The Pathetic Fallacy in Economics

Originally published November 4-18, 1985

ECONOMICS studies what people do and should do in certain situations. Its analyses, like all analyses, search out the factors that make up the situations. Thus a market involves selling and buying, or supplying and demanding. It is obvious that the selling and buying are done by human beings, and that no actual person is only a supplier while very few are only demanders. Though there may be nothing the vintners buy one half so precious as the stuff they sell, they nevertheless do some buying. Since no individual is merely an embodiment of an economic function, personification of economic functions may rate as a variant of the pathetic fallacy, whereby emotions and reasonings are ascribed to inanimate objects.

The fallacy is common among economists (perhaps even more common than the fallacy of composition, which we have noted here many times) and it has fateful consequences. It exercises an almost irresistible attraction, even for writers who explicitly warn against it. Ludwig von Mises, a pundit revered among conservatives, is loud and clear enough in Human Action:

“The entrepreneurs, landowners, workers, and consumers of economic theory are not living men as one meets them in the reality of life and history. They are the embodiment of distinct functions in the market operations. Living and acting man by necessity combines various functions. He is never merely a consumer. He is in addition either an entrepreneur, landowner, capitalist, or worker, or a person supported by the intake caused by such people. Moreover, the functions of the entrepreneur, the landowner, the capitalist, and the worker are very often combined in the same persons.”

I quote extensively because when I came to this passage in von Mises’ massive book, my heart leapt up. It does me good to find virtuous ideas in the midst of others that set my teeth on edge. But by the time I had reached the end of Human Action, my pulse was racing from an excess of adrenaline, not from a surge of joy. In the end von Mises forgets what he has said about living combinations of functions. What he calls investing is done only in a certain way by certain people, and these certain people are exclusively entitled to the rewards. He opposes unemployment benefits because they make it “easier for the unemployed to remain idle.” He sneers at those who talk of economic justice. The pathetic fallacy has led him to a pathetically mean-minded view of the world.

At the other end of the spectrum, Karl Marx seems brazen in announcing his devotion to the fallacy. In the preface to the first edition of Capital he writes: “I paint the capitalist and the landlord in no sense couleur de rose. But here individuals are dealt with only in so far as they are the personifications of economic categories, embodiments of particular class-relations and class-interests.” No matter how much he despises them, he resists the temptation of blaming individual capitalists for what they do. Marx won’t talk of blame, and von Mises won’t talk of justice: The pathetic fallacy knows not right and wrong.

At the same time, Marx is conscious of the danger that philosophical notions like individuality may become reified. For this reason he distances himself from his mentor Hegel and makes his famous move to stand the dialectic “right side up again” in the Preface to the second edition of Capital, holding that “the ideal is nothing else than the material world reflected in the human mind, and translated into forms of thought.”

The exploiting class and the exploited class, being based on materialistic functions, become monolithic and go at each other like the larger-than-life monomaniacal cudgelers in Goya’s “black painting,“ and we may wonder how materialization is an improvement on-or even a distinction from-reification. The notion of class is as surely an idea as anything in Plato or Hegel. No one has ever seen a class (except in a school) or heard one or touched one or smelled one or tasted one. Class is not a result of empirical inquiry.

It is no object of the senses. To talk of its force or action or reaction or progress is to talk pathetically. Class, in short, meets none of the usual tests for matter.

In the present connection, the idea of class is not only an odd ground for materialism, it imposes a rigidity on thought. The struggle is unremitting. It can be neither composed nor compromised but must be fought to the final battle. Marx’s vision is more generous than von Mises’, yet it is no less reductive.

What is true of the far Left and the far Right is true of most economists in between. Their analyses suggest to them the supply side or the demand side, public works or public austerity, saving or consumption, monetary policy or fiscal policy; and these impersonal policies or functions are in unremitting conflict.

To be sure, there is no lack of peacemakers ready to demonstrate that capitalists and workers need each other, nor is there a great lack of more or less grudging acceptance of that mutual need. Otherwise the economy would not work at all. There are periods, though, when the mutuality disappears. These are,  typically, periods of change, when business is faltering, or, quite the contrary, a technological leap forward seems possible or (depending on your point of view) desirable.

In depressions or recessions or growth corrections, some capitalists may lose some money (though mostly they do very well, and have done extraordinarily well the past five years), but what happens first is that many workers lose their jobs. This is so commonplace that no one ever thinks to defend it. I doubt that it can be defended. If both capital and labor are essential to production, by what right are things more worthy of protection than people? How is ownership more important than existence?

Technological advances have always been resisted by workers. How stupid of them! Britain could not have achieved its first breakthrough if landowners had not enclosed the commons and driven tenants off the land to make way for sheep. Later, had the Luddites had their way, the Industrial Revolution would have been aborted; and if the followers of Captain Swing had prevailed, the denizens of the cities could not have been fed even as well as they were.

As economists and editorialists continue to scold, such misguided people are with us still. Automobile workers resist giving up their jobs to robots; labor-saving machines are opposed as labor-eliminating devices. Why can’t these people see that new robotic industries will create new jobs, just as automobile making turned out to employ many more people than harness making? Why should anyone in his right mind fight to preserve mind-deadening work on the old-fashioned production line? What is so great about conditions in Southern textile mills that leads people to want to keep them going in the face of cheap imports from the Orient?

SOCIETY is certainly better off with more mechanization, more robotization. It is a blessing that the bulldozer and the earth mover have supplanted those who used to “push-a, push-a, push” on the Delaware-Lackawan‘. It is a blessing that the back hoe has made “ditch digger” an obsolete term of opprobrium. It is a blessing that the dishwasher has replaced the scullery maid. Not only is progress irresistible, it is largely beneficial.

But there is trouble in paradise. The trouble is systemic. The individuals who are displaced by progress are systematically denied the benefits of progress. Although the working class or the worker-as-function may be better off in the famous long run, many individual living workers are not, either in the short run or the long. As we have noted, when bad times befall, everyone may lose some money (well, almost everyone); however, the worker-as-function and the individual worker will often lose not only money but job, career, independent livelihood, sometimes forever.

The trouble is, I repeat, systemic. Short of war, the system is in no danger of immediate collapse, and it is without doubt a better system than that of India or South Africa or Chile or the Soviet Union or even Japan. Nonetheless, the conflict and squalor and heartbreak produced by this best of present systems, too, are unconscionable. One requirement for reform is cancellation of the pathetic fallacy and the reconstitution of economic man (and woman) as not merely producer or consumer, not merely worker or capitalist, not merely wage earner or profits engrosser, not merely time-clock-puncher or manager, but something of all of them, all at once, all the time, in theory and in law and in fact.

Another requirement is the redefinition of property. The need for this has, interestingly enough, been advanced by Friedrich A. Hayek, usually classed with von Mises as an ultraconservative (see “Strolling Down the Road to Serfdom,” NL, July 1-15). In Individualism and Economic Order Hayek criticizes “a slavish application of the concept of property as it has been developed for material things” (see“Life, Liberty and Property,” NL, July 11-25, 1983) and suggests that “There may be valid arguments for so designing corporation law as to impede the growth of individual corporations” (see “Big is Ugly,” NL, September 9, 1984).

The problem we have been discussing is approached from a different direction in an important short book by Professor Robert A. Dahl of Yale, entitled A Preface to Economic Democracy (University of California Press). A political scientist who, like Tocqueville, is concerned about the future of democracy, Dahl notes that it requires” a widespread sense of relative well-being, fairness, and opportunity.” He worries that this sense – this morale – is being eroded by the modern corporation with its dictatorial control and its unconscionable spread of rewards. Both, he argues, are unnecessary.

Dahl shows, point by point, that the case for political democracy is also valid for economic democracy. Again point by point, he considers the right to property and the peculiar form it takes today. At one stage he remarks drily, “Thus to say that [stockholders] are entitled to a return because they sacrifice the use of their money begs the precise question at issue: whether, if their money represents a return from property ownership, they are entitled to that money.” And later: “Given the passivity of stockholders in a typical firm, their utter dependency on information supplied by management, and the extraordinary difficulties of contesting a managerial decision, it seems to me hardly open to question that employees are on the whole as well qualified to run their firms as are stockholders, and probably on average a good deal more.” In conclusion, Dahl summarizes the experiences of a variety of existing employee-ownership plans operating here and abroad.

Readers of this column will recognize the relevance of Dahl’s argument to what I have been calling the Labor Theory of Right. I urge you to read his new book.

The New Leader

Mercantilism Revisited

Originally published October 7, 1985

 

I have been happily working my way through Fernand Braudel‘ s tangled, lumpy, unmade-bed of a book whose three volumes have the overall title Civilization and Capitalism: 15th-18th Century. About halfway into the second volume Braudel makes some observations about mercantilism, and they have given me furiously to think.

Every American boy or girl who paid even the slightest attention in school knows that mercantilism was a bad idea. It bled the colonies for the benefit of the homeland, and consequently the colonies revolted. Those who listened a little longer also know that the mercantilist striving for a “favorable” balance of trade meant exportation of goods and importation of precious metals, a policy that is ultimately self-defeating because, as Midas found out, gold and silver are not good to eat. Braudel knows all this, too.

As an example of mercantilist foolishness, he tells us that in 1703, toward the start of the War of the Spanish Succession, the English were advised to send “grain, manufactured products and other goods” from home to their troops fighting in the Low Countries. They could have bought these supplies easily and presumably more cheaply on the Continent, but the government was” obsessed by the fear of losing its metal reserves.” Any follower of Adam Smith or David Ricardo can see that this policy led England to waste real wealth (usable goods) and save nominal wealth (unusable metal).

In the world of theory, the mercantilist passion for a favorable balance of trade seems indefensible. It is surely more sensible to collect what you can use than to squirrel away what is of little or no use in bank vaults. But as Braudel reads the historical record of the actual world, he is forced to recognize that the mercantilist policy was in fact successful. “In any case,” he writes, “every time we have to deal with a comparatively advanced economy, its trade balance is in surplus as a general rule.” Flying in the face of classical economics, the more advanced economies exported usable goods and imported gold and silver.

The classical theory fails here (as elsewhere) because it is both ahistorical and asocial. It describes an instantaneous slice of a world without time; and it concerns things, like the GNP, not people, like you and me. Criticism of the English policy of 1703 silently assumes that purchasing war materiel overseas would have had no effect on English farms and factories. The assumption is that the goods purchased on the Continent would have been added to those produced at home, and that the English wealth would have risen accordingly. But in the real world, English farmers, deprived of part of their market, would have cut back production expenses (which is another name for employment) even if production stayed high for a time. And English manufacturers of soldier suits and the like would surely not have continued producing them if the government didn’t buy them. Their employment, too, would have fallen. These drops in employment would have meant a decline in the English standard of living. The mercantilist policy preserved that standard of living (such as it was); the classical theory would have reduced it.

Carlo M. Cipolla, in Before the Industrial Revolution (a marvelous book that covers roughly the same ground as Braudel in about one-tenth the space), has an excellently apposite quotation that dramatizes the failure of the classical theory. In 1675 one Alfonso Nunez de Castro wrote, “Let London manufacture those fabrics of hers to her heart’s content; Holland her chambrays; Florence her cloth; the Indies their beaver and vicuna; Milan her brocades; Italy and Flanders their linens, so long as our capital can enjoy them; the only thing it proves is that all countries train journeymen for Madrid and that Madrid is the queen of parliaments, for all the world serves her and she serves nobody.” As it turned out, for lack of trained journeymen Spain fell into a slough of stagnation it has yet to escape three centuries later.

In the infrequently noticed catch-all Chapter 23 of The General Theory of Employment,  Interest and Money, John Maynard Keynes includes some “Notes on Mercantilism … ” He observes that a favorable balance of trade, by bringing in gold and silver, increased a country’s money supply, which forced down the interest rate (Federal Reserve Board  please note), which stimulated investment.

Let’s carry the argument a step further. Investment is not stimulated rationally, that is – for its own sake. From the point of view of the investor, the purpose of investment is to produce goods that are in demand. From the point of view of the nation, the purpose of investment is to provide employment for its citizens, and to produce things that are wanted. Since employed citizens are able to make purchases create demand – these two purposes can work together, though they do not necessarily do so.

In the early modern world of the mercantilists, the interest rate was, as Keynes said, held down indirectly (and very possibly unintentionally) by fostering a favorable balance of trade. To have a favorable balance of trade, a country must export more goods than it imports. To export more goods, it must produce more goods. To produce more goods, it must employ more people. The secret of mercantilist success lies in the increased employment of labor.

For the power of labor is very great. Even putting to one side the facts that capital is the result of past labor, and that natural resources can be exploited only by labor, labor power is our ultimate power. The laziest, least competent, least efficiently applied labor will today produce far more than it needs to sustain itself. What Marx called surplus labor is exponentially greater than the 11.1 per cent his admittedly arbitrary calculations yielded. Hesiod (eighth century B.C.) was closer to the mark when he wrote in Works and Days: “From men the source of life has been hidden well/Else you would lightly do enough work in a day/To keep you the rest of the year while you lounged at play.”

Less poetically, we know that agriculture now produces more food than we should or can eat, more than enough natural fibers to clothe us, more than enough lumber to house us, with less than 3 per cent of our labor force (or less than 1.5 per cent of our population). Since even at our present Reaganite shabbiest, we allow almost no one to fall through the safety net and actually starve or freeze to death, it is plain that we do not need additional workers to provide for their own subsistence. Therefore, the output of every previously unemployed worker we manage to put to work will raise our standard of living a bit more above subsistence. And we can do this without importing gold or silver to control the interest rate. We simply have to get some sense into the Federal Reserve Board.

READING Braudel on mercantilism in the War of the Spanish Succession, I was struck by the parallels with our current business “recovery.” As I remarked in this space a year ago (” All You Need to Know about the Deficit,” NL, October 29, 1984), military spending increases aggregate demand, which increases employment. Any spending increases demand, for the simple reason that spending is demand. There are limits to some sorts of spending. Keynes cites the uselessness of two railways from London to York. On a more personal level, once you have a television set in every room of your house, your demand for television sets tends to subside. But military spending (because it does not and cannot face a test of profitability or indeed usefulness) has the political advantage of being supported by conservatives who insist the rest of the government be “businesslike.”

As far as the GNP is concerned, it doesn’t make much difference what the government spends its money on. The spending increases employment even when the newly employed people produce battle tanks that won’t run on rough terrain and fighting planes too complicated to service in the field.

The increase in the standard of living would of course be greater if the newly employed people rehabilitated highways and subway systems instead of battleships that were militarily useless two generations ago. It would be greater if the newly employed people built housing here on earth instead of stations in space. It would be greater if the newly employed people were cleaning up existing toxic wastes instead of producing new poison gases that will have to be burned or buried. Yet no matter how useless the things they produce, the newly employed people earn newly augmented incomes that they spend (up to a point), thereby increasing their own standard of living. And the addition of their new demand to the previous aggregate demand calls forth still further employment, and so on.

This outcome can be dramatized by asking what would happen if our present peacetime military budget were cut back, not to a rational peacetime level, but merely to the level of 10 years ago, when we were still winding down a war in Vietnam. The military budget would then be reduced by approximately $200 billion (or roughly the size of the deficit everyone fusses about). If such a reduction were not immediately offset by an increase in domestic spending, can anyone doubt the economy would forthwith crash into a depression that would make the Nixon-Ford recession of 1975 and the Reagan- Volcker depression of 1981-82 seem like paradise?

A deficit, in short, has the same salutary effect on the GNP as a favorable balance of trade; and gold and silver have nothing to do with it. As it happens, we are giving mercantilist theory another and more direct test. Our strong dollar, which is a euphemism for an unfavorable balance of trade, enables some of us to buy Pakistani sports shirts and Japanese automobiles at bargain prices. These bargains for some people, however, cause unemployment and underemployment for many people in North Carolina and New York and Michigan and ultimately throughout the nation. Critics of the mercantilist theory of a favorable balance of trade should ask themselves why an unfavorable balance has such unhappy consequences. I’ll give them a hint: We perversely distribute the benefits of our economy in a way that additionally punishes those who lose their jobs by denying them income to demand the bargains.

The New Leader

The Chicken and the Egg

Originally published September 9, 1985

 

As I WRITE, the great deficit debate is out of the headlines, and it may still be out when you read this. The news of the fall season is tax reform, and a determined effort is being made to separate the two issues. In a more rational world, one might expect taxes and the deficit to be intimately related, but in the lame-duck Presidency of Ronald Reagan the sloganeering calls for a “revenue-neutral” tax bill. Though convinced that the Republic hangs in the balance because the deficit doesn’t, even the Senate Majority Leader, Bob Dole of Kansas (perhaps reflecting on what happened last November to Fritz Mondale’s campaign for fiscal responsibility), is muting his austere determination to raise some taxes somehow.

It would be a mistake to consider the deficit merely a nuisance. It will continue to pop in and out of the news because it has us in what Gregory Bateson termed a “double bind.” Our situation is not so obvious as the classic example (“Have you stopped beating your wife?”); nonetheless, it is binding. If we do something effective about the deficit (such as raising taxes or cutting expenses across the board), we will almost certainly turn the current” growth correction” into a full-fledged depression. If we don’t do anything effective about the deficit, we will almost certainly induce a rate of inflation (and, probably, stagflation) far worse than anything we have yet experienced. That, in turn, simply because of our size, will place the entire free world at risk, not to mention those nations that former UN Ambassador Jeane Kirkpatrick taught us to view as authoritarian but not totalitarian.

Bateson developed the idea of the double bind in connection with his studies of schizophrenia. The pathology takes three recognized forms: paranoia (e.g., Secretary of Defense Caspar Weinberger’s and the Russians’ suspicions of each other), hebephrenia (endless absurd chatter, such as President Reagan’s call for a constitutional amendment mandating a balanced budget), and catatonia. The last has two states: agitated

(New York Republican Congressman Jack Kemp’s manic insistence that there’s no taxes like no taxes), and stuporous (Vice President George Bush’s silences on his best days). The periodic alternation of paranoia, hebephrenia and catatonia is what causes the deficit to be a media event one day and a nonevent the next. But the pathology remains.

It must be recognized that we are in a true double bind. We are damned whether we do or not. One has only to listen carefully to the pronouncements of Federal Reserve Board Chairman Paul Volcker to appreciate how hopeless our situation is. To be sure, Volcker continues to voice confidence that we will pull through. He bases his confidence on Congress’ success in cutting $50 billion from the 1986 budget. This is what he asked for as a signal to the financial markets (a.k.a. the speculators of the Wall Streets around the world) that we are serious about putting our house in order. He got his $50 billion plus a bit more, depending on whether you believe Bob Dole or House Speaker Tip O’Neill of Massachusetts. But now in September it is expected that the 1986 deficit, with the cuts, may be greater than it was predicted to be last January, without the cuts. Nevertheless, Volcker remains cautiously hopeful.

What can a rational man or woman make of that? I think you and I have two choices: We can head for the storm cellar because disaster is about to strike, or we can conclude that Volcker and the rest were in some way mistaken in their understanding of the significance of the deficit. Speaking for myself, I will confess that I am at least taking the precaution of scouting my route to the storm cellar. I’m allowing myself the dim prospect, though, that the almost universal misunderstanding of our distressing situation may suggest a way out of the double bind.

A double bind cannot be broken so long as you wrestle with it on its own terms. As Paul Watzlawick, Janet Beavin and Don Jackson put it in their classic Pragmatics of Human Communication, you have “to step outside the frame and thus dissolve the paradox by commenting on, that is, metacommunicating about, it.” Let us, therefore, do a little commenting on – or metacommunicating about – our predicament and the reasoning behind it.

Judging from the actions of our leaders and the dicta of our opinion makers, it would appear that our economy has three points of reference. One is a high gross national product, the second is a low rate of inflation, and the third is a high rate of saving. It would appear, further, that the rate of saving is understood to control the other two. On the first point, saving is assumed to lead to investment, which leads to increased production. On the second point, whatever is saved is seen to be withheld from consumption, thereby decreasing the number of dollars chasing whatever goods are produced. Hence the rate of saving is, as the mathematicians say, the independent variable: save that and you save all.

It will be observed that practically everyone who counts (with the possible exception of Tip O’Neill) believes this. The spectrum of believers stretches from Jack Kemp and his supply-siders, through Bob Dole and the sound money men, through Paul Volcker and the bankers of every size and shape, through the surviving New Frontiersmen and their investment tax credits, to Gary Hart and the New Industrial Policy of the Atari Democrats. And over them all arches the rainbow of President Reagan’s smile.

Let’s metacommunicate first about the rate of saving, that allegedly independent variable that is supposed to make the system go. We have, constant readers will remember, commented on this before, prophesying in “Why Deficits Matter” (NL, March 8, 1982) that the Kemp- Roth tax cuts and the associated accelerated depreciation allowances would not have the intended effect of increasing the rate of saving. Then, in “The Savings Bust” (NL, October 17, 1983), we diffidently called attention to the fact that our prophecy had come true. Now, as Coach Lombardi used to say, let’s get down to basics.

To illustrate the importance of saving, standard textbooks note that someone has to save seed corn if we are to have a crop to eat next year. This is surely true, and it seems to make saving prior to production. It is true as well that someone has to have harvested this year’s crop if we’re to have any seed to save, and that makes production prior to saving. It’s also true that no one would have planted this year’s crop (farming being uncompromisingly hard work) if we weren’t experiencing diminishing returns from hunting and gathering, so that someone could anticipate a strong demand for a substitute food. And anthropologists show that the demand was increased by an increase in population resulting from our prior success at hunting and gathering.

We have here four truths, independently valid, and they seem to be arranged in a straightforward cause-and-effect order. Accordingly, it would follow that if we want to grow more vegetables, we’d better stimulate hunting and gathering.  No one, however, is likely to see much sense in that, except perhaps the National Rifle Association[1]. Where’s the fallacy?

IN FACT, there are several fallacies here. For our purposes the most important lies in the assumption that living systems – systems composed of people – operate in the same way as the systems of classical physics (see “On Political Arithmetic,” NL, April 4, 1983). The idea of independent and dependent variables – a supremely powerful idea in its own domain – simply does not apply. With living systems you cannot learn much from experiments where you vary one factor, holding the others unchanged, and observe the outcome. The rate of saving depends on the GNP, as much as the other way around; moreover, a high rate of saving often depresses the GNP, while a rising rate of inflation may have a favorable effect on the GNP and on the rate of saving, too. But in other times and places it may not. Everything depends on the historical conditions of an actual place and time.

In a 1928 article that was a significant precursor of Keynes’ General Theory, Professor Allyn A. Young argued that in order to understand economic progress, “What is required is that industrial operations be seen as an interrelated whole.” (Or, in the terminology of the communications theorists, the economy is a system of interrelated feedback loops.)

In this connection Young made an observation that would have saved us all a lot of grief if it had been taken to heart by the late Mohammed Reza Pahlevi (and by Messrs. Richard Nixon and Jimmy Carter, who backed him, and George Shultz and David Rockefeller, who did business with him). “An industrial dictator,” Young wrote, “with foresight and knowledge, could hasten the pace somewhat, but he could not achieve an Aladdin-like transformation of a country’s industry so as to reap the fruits of a half-century’s ordinary progress in a few years.”

Although Young concluded that Adam Smith was right in emphasizing the importance of the division of labor, he cautioned: “The division of labor depends on the extent of the market, but the extent of the market also depends on the division of labor.” In short, in a living system it is nonsense to wonder whether the chicken comes before the egg.

What is not nonsense is to be concerned with people. All three of the points that define our double bind – the GNP, the rate of inflation, and the rate of saving – are measures of things. To break out of our double bind, we will have to shift our attention to measures of people: the number of unemployed; the number of men, women and children living below the poverty level; the spread of living conditions between the poor and the rich. If we did this, we would take a vastly different attitude toward Social Security, Medicaid, Medicare, and all the now-denigrated hopes of the New Deal, the Fair Deal and the Great Society. We would even find that we could afford these decencies once we abandoned the notion of a revenue-neutral tax law that leaves unchanged the taxes paid by the various levels of our society.

Of course, it may be nearly impossible for us to make the necessary moves to break or even weaken the double bind. That is a political problem, and a public opinion problem, and it would be pretty to think that our politicians and our opinion makers will rise to the challenge. Yet, as matters stand at the moment, they are, with a few exceptions, part of the problem.

The New Leader

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[1] In the original it was the “American Rifle Association.”  The editor has decided this was an error.