Chapter 1: Economies, Economics and Economists

Have we elevated market forces into something to be worshipped rather than something to be understood? Harvard theology professor Harvey Cox argues that we have in . "The Market As God" (Atlantic Monthly, March 1999).

In "Can a Christian be an Economist?," ethicist/economist Charles Wilber -- whose own roots are in Catholic Social Thought -- examines the moral foundations of mainstream economics and finds them wanting.

The differences among the major schools of economic thought are covered in
Chapter 3.

The organization of this text is basically chronolgical -- we follow the development of capitalism and of economics through time. But it is not exclusively chronological. For example, the nature of money and the role of central banks are covered in one chapter rather than scattered throughout the book.

There are many fields within economics. Check WebEc, which is the most comprehensive guide to economics resources available on the Web.

Robert Heilbroner, in The Nature and Logic of Capitalism (W. W. Norton, 1985), explores the forces that lead to transformations within capitalism.

Classical economics arose with the Industrial Revolution and dominated 19th century economic thinking. See Chapter 3.

The Marx/Engels Internet Archive is a well-organized source for the works of the 19th century critics of capitalism, Karl Marx and Friedrich Engels.

A strange subject indeed. Sometimes economics is a bit like the physical sciences or engineering -- when, for example, we use numbers to measure an economy's total output of goods and services. Sometimes economics is more like sociology -- for instance when we study the power relationships within a political institution such as the Federal Reserve. And sometimes economics is more like philosophy -- as when we grapple with the problem of "value" or try to understand what money really represents.

Economics as a Science

Economists, just like natural scientists, try to understand the world around us. We observe, develop hypotheses, and test those hypotheses against our observations. We measure and use those measurements to improve our observations and to test our hypotheses. We search, as do physicists, for the least number of theories that will explain the greatest number of observations. But economics is a social science, not a natural science. The social life of humans, even when we limit our studies to the material aspects of social life, is more complex than the movement of electrons. The Law of Gravity is for all time; the Law of Demand describes norms of human social behavior in particular societies during a specific period of history. Immutable laws, definitive experiments and absolute units of measurement are within our desires but beyond our reach.

Economics as a Religion

Economics is also very much like religion, divided into different denominations and sects. We have our fundamentalists -- the neoclassical economists -- who believe that economics is a pure science built on the premise (which they accept as an article of faith) that individuals are always and everywhere choosing among alternatives in such a way as to gain the maximum benefit with the minimal effort. Others are rather like the people who say they are Presbyterians but don't often go to church. They call their religion the neoclassical/Keynesian synthesis or just the neoclassical synthesis. They accept the same premises as the neoclassicals, but more as parables to guide their thinking than as absolute truths. There are several groups of eclectics -- the Institutionalists and Post-Keynesians -- trying to find some useful ideas in all of the sects, and even borrowing from such pagan groups as political scientists, sociologists and anthropologists. Finally we have our atheists -- the Marxists - who have pointed out the flaws and lapses of the fundamentalists even while building a structure on their own system of basic premises.

Economics as Moral Philosophy

Economics might also be considered as a branch of moral philosophy. Our first modern economist, Adam Smith, was Professor of Moral Philosophy at the University of Glasgow. He published The Theory of Moral Sentiments seventeen years before his better-known work, The Wealth of Nations (1776).

Systems of economic thought such as neoclassical economics or Marxism are very much like systems of moral philosophy such as Confucianism or utilitarianism. They all present a vision of an ideal-but-attainable world or way of life. They all prescribe the types of behavior that need to be followed in order to reach that ideal state. They all indicate the implications of not following their behavioral rules.

There is no such thing as a neutral economist. Each school of thought has a somewhat different ideal-but-attainable world in mind. The neoclassical economist's ideal world looks much like a stock market while the institutionalist's ideal looks more like a symphony orchestra or a university. Each prescribes a different set of behaviors as the best way of attaining that goal. And each has different ways of developing and testing hypotheses; each has a different scientific methodology.

It follows that there is no such thing as a neutral economics course or a neutral economics textbook. So I owe it to the reader to state -- right here in the introductory chapter -- the premises on which this textbook is based. It is based on the premises shared by institutionalist and post-Keynesian economists. If your professor selected this book, it is likely that he or she shares the same premises (you can always ask). Most of the rest of this chapter will describe the approach and the major themes of this textbook.

Economic History and the History of Economics

Hopefully the reader has noted the inclusion of the term evolution in my definition of economics. There is little in the economic world that reveals itself while standing still; it is only by observing change over time that we can hope to perceive the inner workings of capitalism. Therefore this textbook is basically historical. And there is an added twist: there are two histories in economics. There is what we call economic history, which is the story of the development of the economy through time. And there is the history of economic thought, which is the story of our attempts to understand the economy.

Economic History

If we want to understand where capitalism might be going we will need to know where it has been. That means that we must look at capitalism historically. We will need to investigate why capitalism -and not previous social formations such as feudalism -- gave rise to the industrial revolution and how the industrial revolution transformed capitalism. We will need to examine the several mutations that occurred along capitalism's evolutionary path: how small scale capitalism mutated into big business capitalism and the metamorphosis of government into the manager of economic growth.

Joseph Schumpeter, the second most important economist of the 20th century, enumerated the various fields of economics and concluded:

Of these fundamental fields, economic history-which issues into and includes present-day facts-is by far the most important...First, the subject matter of economics is essentially a unique process in historic time. Nobody can hope to understand the economic phenomena of any, including the present, epoch who has not an adequate command of historical facts and an adequate amount of historical sense or of what might be described as historical experience. Second, the historical report cannot be purely economic but must inevitably reflect also 'institutional' facts that are not purely economic: therefore it affords the best method for understanding how economic and non-economic facts are related to one another and how the various social sciences should be related to one another. Third, it is, I believe, the fact that most of the fundamental errors currently committed in economic analysis are due to lack of historical experience more often than to any other shortcoming of the economist's equipment.

Schumpeter was referring to the history of the economy. But we also need to know something about the history of economics. Schumpeter would agree with that also -- he spent the last nine years of his life writing a massive history of economics.

All sciences have a history. The curious physics student will probably want to learn something of the history of physics. But understanding the history of economics is not just an option for the curious -- it is a vital component of our understanding of the economy. In economics, but not in physics, the two histories are intertwined. Our understanding of the economy affects the economy itself. The first work of modern economics, Adam Smith's The Wealth of Nations (1776) did not just provide a theory of how a market economy worked; it became the basis of policies which altered the way in which existing economies actually did work. In the 20th century, it was a dreadful period of economic history -- the Great Depression -- that led John Maynard Keynes to write The General Theory of Employment, Interest and Money (1936). In turn, Keynesian economics led to a major restructuring of the role of government in the capitalist economies.

While following the spine of the two intertwined histories from the beginning of capitalism (and of economics) to the present, this textbook will develop several major themes of economics. These themes have been the major concerns of the worldly philosophers (Robert Heilbroner's apt term for the major economic thinkers) from Adam Smith to the present. These themes are also indicative of the great unresolved economic issues of today and tomorrow.

Development, Growth and Evolution of Capitalism

Where did capitalism come from? Why, and under what conditions, does a capitalist economy grow and allow the standard of material life to improve? How does capitalism adapt its institutions to technological change -- how does it evolve? And what will capitalism eventually evolve into? Why did the rise of capitalism lead to a huge disparity in wealth and income between the sixteen percent of the world population in the developed economies and the vast majority in the rest of the world?

One of the hallmarks of capitalism, and one that certainly sets it apart from previous social formations -- such as feudalism -- is the way in which capitalist enterprise, which itself is merely seeking higher profits, continually advances the technology of production. The rapid growth of new technologies, however, forces continual change on the institutional structure of capitalism. Adam Smith studied British capitalism of the mid-18th century. If he could come back to life in the late 20th century, he would find much which would astound him: the giant corporation, labor unions, the material standard of living of workers, manipulation of money and interest rates by central banks (even though the Bank of England was over 80 years old when Smith published The Wealth of Nations), and the many economic roles of modern governments. Yet he would find much of modern capitalism quite familiar: firms with their eyes always on the bottom line, the basic operation of supply and demand in many markets, even the control of the work process by capitalists and the mind-numbing nature of much work. So one of our themes is how capitalism adapts its institutions to new conditions yet still maintains its basic features.

Distribution of Wealth and Income

To some of the classical economists, particularly David Ricardo, the distribution of income was the subject of economics. It is still a major question today: Will economic growth 'automatically' spread its benefits around, or do we need social policies to spread it around? Or, as some maintain, will social policies to spread income around destroy the source of income?

Our theories of the distribution of income are themselves part of our theories of prices, since the price paid by one person is the income received by another. The complexity of this subject is due to the social nature of production. A modern product such as an automobile involves the productive efforts of hundreds of thousands of workers and hundreds of firms. The automobile would be worthless without tires, spark plugs or a windshield. Somehow, the value of the labor of a semi-skilled worker at a spark-plug factory must be determined and that labor must be rewarded. Likewise, the value of the capital investment by the owners of the firm must be determined and rewarded, as must the value of the land on which the factory is located.

Theories of the distribution of income are one of the great divides in economics. The dominant orthodoxy of economics today, neoclassical economic theory, holds that the distribution of income is completely determined by our tastes (which themselves determine what we produce) and our technologies (which determine how we produce). That is one of the reasons that neoclassical economics is an inherently conservative body of thought -- it explains the distribution of income as arising out of 'natural' forces and not subject to change without wreaking havoc on the production process itself.

Most of today's heterodox economic theories, however, hold that social and political factors determine the distribution of income. Society, according to these theories, has a significant amount of economic leeway in altering the distribution of income. It may even be possible to increase a society's total income by shifting some purchasing power from the rich to the workers since greater demand for goods and services by the workers will lead to greater production.

Order: Microeconomic and Macroeconomic

One of the enduring questions of economics is how a capitalist economy brings about order: how the 'right' amount of the 'right' goods and services get produced. There are two parts to this question. One is the question of microeconomic order, or of how the capitalist economic system determines how much of each particular good to produce. The other is the question of macroeconomic order, or of how our economic system determines how much to produce in total. There is less disagreement among economists on the questions of microeconomic order than on the questions of macroeconomic order. Another of the great divides in economics is the issue of whether or not the same market forces that bring about microeconomic order can be depended upon to bring about macroeconomic order.

Capital and State

Unlike previous social formations, capitalism has two centers of power, each operating under somewhat different rules. Economic power is wielded by the firm while political power is wielded by the state. Your boss can fire you, but cannot imprison you or seize your property. Government can fine you, imprison you or take your property, subject to the rules of due process, but cannot fire you (except when government is your employer). Government can establish labor laws, environmental laws and product-safety laws, but cannot determine how much a firm will invest in new plant and equipment. Most manufacturing is carried out by capitalist firms and very little by government -- although there is more government ownership of industry in Western Europe than in the United States -- while most education is produced by government and relatively little by the private sector. One of the themes of this text is the evolution of the division of authority between capital and state.

Technology

Rapid technological change is one of the distinguishing features of capitalism. This was apparent to astute observers of capitalism such as Karl Marx and Friedrich Engels less than 100 years into the Industrial Revolution:

The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of nature's forces to man, machinery, application of chemistry to industry and agriculture, steam navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalization of rivers, whole populations conjured out of the ground - what earlier century had even a presentiment that such productive forces slumbered in the lap of social labor?

Technological progress, however, cannot be evaluated by speed and direction alone, like the path of a projectile. Technology also has scale. Some technologies, the railroad and late 19th century steel mills, can only be utilized on a grand scale. Others, such as the desktop computer, sometimes allow small firms to achieve the efficiencies that were previously attainable only by large enterprises. The technologies of the first seventy years of this century allowed us to produce rivers of manufactured goods with decreasing numbers of blue collar workers, but created a need for armies of clerks. Now the computer is beginning to replace the clerk.

Technology also has a high degree of path dependency. That is, today's technologies are partially the result of paths that we started down long ago. Yesterday's technologies may limit the possibilities for tomorrow's technologies. The classic example of path dependency is the continuing dominance of the QWERTY typewriter keyboard. This particular layout was designed to slow the typist on the early mechanical typewriters in order to keep the keys from jamming. Typing efficiency could be increased with a different keyboard layout, but the path taken in the past has left us with millions of QWERTY keyboards and millions of typists trained to use them, making change very unlikely.

What will the future bring. Many, not just economists, project their visions of the future and construct scenarios of the unfolding of future events. Today we have optimistic 'futurists' predicting a relatively smooth path to a future of technodazzle. We have the dystopians who paint a 'blade runner' future with most living in squalor while very few enjoy the good life. We have the Malthusians predicting that population will outstrip our ability to produce food.

The worldly philosophers were no different, although they were generally more focused. They combined their theories about how capitalism maintained - or failed to maintain -- microeconomic and macroeconomic order with their concepts of how technology might change and with their visions of the nature of humans and of human society.

The major differences between the worldly philosophers and some of today's prognosticators lie in the way in which material life -- the basic subject matter of economics -- exhibits certain regularities. This makes it somewhat easier to predict the course of an economy over the next half-century than to predict artistic trends, major social changes or technological breakthroughs over the same period.

However, we cannot separate the economy from its technological foundations. In general, the worldly philosophers have underestimated the advance of technology in ways which have invalidated their predictions. Still, we have to avoid the opposite: to focus only on technology without developing any real understanding of how it interacts with the economy.

Neither technology nor market relationships, alone or together, tell the entire story. We as members of human societies are not merely passive bystanders. Our particular period of history, including the level of development of our technology, establishes the limits of the possible but does not fully determine our actions. Nineteenth century philosopher-economist Karl Marx put it best:

Men make their own history, but they do not make it just as they please; they do not make it under circumstances chosen by themselves, but under circumstances directly encountered, given, and transmitted from the past.

How people react to their situations makes a difference. If we accept Adam Smith's description of the worker as passive and stupid we will come to a very different conclusion than if we accept Marx's vision of a working class that will eventually realize its own interests. We need to understand the sociology of the capitalist as well. Do capitalists merely make the right combination of labor and capital, passively responding to demand and supply conditions (as today's mainstream economics claims) or do they create demand as they develop new products (a central point of the theories of 20th century economist Joseph Schumpeter).

Chapter 1: Economies, Economics and Economists