 2002), 6.

[5] Clark, "Catholic Social Thought and the Economic Problem," no.

[6] John D. Mueller, God and Money (Washington D. C.: ISI Books, Forthcoming, 2006), 75.

[7] Paul Heyne, Peter Boettke, Dave Prychitko, The Economic Way of Thinking, 10th ed. (Delhi, India: Pearson Education (Singapore) Pte. Ltd, 2003), 5.

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Chapter III: Political Economy as a Science

Science, Normative and Positive

Some wag somewhere has remarked that economists suffer from “physics envy.” One could certainly make that charge against W. S. Jevons (1835-1882), one of the founders of marginal economics, when he wrote that a “perfect system of statistics … is the only … obstacle in the way of making economics an exact science”; once the statistics have been gathered, the generalization of laws from them “will render economics a science as exact as many of the physical sciences.”[1] More than a century has passed since Jevons wrote these words, and in that time there has been a growth of vast bureaucracies, both public and private, devoted to establishing this “perfect system” of statistics. Yet today economics seems no closer to being an exact science than it was in Jevons’s day. Despite this failure, economic orthodoxy clings to the notion of itself as a positive science. As Milton Friedman puts it,

Positive economics is in principle independent of any particular ethical position or normative judgments. As [J. N.] Keynes says, it deals with “what is,” not with “what ought to be.” Its task is to provide a system of generalizations that can be used to make correct predictions about the consequences of any change in circumstances. Its performance is to be judged by the precision, scope, and conformity with experience of the predictions it yields. In short, positive economics is, or can be, an “objective” science, in precisely the same sense as any of the physical sciences.[2]

Underlying Friedman’s view are two distinctions: a distinction between facts and values (the “is” and the “ought to be” of things), and a corresponding distinction between a “normative” science and a “positive” one, with the former reflecting the world of values and the latter the world of facts. So which kind of science is economics, normative or positive?

Let me suggest that the question is meaningless. Every science, insofar as it really is a science, is both positive and normative. Every science, insofar as it is a science, must be “normalized” to some criteria of truth. These truths will arise from two sources: an internal and an external source. The internal criteria involve a science’s proper subject matter and methodology. But these criteria are insufficient to found any science as a science. In addition, there must be external criteria of truth, and these truths can only come from one or more higher sciences. In the absence of such an external check, the science will merely be circular, dependent on nothing but itself and disconnected from the hierarchy of truth. Thus, for example, biology is responsible to chemistry, chemistry to physics, physics to metaphysics. No biologist can violate the laws of chemistry, and no chemist can reach a conclusion contrary to physics. Thus every science is responsible to its own methodology (and therefore “positive”) and to the higher sciences (and therefore “normative”). Every science has, therefore, both its own proper autonomy, based on its subject matter and methodology and its own proper connection to the near sciences, based on the hierarchy of truth. In speaking of the autonomy of a science, we should note that it is only a relative autonomy, not an absolute one. A scientist’s obligation to be faithful to his proper method does not relieve him of the obligation to higher truths. No science can provide its own criteria of truth without being merely circular. When a science attempts to do so, one of two things happens. The first possibility is that the science breaks up into mutually warring camps whose disputes can never be resolved because there are no accepted criteria of truth by which to resolve them. The second possibility is that the science becomes merely dogmatic, and no rational examination of its premises is permitted. In economics, both things have happened: the science is divided into warring factions with no arbiter of truth among them; the principles of the various factions have become dogmatic statements with little connection to reality.

The Physical and Humane Sciences

The hierarchy of science allows us to define what science is, because science is not a mere random collection of “facts,” nor just a free-floating knowledge. Rather, it is knowledge integrated into a hierarchy of truth. To know a thing, anything, it is not sufficient to know the thing in itself, but also how it “fits” with everything else, what its relationships are with the rest of the world. Science then is not just knowledge, but organized knowledge. It is precisely this organization that makes it science. We have many other kinds of knowledge, such as tacit or intuitive knowledge, but these are not scientific until they can be integrated into the hierarchy of knowledge, and thereby submit themselves to the tests of truth that come from the higher sciences. Until we know the thing in the fullness of its relationships, we don’t really know it at all. Therefore science is not just about describing things in themselves, but about describing things in their full relationships with everything else. Now, everything that is, is related to everything else that is, in one way or another. Nevertheless, we can identify two general hierarchies of knowledge, two great branches of science, the physical and the humane sciences. So the first thing to determine about any science is not whether it is normative or positive, but whether it is a physical or a humane science.

The distinction between these two branches of science concerns how the objects of the science are moved to their ends. Physical objects are moved to their ends by “laws” outside of themselves, such as the law of gravity. They do not exhibit any degrees of freedom; that is to say, the planets are kept in their orbits by the law of gravity and no planet can suddenly decide to reverse its course and visit a new region of the heavens. In other words, the motions of physical objects are completely deterministic; they are bound by the laws of nature and cannot deviate from them. We can examine nature and discover its laws, laws that exist independently of will and intention. This examination of nature we may call “naturalism,” and these sciences all terminate in physics, the master-science for the study of physical objects.

Man, of course, is another physical object in the universe of objects, and is bound by the law of gravity no less than any of the planets. However, he is also something more, because while a planet cannot determine its own course, we must determine ours. That is, we are not moved to our ends by a law like gravity, but by the choices we make. Man is that being that can choose his own ends and make judgments about the best means to achieve those ends. This freedom towards ends and means is the essence of what it means to be human. The humane sciences, therefore, have a completely different aim than the physical sciences. The latter aim at discovering the physical laws that must be followed and are always in fact followed; the former aim at discovering laws that ought to be followed if we are to achieve the ends we set for ourselves, and of detailing the consequences of not following those laws. Humane sciences have the human person for their object, and specifically the human person in relationship, whether that is the relationship a person has with himself, his family, his community, the natural environment, or God. Now, political economy deals with economic relationships, those relationships necessary for the material provisioning of society. It is therefore a humane science and not a physical science. Like all humane sciences, it is about right relationships.

Facts without Values?

At this point, the positivist is likely to object that no one can tell us what kinds of relationships are “right” or “wrong.” We can only note the facts and predict the consequences. Therefore science, economic or otherwise, should simply stick to the “facts” and let the “moral” chips fall where they may. This view is based on a distinction between facts and values. As D. Stephen Long has noted, “The fact-value distinction has become so determinative in the modern world that we seldom even recognize the many ways our politics, economics, even our theology assume and perpetuate this distinction.”[3] The fact-value distinction actually has its roots in medieval theology. The medieval theologians insisted that the material world reflects the eternal order of God and operates on God-given laws which could be known without any direct reference to theology. This allowed a certain autonomy for the physical sciences. However, this distinction was not a real distinction, but a methodological one, and a method that is confined to physical motions; the motions of the human will could not so easily be measured and numbered. With the Enlightenment sages, however, the distinction became a real one, became an ontological distinction, one that extended even to human motions. All motions, even human ones, would be reduced to number and quantity and divorced from theology and ethics. As David Hume put it,

When we run over libraries, persuaded of these principles, what havoc must we make? If we take in our hand any volume; of divinity or school metaphysics, for instance; let us ask, Does it contain any abstract reasoning concerning quantity or number? No. Does it contain any experimental reasoning concerning matter of fact and existence? No. Commit it then to the flames: for it can contain nothing but sophistry and illusion.[4]

This test, known as “Hume’s fork,” is by now so enshrined in our thinking that it has become traditional, with even Christian economists joining in his book-burning without a second thought.

Perhaps the best example of the Christian expression of this distinction comes from Alejandro Chafuen, who posits a distinction in natural law itself between the “analytical” and the “normative.” For Chafuen, “ethical considerations… have no impact on underlying truths”[5] and “no ethical judgment can invalidate an economic law,”[6] a law arrived at without regard to ethics. However, a question arises as to whether Chafuen (and the moderns in general) have a proper understanding of natural law, or has he merely confused it with naturalism? Can there be a “value-free” law for humans? The answer to this question depends on one’s theology. The older view of natural law situated it within a discernment of the meanings of things, that is, within their proper acts and ends. Thus, natural law would always involve a teleology, a perception of final meaning, but such perceptions involve philosophical, theological, and cultural questions. The Enlightenment view of nature sought to divorce natural law from any moral or theological authority. Is this actually possible?

Let us take a simple deduction from “nature”: “Lions eat lambs; therefore the strong prey on the weak.” The conclusion would seem to be an unavoidable deduction from the indubitably factual premise, a pure instance of a “natural law,” blissfully free of any moral or theological foundation. But in fact it contains a hidden assumption: the premise concerns animals, but the conclusion is applied to men. Is this valid? Yes, if man is no more than an animal; no, if man transcends the animals. If the latter is true, then natural law can never be just a “reading” of nature, but must be guided by a consideration of the end and nature of man. Can the issue be resolved one way or another by an appeal to pure reason? No, because both views rest on a purely theological foundation. Man may or may not be just an advanced animal and nothing more. Certainly, he is an advanced animal, but the status of the “something more” cannot be proved—or disproved. Certainly, both men and lions enjoy a leg of lamb for lunch; quite possibly, speech is no more than an advanced form of roaring or baying. There is simply no “proof” that men transcend, or do not transcend, the animals; it is a matter of faith and faith alone. Therefore, the question of whether the proposition is a valid deduction from nature depends not on the raw facts (which cannot be disputed) but on the theology by which one reads those facts. And this will be true for every statement which purports to be a “value-free” conclusion from the natural world. The only question is whether the values are explicit or hidden; if the latter, men will delude themselves into thinking that their thinking is “value-free,” when in fact it is a mere attempt to impose their values on others. The solution is never to proclaim a “value-free” conclusion, but to make the values that underlie the conclusion explicit, thereby exposing them to critique and evaluation.

Even if the fact-value distinction could be maintained, it is not always clear which are the “facts” and which are the “values.” For example, if we take the distinction seriously, we must allow the following case:[7] Mrs. Harris is an attorney at the top of her profession who bills her time at $500 an hour. Mr. Harris, on the other hand, is a bit of a lout. He calls her at work demanding a bit of “afternoon delight.” Wishing to be a dutiful wife, she considers her options. Since she is not only an attorney, but also understands economics, she believes that her decision ought to turn on the opportunity costs of the alternatives. She can go home for an hour and lose $500, or she can call an escort service to provide a suitable surrogate for $150. Thus she must measure the gain of $350 against the loss of $500 and decide how the “opportunity cost” compares to the relative values of sexual pleasure and infidelity. Now, an economist might say that the “facts” of the case involve the opportunity costs, while the concepts of adultery and fidelity are mere values. But this is not at all clear. The relative prices of lawyers and prostitutes are mere social valuations that change from culture to culture and, indeed, from moment to moment; they seem to lack the ontological grounding that one would expect from a “fact.” On the other hand, adultery is a fact which “has much more concrete or empirical reality than the putative economic facts mentioned. We can point to the historical embodiment of something called ‘adultery’ much more readily than something called ‘opportunity cost.’”[8]

It would seem, therefore, that the world of human beings cannot be neatly divided into a realm of “facts” and a realm of “values.” While there may be, at certain times and in certain cases, a methodological advantage in making such a distinction, it is merely a way of speaking of things for limited purposes and involves no real ontological distinction. Therefore, Chafuen’s case for a division in the natural law would seem to have failed. A realm of pure “facticity” in human affairs is doubtful. All human observation requires some theoretical framework to make sense of the mere sense impressions. The theoretical framework always involves some value judgments.[9] For example, in measuring unemployment, the economist must first start by

making the decision that it needs theoretical explanation and second [he] must define what unemployment is, both of which are blatantly value-laden (and political) activities. Furthermore, the choice of what methods to use to investigate this phenomenon also involves value judgments, as does selection of the critical criteria about what will be accepted as the “final term” in the analysis, the bases of what arguments will or will not be accepted. However, values and value judgments enter into theory construction on the ground floor by giving the theorist the “vision” of the reality s(he) is attempting to explain. This “vision” is pre-analytical in the sense that it exists before theoretical activity takes place.[10]

We are, of course, bombarded each day by a reams of economic “facts” and statistics. Each and every one of them is surrounded by the same constellation of political and value-laden decisions as is the statistic called “unemployment.” This does not make them invalid or useless, but we must understand the value-laden decisions that went into making each of these numbers. The numbers are not like the numbers we get from looking at a telescope or a oscilloscope or some instrument used in the physical sciences. Rather, each number reflects a judgment about what the purpose and meaning of “economics” is.

Humane Science and Teleology

The major division of the sciences, then, is not the normative-positive duality, but a division based on the object of the sciences, whether they be merely physical or fully human. For the physical sciences, we need only examine the physical world to note the relationships and regularities, and we have, in most cases, ample room for discovering laws and testing them empirically. But when we deal with the humane sciences, the task becomes more complex, for a simple examination of persons cannot be undertaken without first determining what a “right” state of affairs ought to be. For example, if we practice medicine, we must have some idea of what good health is; we must have some “normative” state the departure from which constitutes disease. This seems a straightforward process in physical medicine (although it is actually fraught with many difficulties and conundrums), but can become somewhat complex when we look at, say, psychology. For example, if we take two psychologists, one of whom believes that mental health means giving expression to every sexual impulse, and another who believes that sexuality should mainly be expressed in marriage and family, it is obvious that they will give very different kinds of advice. I have no intention of trying to sort out those issues here; I merely point out that the advice given will depend on each psychologist’s perception of what it means to be a human being, on what the end and purpose of our humanity is.

This is the case with every humane science. Its first task is to understand the end and purpose of the human person, in all of his or her relationships, and that particular science’s role in contributing to those ends and purposes. This search for ends and purposes is called teleology, from the Greek telos, a word which connotes “that which completes or perfects a thing.” Each humane science begins, as it were, backwards, with the ends of man, whether those be the ends of his physical or mental health, his social order, his political peace, his need to pursue truth and knowledge, etc. Underneath all of these ends there lies the necessity of a certain material sufficiency. Without having some security of food, clothing, and shelter, it is difficult to pursue any of the other ends of man. Now, all of these other ends may be higher than these bare necessities, but every other end presumes the necessities, for no man can long pursue anything else if he cannot get enough to eat. Hence, the pursuit of these ends is basic to the pursuit of every other end, and the more easily they can be obtained, the more time and energy can be devoted to the pursuit of other goals. Now, the political economy is the science which deals with the pursuit of man’s material needs, and so it is foundational to every other humane science; even the priest, the philosopher, and the artist need to eat. Therefore, in order to understand the science of political economy, we must ask in greater detail just what the purpose of this science is, which is the topic of our next chapter.

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[1] Quoted in James E. Alvey, "A Short History of Economics as a Moral Science," Journal of Markets and Morality 2, no. 1 (Spring, 1999): 62.

[2] Milton Friedman, Essays in Positive Economics (Chicago: University of Chicago Press, 1953), 4.

[3] D. Stephen Long, Divine Economy: Theology and the Market, ed. Catherine Pickstock John Milbank, Graham Ward, Radical Orthodoxy (London and New York: Routledge, 2000), 3.

[4] David Hume, An Enquiry Concerning Human Understanding (1748 [cited April 3 2006]); available from http://www.infidels.org/library/historical/david_hume/human_understanding.html.

[5] Alejandro A. Chafuen, Faith and Liberty: The Economic Thought of the Late Scholastics (New York: Lexington Books, 2003), 24.

[6] Ibid., 25.

[7] Adopted from Long, Divine Economy, 4-5.

[8] Ibid., 5.

[9] Charles M.A. Clark, "Catholic Social Thought and the Economic Problem," Oikonomia, no. 1 (2005), http://www.pust.edu/oikonomia/pages/febb2000/Clark.htm.

[10] Charles M.A. Clark, "Economic Insights from the Catholic Social Thought Tradition: Towards a More Just Economy," (2005).

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