Economics 380 Home Page

Elemental Economics


Lecture Notes

Harry Hillman Chartrand © January 2006

Economics 380, USASK, 2005-6




The Counter-Revolutionaries

a) American Institutionalism

b) Karl Polanyi

c) Joseph Schumpeter

a) American Institutionalism

Other than Marxist economics which he treats as a form of Classical Economics, Blaug gives significant space to only one heterodox school of economic thought: American Institutionalism (Chapter 17.5).   For him the Institutionalists represent the last attempt to base economics not on Newtonian mechanics, as is the Marginalist Revolution, but on biology and law.  As noted above, modern economics arguably began with the Physiocrats of pre-Revolutionary France.  With economic surplus flowing primarily from agriculture – one seed planted, thousands reaped, the Physiocrats did not survive and biology was displaced in the theoretical hierarchy by the division and specialization of labour in manufacturing cum Adam Smith’s ‘pin factory’ which with the Marginalist Revolution married the mechanical calculus of Newton in the 1870s. 

There is, however, another epistemological difference or distinction in the nature of knowledge portrayed by the Institutionalist School of thought – empiricism.   Like physics, the economics of the Marginalist Revolution are based on hypo-theoretic assumption and deduction, e.g., there is a utile and from its assumption we deduce diminishing marginal utility.  Institutionalism, on the other hand, is based on empirical observation and induction. 

In logic, induction refers to reasoning from the specific to the general in contrast to deduction which refers to reasoning from the general to the specific.  The word ‘induction’ derives from the French meaning “the action of introducing to, or initiating in, the knowledge of something” (OED, induction, 2).   

If induction carries the sense of increase, then deduction carries the sense of decrease.  In fact, the word ‘deduction’ derives from the French meaning “the action of deducting” (OED, deduction, 1a).  Put another way, deduction involves simplification of the complex; induction involves the complication of the simple.  Deduction serves as the basis of reductionism in the natural and engineering sciences as well as in the social sciences practicing ‘calculatory rationalism’ such as Marginalist economics.

While all shared a background or sensitivity to the German Historical School, one reason why Institutionalism failed to maintain its early dominance of economics in the United States, arguably from the 1880s with the beginning of the American Economics Association to the 1950s, was that its major practioners did not induce findings from the same object of observation. 

In the case of John R. Commons, the object of observation was the legal system and its progressive re-definition of the nature of property and property rights defined in terms of liberty and obligation of action.   For Wesley C. Mitchell, the object of observation was statistical time series of economic activity.  In fact it was Mitchell’s efforts at the National Bureau of Economic Research that provided the statistical input for the initial Keynesian system of national income accounting.  In the case of Thorstein Veblen, the object of observation was the cultural specific economic choices made by individuals and organizations especially ‘business enterprise’ through the evolutionary development of the economy.   Thus in his Theory of the Leisure Class (1899) he highlighted and introduced concepts such as ‘conspicuous consumption’.   In his Theory of Business Enterprise (1904), Veblen laid the seeds for the post-revolutionary emergence of what is now called ‘evolutionary economics’. 

In class I will put colour to these observations.


b) Karl Polanyi

Neither Blaug nor Schumpeter make mention of him (Screpanti & Zamagni 2005 do) but in 1944 Karl Polanyi, brother of the chemist and philosopher of science, Michael Polanyi, published the first edition of The Great Transformation.  According to some scholars this book is of renewed relevance in a post-Cold War world due to the emergence of a global knowledge-based economy (Block 2000; Munck 2003).  In essence, Polanyi finds transcendent, teleological forces at play (final causes) in the economy.  Specifically, Adam Smith’s ‘invisible hand’ is made plainly visible.

Polanyi traces the evolution of the market from its prehistoric roots to The Great Transformation of the 19th century.  Until then the market was, Polanyi contends, embedded in and subordinate to the social system.  In Western Europe, this embedding was evidenced by charters and patents granted by monarchs to guilds, municipal corporations, trading companies, universities and other bodies corporate.  Arguably the first break in this system was the 1624 Statute of Monopolies which, in England, ended royal grants of industrial privilege with the notable exception of patents of invention and copyrights.  This marked the beginning of the laissez faire economy, i.e., let producers produce what they want, not what the Crown wants.  The final break was arguably abrogation in 1814 of the Statute of Artificers that ended guild control of the labour market and signaled the beginning of a laisser passer economy, i.e., let workers move to where they can find work.  With the 18th century Republican Revolutions, the underlying political system of subordination also slowly gave way before popular democracy in the form of a republic or constitutional monarchy. 

While markets have always existed as places or networks where goods are bought and sold, the new free or self-regulating market was society-wide.  Both outputs and inputs including capital, labour and natural resources went up for sale.  State involvement in the economy was minimized according to selectively interpreted principles articulated in Adam Smith’s 1776 The Wealth of Nations.  These were, however, most succinctly expressed by Smith’s contemporaries, the French Physiocrats as laissez faire and laissez passer.  In this regard, “Polanyi is insistent that ‘laissez-faire was planned; planning was not’” (Block 2000, 12).  It is ironic that the Republican Revolutions that gave birth to modern political democracy based on the inalienable ‘rights of man’ coincidentally converted human beings and nature into marketable commodities.

For Polanyi, “the definition of a commodity is something that has been produced for sale on a market” (Block 2000, 9).  By this definition, labour and natural resources are ‘fictitious’ commodities because they were not originally produced to be sold on a market.  The Standard Model assumes, however, that such inputs behave like ‘real’ commodities. 

To Polanyi, this assumption is false and places human society at risk.  It is false for two reasons.   First, it “violates the principles that have governed societies for centuries: nature and human life have almost always been recognized as having a sacred dimension” (Block 2000, 9).  According to Polanyi, it is impossible to reconcile this sacred dimension with the subordination of labor and nature to market price.  Second, while the economy is supposedly self-regulating, the State actually plays an inevitable role in, for example, control of the money supply as well as managing education, unemployment, training and a host of other policies that effectively, even if unnoticed, regulate the marketplace (Block 2000, 9-10).  This contradiction of market liberalism is evident with respect to intellectual property rights.  Knowledge, by its nature, is not a private good yet government fiat converts it into a legally enforceable monopoly.   

On the one hand, the self-regulating market displays a remarkable efficiency of knowledge especially compared to centrally planned material balances as practiced by the failed Marxist command economies.  The knowledge efficiency of the price system was central to the work of one of Polanyi’s archrivals, Fredrick von Hayek (Hayek 1937, 1945, 1989).  On the other hand, the self-regulating market places costs associated with economic downturns on the atomized individual rather than on the guild, corporation, community or government.  The resulting stress on business as well individuals, according to Polanyi, produces an inevitable political countermovement to regulate the supposedly self-regulating market economy.  Taken together – movement towards the self-regulating market and movement towards its regulation – represent what is called the ‘double movement’ of Polanyi’s Great Transformation (Munck 2002, 17).

For Polanyi, this double movement can only be resolved by the eventual disappearance of the self-regulating market to be replaced by some form of socialism.  Like Marx, he was wrong with respect to the end state (as of today) as demonstrated by membership of the communist People’s Republic of China in the WTO.  In law, the self-regulating market now rules a world no longer split between capitalist and socialist blocs.  Like Marx about alienation, however, Polanyi appears correct in that counter-movements to globalization have arisen (Munck 2002).  I can identify three.  Before examining them, however, I must establish what I call ‘Phase II’ of The Great Transformation.

As previously noted, the success of the self-regulating market rests on the inherent knowledge efficiency of the price system.  This has been amplified to levels unthinkable by Karl Polanyi or von Hayek in the 1930s and ’40s.  In the 1970s, a global electronic payments system emerged spinning a transactional web over all market-based economies and subsequently all Nation-States with the exception of North Korea and Cuba.  Visa, Mastercard and American Express are everywhere.  The technological ability to collect, compile and process transactional data on a global scale marks what I call Phase II of The Great Transformation.  What must be appreciated is that Polanyi and Hayek agree that there is something happening above the range of conscious human control, i.e., the self-regulating market (Polanyi) and the price system (Hayek).  In this regard, Vacel Havel has suggested that what the West did not appreciate that the fall of Communism marked the end of the Age of Reason, i.e., in the belief that the economy could be rationally planned and centrally controlled.  This belief has surrendered to a belief in a transcendent function - the market - over which, ideally, no economic agent exercises market power and in which the ‘invisible hand’ produces the greatest good for the greatest number (Havel 1992).  The ideological foundation of this belief is, of course, the Standard Model of economics.

Phase II succeeded, however, because of an institutional matrix created after the Second World War and designed by another of Polanyi’s rivals, John Maynard Keynes.  The Breton Woods Conference of July 1944 planted the roots for a global monetary order designed to escape the damaging effects of the Gold Standard that both Polanyi and Keynes believed doomed the pre-war global market.  Out of this conference came the International Bank for Reconstruction and Development (later divided into the World Bank and Bank for International Settlements) and the International Monetary Fund.  Within four years, the General Agreement on Tariffs and Trade (GATT) came into effect (January 1, 1948).  In turn, GATT gave birth to the WTO in 1995 marking the arrival of a truly global self-regulating market governed by international law.  Thus, on the one hand, the self-regulating market has become formally embedded in the law of nations, or more precisely, the law of Nation-States.  On the other hand, economic sovereignty and the ability to set national policies have been compromised to gain admission to the global marketplace. 

With respect to counter-movements to the global marketplace, the first, and most obvious, is the non-governmental anti-globalization movement around the world.  In effect, it rejects embedding society within the economy.  Put another way, one should work to live, not live to work and anti-globalization forces do not want the tail to wag the dog.

The second is the New Regionalism in international studies (Spindler 2002).  According to this school of thought, business is responding to globalization by reshaping the regional geo-political landscape, e.g., NAFTA, to allow a more efficient and effective embedding of business in a reconstituted political economic matrix.  Polanyi argued, of course, that the political system (and society as a whole) is being embedded in the economy.

The New Regionalism also raises the question of whether such regionalization is a stepping stone or stumbling block to globalization.  The question must, I argue, be addressed with respect to the ideology of the market, i.e., the Standard Model of economics.  This claims that the market works best without political interference.  It is on this basis that if the WTO finds in its ‘courts’ that a member state has interfered then countervail is authorized.  That surreptitious efforts are constantly being made to subvert the market is clear - banana wars, steel wars, BSE bans, GM restrictions, et al.  Nonetheless, the ideal is equally - Let the market do it’.  This is the ideological bench mark against which the global market behaviour of Nation-States is judged. 

Regionalization is, to my mind, a stepping stone towards a global economy so long as the ideology of the market remains the bench mark, e.g., in NAFTA and the EU.  Of course, similar surreptitious attempts to intervene occur at the regional level, e.g., the ongoing softwood lumber controversy between Canada and the United States.  However, to the degree that these attempts are subject to countervail then the direction remains clear: towards a self-regulating market.

The third counter-movement to globalization is the internal growth of government itself.  Bertrand De Jouvenal, in his 1949 Power: Its History and the Nature of Its Growth, demonstrates the process whereby the power of the Nation-State has grown from the time of the Absolute Monarchs of the 17th and 18th centuries.  This process he characterizes as the increasing penetration of the State into the daily life of its citizens and the growing sophistication of its organization to enhance internal sovereignty.  He documents the resulting increase in the scale and damage of warfare up to WWII.  He also notes that traditional inhibitions on state power resulting from its embodiment in the person of a Monarch disappeared with the arrival of popular democracy (de Jouvenal 1949, 8-9).

De Jouvenal exposes the equation of power, or what he calls “the Minotaur” of popular democracy.  For Marx there is struggle between Top (the rich) and Bottom (the poor) leading to revolution.  De Jouvenal, however, argues the struggle is between the Top (the State) in alliance with the Bottom (the oppressed) squeezing the Middle (the Establishment) and progressively penetrating ever deeper into the personal lives of citizens.  As a new Bottom is recognized, the Middle is squeezed again and again so that State Power perpetually grows.


c) Joseph Schumpeter

Like Thorstein Veblen, Joseph Alesoph Schumpeter is one of the most colourful figures in the history of economic thought.   Born in the Austro-Hungarian Empire he entertained Harvard staff and faculty long into the night with tales of his Arabian Nights in the east of the empire at the University of Beesarabia.  Schumpeter rejected the Marginalist Revolution for, among other things, the trivial consequences of its conclusions.  He claimed it amounted to no more, nor less, than concluding that people will make the best out any situation in which they should find themselves.  This attitude is reflected in the challenge cast by mathematician Stanislaw Ulam to Paul Samuelson to “name me one proposition in all of the social sciences which is both true and non-trivial.” Samuelson responded with the theory of comparative advantage.

Instead of hedonics, Schumpeter, after extensive study of the business cycle and the nature of the firm, concluded that perfect competition did not provide an appropriate benchmark for performance of the firm.  Rather, being small and working at the margin, the perfectly competitive firm was not an agent for economic change and growth but rather of risk aversion and stagnation.  Growth and evolution of the economy for Schumpeter was fuelled by technological change or rather the winds of 'creative destruction'.  These winds blew out of oligopolistic and monopolistic enterprise possessing sufficient resources to invest in R&D.  As the scale of the required investment grew, e.g., 'Big Science', government would inevitably become involved.  This opens up various connexions with both the philosophy of science and its relationship with the public and private sectors, e.g., national innovation systems, and the philosophy of technology, especially that of Martin Heidegger and his view of technology as progressively enframing and enabling Nature at a larger and larger scale to serve human purpose.  Schumpeter wavered back and forth on whether or not the end state would be socialism but tended, overall, to think so. 

The contradiction between the ideology of market economics with its perfectly competitive firm and the critical role of large scale industrial enterprise in initiating and being the perennial victims of creative destruction was one of Schumpeter's seminal insights.  A related contradiction was arguably picked up by Daniel Bell in his The Cultural Contradictions of Capitalism (1976) which highlights the conflict between an avante guarde Arts and its mission of change for the sake of change and the settled expectations required for bourgeois savings and investment.

For Schumpeter, like Marx, there was a teleological force at work shaping the evolution of the economy - the technological imperative for Marx and creative destruction for Schumpeter.   Schumpeter was not, however, a Marxist but in many ways more an Institutionalist in the evolutionary tradition like Veblen.  Nonetheless, Schumpeter's economics centres on teleological or final cause rather than the when-then causality of mechanics and of the Marginalist Revolution.  I recommend Nathan Rosenberg's chapter on Schumpeter (Rosenberg 1994).


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