In Marx’s shadow again. REASON(S)

J Bradford Delong

A century and a half ago, Karl Marx both gloomily and exuberantly predicted that the modern capitalism he saw evolving would prove incapable of producing an acceptable distribution of income. Wealth would grow, Marx argued, but would benefit the few, not the many: the forest of upraised arms looking for work would grow thicker and thicker, while the arms themselves would grow thinner and thinner. This injustice would provoke revolt and revolution, producing a new, better, fairer, more prosperous, and far more egalitarian system.

Ever since, mainstream economists have earned their bread and butter patiently explaining why Marx was wrong. Yes, the initial dis-equilibrium shock of the industrial revolution was and is associated with rapidly rising inequality as opportunities are opened to aggressiveness and enterprise, and as the market prices commanded by key scarce skills rise sky-high.

But this was — or was supposed to be — transient. A technologically stagnant agricultural society is bound to be an extremely unequal one: by force and fraud, the upper class push the peasants’ standards of living down to subsistence and take the surplus as the rent on the land they control. The high rents paid to noble landlords increase their wealth and power by giving them the resources to keep the peasants down and widen the surplus — for, after all, they cannot make more land.

By contrast, mainstream economists argued, a technologically advancing industrial society was bound to be different. First, the key resources that command high prices and thus produce wealth are not fixed, like land, but are variable: the skills of craft workers and engineers, the energy and experience of entrepreneurs, and machines and buildings are all things that can be multiplied. As a result, high prices for scarce resources lead not to zero- or negative-sum political games of transfer but to positive-sum economic games of training more craft workers and engineers, mentoring more entrepreneurs and managers, and investing in more machines and buildings.

Second, democratic politics balances the market. Government educates and invests, increasing the supply and reducing the premium earned by skilled workers, and lowering the rate of return on physical capital. It also provides social insurance by taxing the prosperous and redistributing benefits to the less fortunate. Economist Simon Kuznets proposed the existence of a sharp rise in inequality upon industrialisation, followed by a decline to social-democratic levels.

But, over the past generation, confidence in the “Kuznets curve” has faded. Social-democratic governments have been on the defensive against those who claim that redistributing wealth exacts too high a cost on economic growth, and unable to convince voters to fund yet another massive expansion of higher education.

On the private supply side, higher returns have not called forth more investment in people. America’s college-to-high-school wage premium may now be 100 percent, yet this generation of white, native-born American males may well wind up getting no more education than their immediate predecessors. And increasing rewards for those at the increasingly sharp peak of the income distribution have not called forth enough enterprising market competition to erode that peak.

The consequence has been a loss of morale among those of us who trusted market forces and social-democratic governments to prove Marx wrong about income distribution in the long run — and a search for new and different tools of economic management.

Increasingly, pillars of the establishment are sounding like shrill critics. Consider Martin Wolf, a columnist at The Financial Times. Wolf recently excoriated the world’s big banks as an industry with an extraordinary “talent for privatising gains and socialising losses...[and] get[ting]...self-righteously angry when public officials...fail to come at once to their rescue when they get into (well-deserved) trouble...[T]he conflicts of interest created by large financial institutions are far harder to manage than in any other industry.”

Wolf then announced his “fear that the combination of the fragility of the financial system with the huge rewards it generates for insiders will destroy something even more important — the political legitimacy of the market economy itself...”

For Wolf, the solution is to require that such bankers receive their pay in instalments over the decade after which they have done their work. That way, shareholders and investors could properly judge whether the advice given and the investments made were in fact sound in the long run rather than just reflecting the enthusiasm of the moment.

But Wolf’s solution is not enough, for the problem is not confined to high finance. The problem is a broader failure of market competition to give rise to alternative providers and underbid the fortunes demanded for their work by our current generation of mercantile princes.

-DT-PSJ Bradford DeLong is Professor of Economics at the University of California at Berkeley and a former Assistant US Treasury Secretary

The end of history?

Jean-Paul Fitoussi

Some academic works, for reasons that are at least partly obscure, leave a persistent trace in intellectual history. Such is the case with John Maynard Keynes’s paper “Economic Possibilities for our Grandchildren.”

The importance of Keynes’s paper consisted not so much in how he answered the questions he posed, but in the nature of the questions themselves. Could the very functioning of the capitalist system bring an end to the problem of scarcity — and hence to capitalism itself? What might people’s lives in such an era reasonably be expected to look like?

Keynes began to examine these questions with the calculus of compound interest and its spectacular outcome when applied to long periods. At a 2% rate of growth, any figure, including GDP, will increase 7.5-fold in a century. So, would the problem of scarcity — which underlies all economics — be resolved by such an increase?

For Keynes, the answer was a straightforward yes, because such an increase would allow the satiation of what he calls “absolute needs.” True, Keynes was well aware that relative needs — “keeping up with the Joneses” — will never be satiated, but he thought that these needs would become of second-order importance, so remote from the search for the good life that seeking to satisfy them would be recognised as a form of neurosis. According to Keynes, we would instead progressively learn how “to devote our further energies to non-economic purpose.”

But here arithmetic ends and the complexity of human nature begins. How are we to define “absolute needs”? Are they independent of time and place? Were they the same at the beginning of the twentieth century as they are now?

This is where Keynes’s thesis runs into trouble. As soon as we abandon the fiction that economic agents are Robinson Crusoes, absolute needs turn out to be indistinguishable from relative needs, because the goods that satisfy our needs change. For example, life expectancy has increased over time thanks to the progress of medicine and hygiene and to the increased quality and diversity of goods (for example, safer food). The demand for better goods (and services) to meet our needs seems to be boundless, driving science and innovation.

Keynes may have relied so heavily on such a simplistic characterisation of human needs to make his point “that the economic problem is not...the permanent problem of the human race.” While this view may be exaggerated, for believers in economic and social progress, it is not entirely wrong. At the very least, scarcity need not be a question of life and death. All that is required is an increase in the standard of living and social cohesion — the refusal to endanger the lives of the poorest through a lack of redistribution. Nevertheless, scarcity would remain, because there is no such a thing as a stationary state in which all needs are satisfied and mankind ceases to hope for a better future.

But Keynes’s emphatic tone suggests that he believed in his own taxonomy of needs. What he found most detestable was capitalism as an end in itself. Capitalism is an efficient means, but pure communism is the only moral end of any economic system. At that point, “[t]he love of money as a possession...will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.”

For Keynes, only those who will be able to sublimate their non-satisfied relative needs into a higher ideal would find their way in the new paradise. “We shall honour those who can teach us how to pluck the hour and the day virtuously and well, the delightful people who are capable of taking direct enjoyment in things, the lilies of the field who toil not, neither do they spin.”

Keynes seemed to be extolling a kind of elite communism. Of course, in a world of abundance, one may hope that the class of elites will become ever larger. But, while every economist should try to answer the question of the ends of the economic system and of its possible end, Keynes’s understanding of human needs embodied a highly idiosyncratic combination of arrogance and naïveté. It is not surprising that it didn’t survive.

DT-PSJean-Paul Fitoussi is Professor of economics at Sciences-po and President of OFCE (Sciences-po Centre for Economic Research, Paris)

Time to ask Milton Friedman?

By Peter S. Goodman

Joblessness is growing. Millions of homes are sliding into foreclosure. The financial system continues to choke on the toxic leftovers of the mortgage crisis. The downward spiral of the economy is challenging a notion that has underpinned American economic policy for a quarter-century — the idea that prosperity springs from markets left free of government interference.

The modern-day godfather of that credo was Milton Friedman, who attributed the worst economic unraveling in American history to regulators, declaring in a 1976 essay “the Great Depression was produced by government mismanagement.” Five years later, Ronald Reagan entered the White House, elevating Mr Friedman’s laissez-faire ideals into a veritable set of commandments. Taxes were cut, regulations slashed and public industries sold into private hands, all in the name of clearing government from the path to riches. As the economy expanded and inflation abated, Mr Friedman played the role of chief evangelist in the mission to let loose the animal instincts of the market.

But with market forces now seemingly gone feral, disenchantment with regulation has given way to demands for fresh oversight, placing Mr Friedman’s intellectual legacy under fresh scrutiny.

Just as the Depression remade government’s role in economic life, bringing jobs programs and an expanded welfare system, the current downturn has altered the balance. As Wall Street, Main Street and Pennsylvania Avenue seethe with recriminations, a bipartisan chorus has decided that unfettered markets are in need of fettering. Bailouts, stimulus spending and regulations dominate the conversation.

In short, the nation steeped in the thinking of a man who blamed government for the Depression now beseeches government to lift it to safety. If M. Friedman, who died in 2006, were still among us, he would surely be unhappy with this turn.

“What Milton Friedman said was that government should not interfere,” said Allen Sinai, chief global economist for Decision Economics Inc., a consulting group. “It didn’t work. We now are looking at one of the greatest real estate busts of all time. The free market is not geared to take care of the casualties, because there’s no profit motive. There’s no market incentive to deal with the unemployed or those who have lost their homes.”

To Mr. Friedman, such sentiments, when turned into policy, deprived the economy of the vibrancy of market forces.

Born in Brooklyn in 1912 to immigrant parents who worked briefly in sweatshops, Mr. Friedman retained a sense that America was a land of opportunity with ample rewards for the hard working.

His intellectual bent was forged as a graduate student at the University of Chicago, a base for those who saw themselves as guardians of classical economics in a world then under the spell of woolly-headed revisionists.

The chief object of their scorn was John Maynard Keynes, and his message that government had to juice the economy with spending during times of duress. That notion dominated policy in the years after the Depression. Mr. Friedman would spend much of his career assailing it: He argued that government should simply manage the supply of money — to keep it growing with the economy — then step aside and let the market do its magic.

So firm was his regard for market forces, so deep his disdain for government, that Mr Friedman once said: “If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.”

This antagonism toward bureaucracy seemed to spring from Mr. Friedman’s conception of his country as a bastion of rugged individualism. During an interview on PBS in 2000, he noted that Adam Smith, the father of classical economics, published his canonical work, “The Wealth of Nations,” in 1776, “the same year as the American Revolution.”

He spoke in the interview of his concern at the end of World War II that socialism was gaining adherents because countries had been forced to organize collectively to produce armaments. “You came out of the war with the widespread belief that the war had demonstrated that central planning would work,” Mr. Friedman said. “The left, in particular, ... interpreted Russia as a successful experiment in central planning.”

Mr. Friedman’s brand of libertarianism rested on the assumption that economic and political freedoms were one and the same. It meshed with and fed the cold war thinking of his time, as the United States offered up capitalism as liberty itself in contrast to the authoritarian Soviet Union.

Among professional economists, Mr Friedman’s analytical mastery was near-universally admired.

His first breakthrough came in the 1950s with his idea that people’s savings and spending were not a function of psychological factors, but based on rational estimations of wealth.

His greatest contribution came the following decade, when Mr. Friedman dismantled the consensus view that inflation was a tolerable byproduct of high employment. He demonstrated that high inflation would eventually cost jobs, as businesses were discouraged to invest by the higher wages they had to pay.

“This triumph, more than anything else, confirmed Milton Friedman’s status as a great economist’s economist, whatever one may think of his other roles,” Paul Krugman, an economist (and a New York Times columnist) wrote last year in The New York Review of Books.

Mr. Friedman captured the era with a new formulation known as monetarism: that the government should gradually and predictably inject cash into the financial system, and then let the market figure out where it should go.

“Any honest Democrat will admit that we are now all Friedmanites,” Lawrence H. Summers, the Harvard economist and former Clinton administration Treasury secretary, wrote in an appreciation published in this newspaper when Mr. Friedman died. “He has had more influence on economic policy as it is practiced around the world today than any other modern figure.”

But the reviews for Mr. Friedman’s work grow mixed when the subject moves to his role as chief proselytizer in the drive to reduce the role of government in public life.

He laid out a blueprint in his 1962 book, “Capitalism and Freedom,” calling for the end of the military draft, the abolition of the licensing of doctors and the creation of “education vouchers” that parents could use to send children to private schools, injecting competition into public education.

Two years later, Mr. Friedman put those principles to work as an economic adviser to the presidential campaign of Senator Barry Goldwater, a Republican from Arizona. The campaign called for the abolition of government oversight of the energy, telephone and airline industries and the dismantling of the Social Security system and national parks.

Mr. Goldwater took a drubbing at the hands of Lyndon Johnson. Mr. Friedman would remain in the policy wilderness until the rise of President Reagan. Then, his notions about rolling back government took on the force of dogma.

This was so not only in the United States, but also throughout much of the world. As former Iron Curtain countries embraced free markets, they did so with Mr. Friedman’s books in hand. The International Monetary Fund and the World Bank leaned heavily on his ideas in prescribing policies for countries from Asia to Latin America.

Q. Quotes

1. It doesn’t matter a jot if three-fourths of mankind perish! The only thing that matters is that, in the end, the remaining fourth should become communist – Lenin (1870-1924)

2. Communism has never come to power in a country that was not disrupted by war or corruption, or both – John F. Kennedy (1917-1963)

3. If Karl (my son), instead of writing a lot about Capital, made a lot of Capital, it would have been much better – Henrietta Marx (19th Century)

4. All I know is that I am not a Marxist – Karl Marx (1818-1883)

5. A society is rich when material goods, including capital, are cheap and human beings dear: indeed the word “riches” has no other meaning – R. H. Tawney (1880-1962)

6. I am indeed rich, since my income is superior to my expense, and my expense is equal to my wishes – Edward Gibbon (1737-1794)

7. When I was a child, my mother said to me, “If you become a soldier, you’ll be a general. If you become a monk, you’ll end up as the pope “Instead, I became a painter and wound up as Picasso – Pablo Picasso (1881-1973)

8. A simple and a proper function of government is just to make it easy for us to do good and difficult for us to do wrong – Jimmy Carter (1924-)

9. My experience in government is that when things are noncontroversial, beautifully coordinated, and all the rest, it must be that not much is going on – John F. Kennedy (1917-1963)

10. If a man can write a better book, preach a better sermon, or make a better mouse-trap than his neighbor, though he build his house in the woods, the world will make a beaten path to his door – Sarah Yule

11. In China the sovereign is worshipped as a god. That I think is how it ought to be – Napoleon (1769-1821) Talks of Napoleon at St. Helena

12. I believe the greatest asset a head of state can have is the ability to get a good night’s sleep – Harold Wilson (1916-1995)

13. I have a dream that my four little children will one day live in a nation where they will not be judged by the colour of their skin but by the content of their character – Martin Luther King Jun. (1929-1968)

14. If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand – Milton Friedman (1912-2006)