Normative and Positive Economics: A Isocratic Sketch

Introduction and Definitions

Whilst it is certainly more appropriate for a sketch for appropriate normative and positive economics to take up several hundred pages more than the several hundred words offered here, such as sketch is nevertheless provided. It is considered possible, albeit just, to provide in summary form the knowledge and experience of modern economics to state quite succinctly what works, what doesn't, and what is fair and what isn't.

This sketch begins with a definition of socialism which refers to those systems of economic organisation which is characterised by public forms of ownership; conversely capitalism is defined by economic organisation those which have private forms of ownership [1]. As is well known, there are many variants of public and private ownership and indeed many variants within the continuum of the two extremes. One such dimension refers to the means of distribution and exchange in contrast with the ownership of productive forces [2]; here the significantly differences are between market mechanisms and centralised planning. Another such dimension refers to a political subsystem that operates in parallel to the economic; by which varieties dictatorships may be contrasted with varieties of democracy.

Another set of definitions necessary for this discussion is reference to political economy and the factors of production, a field largely ignored since the development neoclassical economics in the latter part of the 19th century. From the work of Whilst providing important contributions to price, value, scarcity and studies in marginal utility [3], the conflation of land and capital into a single entity has all the signs of a tragic mistake. Whilst the conflation has been supported by both advocates of capitalism and socialism, economists are largely aware of the distortions that arise from the forced union.

Thus the relationship between the factors of production and classes is poorly understood today. This is partially as a result of the aforementioned conflation of capital and economic land by neoclassical economists [4], but also partially as a result of dogmatic Marxists who could only see the existence of the worker and capitalist classes, and also partially because of sociologists who investigated relationships and activity on the basis of income, rather than ownership of the means of production. In contrast all classical economists, including Adam Smith, David Ricardo, Karl Marx, Léon Walras and John Stuart Mill, recognised the distinction between the factors of production (land, labour and capital), the respective sources of income derived from each of these factors (rent, wages and interest) and the respective economic classes (landlord, worker and capitalist); it is noted of course that an individual can be a member of multiple classes simultaneously and proportional to the way their income is derived.

Perfect Models and Empirical Results

Advocates of capitalist economics were quick to associate themselves with the model of perfect competition resulting in a dynamic market equilibrium. This model, (which assumes a lack of externalities, perfect market knowledge, no barriers of market entry and exit, and a large number of buyers and sellers each unable to affect market price etc), is common in a variety of unimaginative economics textbooks and is routinely justly lampooned by various heterodox, including socialist, economists. Proper elaborations, more grounded in reality, from this 'perfect model' was initiated in studies of imperfect competition, including monopolies and monopsonies [5], and an apparent inability of capitalism to recover from recessions due to a particular liquidity preference [6].

Such criticisms are not all one-way however. Advocates of socialist command economies were likewise prone to advocate that advance planning in itself would somehow elucidate economic wants without complexity. Such a proposition was harshly criticised by the Austrian economists [7], who claimed that without a free market price mechanism in planned economies they were incapable of allocating resources efficiently or effectively, lacking a common denominator to compare different goods and services, lacking the means to evaluate consumer satisfaction, lacking profit-orientated and entrepreneur motivations, and facing insurmountable problems in planning and coordination in an increasingly complex economy. Socialists who consistently think that economic problems can resolved simply through the right level of planning are engaging in the same sort of fallacy that free market dogmatists engage in, but with a different spin. Without a price feedback mechanism to evaluate relative scarcity another mechanism has to be imposed; either rationing or queue and whilst these may be appropriate in some situations, they are certainly should not be the dominant means of exchange in in an advanced economy for commodities!

These criticisms were borne by the experience of planned economies in Eastern Europe and the Soviet Union in the twentieth century. Whilst such economies were quite effective in providing high levels of producer goods and infrastructure, which have significantly lower levels of input complexity, they were invariably extremely poor at providing consumer goods, with serious shortages in a variety of goods, even when the goods were produced in surplus [8]. Whilst these effects were slightly mitigated by the improvements in computer systems, such as Cybersyn in Allende's Chile, and the development of input-output analysis [9], increasingly empirical pressure was placed on the use of price mechanisms in a form of a planned "market socialism" such as that proposed by Polish economist Oskar Lange [10], which is largely considered a successful response to Mises and Hayek. Market socialism was significantly implemented in Hungary with "goulash communism" and the contemporary "Socialism with Chinese characteristics", and in a more democratic form, the model fo worker's self-management in Yugoslavia and the 1988 Law on Cooperatives in the Soviet Union enacted under Gorbachev, which bore a similarity to the principles established by the anarchist Proudhon's mutualism, a network of free-market voluntary cooperatives [11].

An alternative in the advanced democratic countries in the second half of the twentieth century, recognition of the problems of both socialist calculation and capitalist externalities and liquidity preferences led to the dominant model of a mixed economy (e.g., German ordoliberalism, and the Commonwealth welfare states). Combining elements of capitalist and socialist means of ownership, planned and free market means of distribution, the general concept provided a core of publicly funded or owned infrastructure services, regulated capitalism for the majority of economic activities, and with a market-competitive fringe. This post-war political and economic compromise was successful for the better part of thirty years (1945-c1975), with consistent improvements in wealth and well-being. The mainstream interpretation for collapse of this model was the effects of a sudden critical supply shock, (i.e., the OPEC oil embargo in 1973) and by macroeconomic policies which implemented excessive growth in money supply and excessive regulation of goods, services and the labour market; these actions generated both inflation and unemployment simultaneously.

The orthodox criticism and solution for such "stagflation" comes from both the monetarist economics of the Chicago School, and by neo-Keynesian responses and adaptions. An explanation was the wage-price spiral of inflation, which represented a shift in the Phillips Curve. Monetary and fiscal policy retained its usefulness as a tool to manage instabilities in aggregate demand, but not so for aggregate supply (e.g., cost-push inflation). The perceived solution for the monetarists was a sharp reduction in government expenditure, which was bitterly opposed by those who saw this as a reduction in the proportion of income under at least nominally democratic control. An unorthodox interpretation can be derived from a "value of money" orientation in Austrian School and in particular from Schumpeter's claim that democracy and state-regulated capitalism would reduce entrepreneurship in favour of stability; and capitalism thus would not end with a bang, but a whimper. Although coming from, superficially, a different political direction Galbraith also recognised the same problems [12].

Socialism and Capitalism; Planned and Market

Rather than a "mixed economy", where the public and private ownership is appropriately allocated along with planning and market mechanisms is not entirely unfair to suggest that the world system is a "muddled economy", a quasi-political system where productivity and efficiency come a poor second to supporting an increasingly powerful alliance of a section of the capitalist class with the landlord class. Recognising these class relations brings the normative question; on what possible basis is earned income justified? With the assumption of honest provision of labour and the honest acquisition of capital, the moral right of wages and interest can be ascertained; but the same cannot for the income of the landlord class. Their income is acquired entirely from the ownership of a pre-existing resource which is necessary for other economic activity; in effect the landlord derives their income for workers and capitalists whilst providing nothing in return.

The long-recognised solution to this injustice is the public socialisation of income according to site-rental market value, and the use of this income for public expenditure, instead of the range of onerous and inefficient taxes placed on workers and capitalists and all of which come with both a high administrative cost and deadweight loss through the restriction of trade (land value taxation in contrast suffers from neither of these features). Economists are nearly unanimous that as much public income should be derived from land values and use of natural resource as possible; and as little as possible should be derived from labour, capital and transactions. The normative effect should be the abolition of the premodern landlord class as the normative economic priority for advocates of socialism and capitalism alike.

Such a normative claim is not made however without reference to positive effects. With both the incentive to seek rental income from not engaging in productive activity, economic activity is redirected towards the actual production of goods and services. This raises both the appropriate normative and economic models for ownership and distribution in all these cases which, by necessity, must be abstracted. A general principle that can be suggested here is that the closer that a good or service is to being a natural monopoly the greater the requirement for centralised socialisation as a public service, and the close the good or service is to being in accord to perfect competition (including monopolistic competition), the greater the requirement for decentralised private ownership in a variety of forms (including cooperatives etc). Likewise the smaller the number of input and output variables the greater the possibility of accurate planning, whereas the greater number of such variables suggests efficacy of a price mechanism to deal with issues of relative scarcity and opportunity cost. The aforementioned public income should be spend entirely on matters of transparent public goods for the general benefit; the mitigation of negative externalities (e.g., pollution), the enhancement of positive externalities (e.g., networks, education).

No doubt more purists advocates of both the capitalist and socialist or free market and planner breeds with find the general idea of allocated "shared power" distasteful, regardless of the proposed or evident appropriateness. It is, in a sense for such objections that the initial sketch is raised. It is hoped that through fruitful discussion median points can be reached and perhaps a degree of understanding between these traditionally antagonistic camps. What is hoped more so from such a dialogue is that all sides will be alerted to the environmental and economically destructive affects the private extraction of economic rents from natural resources and, conversely, undemocratic management - and lack of management - of the commons. For the great modern debate between capitalism and socialism, plan and market, remains secondary whilst the shackles of feudalism remain.

References

1] Michael Newman, Socialism: A Very Short Introduction, Oxford University Press, 2005 and James Fulcher, Capitalism: A Very Short Introduction, Oxford University Press, 2004.

2] For example varieties of 'market socialism' have been explored by Joseph Stiglitz, "Whither Socialism?", MIT Press, 1995 and a similar paper for varieties sof capitalism, Peter A. Hall and David Soskice, "An Introduction to Varieties of Capitalism", Oxford University Press, 2001

3] The key contributions are considered to be from William Stanley Jevons's, The Theory of Political Economy, 1871, Carl Menger's Principles of Economics, 1871, Léon Walras, Elements of Pure Economics, 1874 and 1877.

4] An interesting exposé of how neoclassical economics conflated land and capital, landlord and capitalist can be found in Mason Gaffney and Fred Harrison, "The Corruption of Economics", Shepheard-Walwyn, 1994

5] Joan Robinson, The Economics of Imperfect Competition, 1933

6] John Maynard Keynes, The General Theory of Employment, Interest and Money, 1937

7] See in particular Ludwig von Mises, Socialism, an Economic and Sociological Analysis, 1922 and Friedrich von Hayek, The Road to Serfdom, 1944 and The Use of Knowledge in Society, 1945.

8] János Kornai, Socialist economy, Princeton University Press, 1992

9] Leontief Wassily, Input-Output Economics. 2nd ed., Oxford University Press, 1986

10] Oskar Lange and Fred M. Taylor, On the economic theory of socialism, The University of Minnesota Press, 1938 [FP 1935]. See also Henry Douglas Dickson, "Economics of Socialism", Oxford University Press, 1939

11] Kevin Carson, Studies in Mutalist Political Economy, BookSurge Publishing, 2007

13] Joseph Schumpeter, Capitalism, Socialism and Democracy, Harper Perennial, 1962 FP 1942 and John Kenneth Galbraith, American Capitalism: The Concept of Countervailing Power, Houghton Mifflin Company, 1952 and The New Industrial State, Houghton Mifflin, 1967

Commenting on this Page will be automatically closed on May 13, 2009.

Comments

I think a lot of the conceptual problems faced when weighing free-market capitalism and state socialism melt away in the face of the kinds of political/economic structures advocated by libertarian socialists (from ParEcon to council communism to anarchism). Both market and centralized decision-making models are deeply flawed - for the reasons you lay out so well and many others.

And in an era of sophisticated products manufactured and coordinated on a global basis by massive multinationals and affiliates, what little flexibility market apologists could boast is all but gone for significant sectors of national and international economies. Corporations are both integrating more with nation-states (which seems a function of the reduced power of national governments on the economic world stage) and acting more like nation-states (internally and with those it interacts).

Decentralizing and democratizing our economies (and our polities as well!) looks like the path that best addresses the concerns raised with both dominant models (though of course it raises some new concerns).

I think there is a genuine concern of 'capital strikes' (i.e., fund us or we will take our money/plant elsewhere) which you raise with the increasing ties of corporates with states. More moral pro-capitalist advocates will argue that this is 'crony capitalism' and, of course, they are absolutely correct. Many socialist advocates of course tend to lie the blame on capitalism as a whole which isn't necessarily correct; after all state socialism was prone to such corrupt practices as well.

Avoiding such things is, at least in part, a matter of transparency and democracy; which is why when the original 'about' statement for this site was put together there was the demand that public expenditure should be for the public good. Of course, as Tony Benn once pointed out, the existing situation isn't going to resolve itself or by the goodwill of our rulers.

One remaining hurdle your model faces is the question of quantitatively measuring how close something is to competitive monopoly and to perfect competition. After all, the Herfindahl Index doesn't mean much; a Herfindahl value that constitutes a monopoly under one administration may fall under perfect competition under another. Public Choice economists point smugly at this and snicker.

One more thought. You worry about the remnants of feudalism in the modern economy: one aspect of feudalism is the inability of peasants to participate in the market. In the majority of developed nations, every citizen has the right to participate in the free market. As Amartya Sen agitates, one can have the right to participation without the ability to do so. Sen advocates good socialized education and healthcare coupled with a welfare program.

There are ample critics of all socializing those three programs; being one of them, I am most concerned with the frankly lower quality of education and healthcare provided by the state. Like all critics of welfare, I struggle to find the balance between empowering those in need and reducing their incentive to work.

I support free education, free healthcare, and comprehensive welfare in concept. In practice, I recommend that we consider Milton Friedman's proposals. He proposes that every family in a nation be given a set of coupons redeemable at any educational institute; instead of evaluating school performance through standardized tests (which do not measure intelligence or creativity), he trusts parents to bring kids to the best school, effectively privatizing the educational sector. As schools compete for families to spend their coupons there, the quality of education and breadth of choice should increase dramatically. The same would be true of hospitals. Market forces thus help us improve education; the government would subsidize the full cost of education.

The challenge for that model is good regulation as to what qualifies as 'education'. Does a home-sewing group count, for example?

As for welfare, how about a simple negative income tax up to a certain tax bracket?

Together, education, healthcare, and welfare would empower every citizen to be active participants in the free-market.

Thoughts?

Firstly, I appreciate a post which correctly refers to the Herfindahl Index, Amartya Sen's developmental economics and Milton Friedman voucher system as a model of public education. With regards to the former, I certainly think it is an excellent objective standard but, as you say, prone to subjective interpretation of meaning. That does not mean that it isn't a tool that can be used.

My initial response to the latter suggestion is "it depends". Whilst I think that it would work in a supplementary sense and in an economy that is undergoing diversification and increased specialisation, I am not sure whether a diverse voucher system can provide the sort of minimal standard mass education that is required in the first instance to reach such a level (which refers to Sen's comment); I am thinking here for example of the mass literacy campaigns carried out by the Nicaraguan government in 1980.

Other than that, what you say seems true; the application of public funding, regulative standards when combined with direct citizen-consumer power is a very potent (and particularly democratic) means of ensuring efficient and effective approach to welfare economics, and certainly does not seem to be particularly disagreeable to either the approaches of (say) Pigou or Pareto; however I would have to investigate this further (it's been a long time since I've looked at welfare economics).

For what it's worth, there's no data showing that school choice improves educational outcomes. I live in Washington DC, which has been a bit of a guinea pig when it comes to publicly-funded charter schools. While there were high hopes and a lot of hoopla, we've seen no statistically significant change - in DC or anywhere else in the country.

And when it comes to school competition, several studies have shown that teacher efficacy actually decreases when they're under pressure to perform (e.g. standardized tests, pressure from administrators).

Judging from community-integrated schools in the midwest and the pluralistic model of Sudbury schools and Free schools, the problem of unaccountable bureaucracies and lagging performance would likely be better solved in democratizing the schools than marketizing them.

This article was discussed on the livejournal economics community.

I would like to thank ikilled007, engelhardtlm1, franciscanorder, and ragnorok20 for their contributions to the discussion.