Some argue that Basic
Conditions lead to Structure; Structure leads to Conduct; and,
Conduct leads to Performance. Others, however, including Joe
Bain, argue that Structure leads to Performance. In either case
the question remains: How well does an industry perform –
internally and externally?
Internal Performance is
reflected by, among other things, how efficiently an industry
utilizes its resources, accounts for its opportunity costs and
benefits and the profit that it earns. External Performance is
reflected by, among other things, the external costs and
benefits an industry generates in the natural environment or
biosphere and in society. This last point is critical.
Performance accounts not just for costs and benefits internal
but also external to the industry such as environmental impact
and economic equity. Put another way: the economy is a means to
satisfy human ends; it is not an end in and of itself.
Allocative Efficiency & Profitability
Allocative efficiency implies
all factors of production and all commodities demanded by
consumers are in their best use and receive their opportunity
cost. Further, it is assumed that there are no external cost or
benefits, i.e. all external costs and benefits have been
‘internalized’. Three conditions must hold:
Efficiency: when consumer cannot increase utility by
Efficiency: when firm cannot reduce cost by shifting input
Exchange Efficiency: when all gains from trade have been
exhausted. Gains from trade to consumer is called consumer
surplus which measures difference between what consumer are
willing to pay and what they actually pay for a total quantity
of a good or service at market price. Gains from trade to
producers are called producer surplus which measures the
difference between what producer are willing to accept and what
they actually receive for providing a market equilibrium level
of supply (P&B 4th Ed.
5th Ed. Fig. 11.12;
7th Ed Fig.
12.12; R&L 13th Ed not displayed).
I will now examine allocative efficiency and profitability of
the four forms of market competition.
To determine profit-maximizing output of a firm under perfect
competition, one can use two methods:
total revenue less total cost; and,
(i) Total Revenue
less Total Cost
Profit equals TR – TC. By plotting TR and TC curves one can see the
changing relationship: initially there is a section of economic
loss followed by economic profit followed by economic loss with
two points of ‘normal’ profit points (P&B 4th Ed.
5th Ed Fig. 11.2;
7th Ed Fig.
12.2; R&L 13th Ed
(ii) Marginal Analysis
Marginal revenue (MR) can be compared with average cost (AC). To
maximize profit a firm must sell at MR = P = MC. But if MR >
AC producing an additional unit output will add more revenue
than cost, i.e. economic profit earned in the SR. If MR
= AC then ‘normal profit’ is earned, i.e. all factors of
production paid their opportunity cost value. If MR < AC
producing another unit with result in a loss (P&B 4th Ed.
5th Ed. Fig. 11.3; P&B
7th Ed Fig.
12.3; R&L 13th Ed
Three possible outcomes are possible for the firm in the
short-run: normal profit, economic profit or economic loss (P&B
5th Ed. Fig. 11.4;
7th Ed Fig.
12.8; R&L 13th Ed
In short-run firm will continue producing if at least all
variable costs are covered even if the firm suffers a loss
because it is not covering all of its fixed costs. If all
variable cost cannot be covered, the firm will shutdown (P&B 4th
5th Ed. Fig. 11.5;
7th Ed Fig.
12.4). In the LR, firms suffering short-run
losses either adjust their scale of production (assuming
economies of scale are available) or they exit the industry.
Exit reduces supply (shifts SC to left) and raises price (R&L
The LRAC curve is the envelop of minimum points of sequence of
SRACs reflecting scale increases.
If some firms enjoy SR economic profits, new firms will enter
increasing supply (shifting SC to right) and reducing price (P&B
5th Ed. Fig. 11.8;
7th Ed Fig.
12.9; R&L 13th Ed
In the long-run, firms can adjust the size of their plants
creating a series of short-run average and marginal cost
curves. The long-run average cost curve is made up of an
envelope of the minimum points of the short-run average cost
curves where SR average cost equals SR marginal cost. At some
point the most efficient plant size is achieved where LR average
cost is lowest for a particular short-run situation. At this
size the short-run marginal cost curves, in effect, becomes, the
long-run marginal cost curve (P&B 4th Ed.
5th Ed. 11.9; 7th Ed not displayed; R&L 13th Ed
Given that each firm’s product is slightly
different it faces a negatively sloped demand curve or rather a
‘market niche’. In effect, the industry demand curve is
disaggregated into market segments. The position of the demand
curve depends, however, on the price of other firm’s output.
Thus an increase in the prices of rivals will shift the firm’s
demand curve up to the right; a decrease would cause a shift to
the left. In the short-run equilibrium will be reached where
marginal cost equals marginal revenue, i.e. profit
maximizing. In the long-run, however, firms are able to change
the scale of product and enter or leave the industry. Therefore
long-run equilibrium is reached where long-run average cost is
tangent to the demand curve and where marginal cost is equal to
marginal revenue, i.e., firms are maximizing profits.
But because price is equal to average cost, economic profits
are zero. At this point there is no incentive to entry and
equilibrium is established (P&B 4th Ed.
Fig. 14.2; 5th
Ed. Fig. 13.2; 7th Ed
Fig. 14.1 &
Fig. 14.3; R&L
The monopolist faces the same demand curve as the industry. As
in perfect competition, the market demand curve is constructed
from the horizontal summation of individual consumer demand
curves and is usually negatively sloped, i.e. if price
goes up, demand goes down. In perfect competition, however, if
the market price (over which the perfect competitor has no
control facing a horizontal demand curve) goes up the quantity
supplied by firms will increase. In monopoly, however, an
increase in price will cause a decrease in the quantity supplied
by the monopolist. Thus unlike the perfect competitor, a
monopolist can choose which price to charge and thereby what
quantity will be demanded. The monopolist can thereby charge a
price that supplies a quantity that maximizes profits but cannot
adjust both independently. This can be seen by reference to
marginal revenue in perfect competition and monopoly: if
R = pq
MR = dR/dq
in perfect competition, the firm is a price taker
at a given market price facing a horizontal demand curve and
therefore MR = p
in monopoly facing a negatively sloping demand
curve, the firm is a price setter and MR does not = p because an
additional unit of q can only be sold at a lower price (P&B 4th
5th Ed Fig. 12.2;
7th Ed Fig.
13.2; R&L 13th Ed
(i) Short-Run Equilibrium
If free from outside interference a monopolist will choose the
price/quantity relationship where the difference between total
revenue and total cost is at a maximum, i.e. maximum
profits. In perfect competition, the maximizing firm will
equate price to marginal cost to maximize profit and the supply
curve is derived from these points. Under monopoly, maximum
profit is obtained when output is at the point where marginal
revenue equals marginal cost. Thus at any output where marginal
revenue exceeds marginal cost, total or accumulated profits can
be increased by more output. When marginal cost exceeds
marginal revenue, accumulated profits decline and can only be
increased by reducing output (P&B 4th Ed.
5th Ed Fig. 12.4;
7th Ed Fig.
13.4; R&L 13th Ed
In perfect competition a unique relationship exists between the
price and the output supplied. In monopoly there is not a
unique relationship. This is because variation in marginal
revenue of the monopolist caused by a shift in demand can result
in a different output level but at the same price.
(ii) Long-Run Equilibrium
In perfect competition there can be no long-run economic profits
or losses because firms will enter or leave the market. In
monopoly, there are no long-run competitors unless the industry
ceases to be a monopoly - by definition. Thus long-run
equilibrium in a monopoly will be characterized by economic
profits. If, on the other hand, a monopoly experiences
short-run losses it will adjust the scale and characteristic of
its plant to eliminate such losses in the long-run. If this is
not possible the monopolist will leave the industry.
Assuming short-run profits, in the long-run the monopolist will
adjust its plant to achieve even larger profits. Output will be
provided at the level at which long-run marginal cost equals
long-run marginal revenue.
The most profitable form of monopoly is the price discriminating
monopolist who, in effect, is able to disaggregate the market
demand curve into individual consumer demand curves and charge
each consumer a price that maximizes profit on each sale (P&B
7th Ed Fig.
13.9; R&L 13th Ed
Classic example is the town doctor who charges the farmer a
chicken or sheep for a broken leg but charges the town banker a
much higher price for the same service
In perfect competition and monopoly there exists a determinant
solution to a firm’s price and output decision-making. When
there are only a few sellers, however, each firm recognizes that
its best choice depends on choices made by rivals. There are
dozens of alternative oligopoly pricing theories and some
economists claim there is no determinant solution. In an
oligopolistic market there is usually price stability because of
the interdependence of sellers. Interdependence results in
‘game playing’ behavior whereby suppliers act like players in a
game acting and reacting to the moves of their competitors.
Competition tends to take place on a secondary level of:
product differentiation; technological innovation; and,
diversification, i.e. producing more than one commodity.
In theory, oligopoly is considered inefficient because price is
higher and quantity lower than under perfect competition.
(i) Cournot Solution
The Cournot Solution proposes that firms choose an output that
will maximize profits assuming the output of rivals is fixed.
The solution concludes that there is a determinant and stable
price-quantity equilibrium that varies according to the number
of sellers. In effect each firm makes assumptions about its
rival’s output that are tested in the market. Adjustment or
reaction follows reaction until each firm successfully guesses
the correct output of its rivals.
A much more sophisticated and complex solution known as the ‘Nash-Cournot’
equilibrium was proposed by
Nash, the protagonist of the movie ‘A
Kinked Demand Curve Solution
The Sweezy solution postulates that oligopolists face two subjectively
determined demand curves that assume:
rivals will maintain their prices; and,
rivals will exactly match any price change.
A key assumption is that rivals will choose the alternative
least favorably to the initiator. If initiator raises p, rivals
will not follow; if lowers price everyone follows. The result is
p will be relative rigid in the face of moderate changes in cost
or demand (P&B 4th Ed.
5th Ed. Fig. 13.6;
7th Ed Fig.
15.2; R&L 13th Ed not displayed).
Perfect Competition vs.
First, under perfect competition, each firm
operates at the point where long-run and short-run average costs
are at a minimum. Under all forms of imperfect competition,
however, the firm will operate at minimum average cost but not
at its long-run minimum.
Second, under perfect competition output
tends to larger and price lower (P = MC) than under imperfect
competition (MR = MC). This results in the ‘dead weight loss’
of imperfect competition which reflects the fact that the
consumer surplus is reduced but the gain to the firm is less
than the loss to consumers (P&B 4th Ed. Fig.’s
13.6; 5th Ed.
Fig.’s 12.5 & 12.6; 7th Ed
Fig. 13.5 &
Fig 13.6; R&L
There is no doubt
that competitiveness results from the division and
specialization of labour in a larger market. But
competitiveness as comparative advantage has its limits. In
sports, the preferred metaphor used in discussing
competitiveness, it is the opposing team that is the challenge.
The playing field, the environment itself, is generally fixed,
invariant and subsidiary to the consciousness of players at
play. In biology, however, natural selection involves not just
an opponent but also an ever changing environment or ‘fitness
Given an active
environment, autonomous agents, organisms or institutions,
constantly adapt, adjust and evolve or go extinct. They adapt
by experimenting with mutations called preadaptations or
exaptations. According to Kauffman, these come from the
adjacent possible - the realm where possibilities one step away
from being realized reside. Creativity, inventiveness and
imagination are required to see them and courage and confidence
to grasp them.
New products and
processes generated by R&D in the Natural & Engineering
Sciences; new methods emerging from the Humanities & Social
Sciences including management sciences; and, new aesthetics,
forms and designs thrown up by the Arts, this is creative
destruction. Biological systems expand or explore the adjacent
possible filling all possible niches as quickly as possible
subject to timely selection of the fit and unfit, e.g.,
going out of business. Such timely selection is called ‘early
visibility’ and ‘fast failing’ in the innovation literature.
If selection takes
too long, then fitness may decline or simply melt away.
Arguably, this explains ‘de-industrialization’ of Anglosphere
Nation-States. They maintained existing plant and equipment,
e.g., in steel production, until fully depreciated through
voluntary (and sometimes involuntary) quotas on imports from
developing Asian producers who invested in the best new
technologies emerging from the adjacent possible. The fitness of
the West fell, at least in terms of the traditional
manufacturing-based economy. A balance must be struck between
fitness defined as the ability to adapt to a changing
environment and competitiveness defined as optimal adaptation to
the current environment. This balance includes conserving and
preserving the best of the Past. More dramatically it means
maintaining some minimum domestic capacity in case of
interruption to international trade, e.g., caused by a
deadly world flu pandemic. For 3 to 6 months international
shipping may stop. Competitiveness means being the best in the
current environment. Fitness means surviving environmental
change. Sustainability means staying fit through time.
is a term with many meanings to many people. It can mean
sustaining our current life style and/or standard of living into
the future. This is analogous to the long-run outcome of
perfect competition in economics - the steady state. It is an
equilibrium end state. It can mean curtailing our current
standard of living to ensure future generations have resources
available to sustain their needs into their future. It can
mean curtailing our current standards in order to sustain the
remaining ‘natural’ environment and other species. Such
curtailment, to be effective, would, however, require what
futurists of the 1970 called ‘the spontaneous dawning of
awareness’ by virtually the entire human population. It can
also, as suggested in the
meeting the needs of the present without compromising the
future. This last definition sounds like Bain’s definition of
economic conservation - wise use (See
Conservation & Present Value).
4.3 Conservation, Present Value & the Precautionary Principle
As benefits and costs extend out into
the future they become ever more uncertain. One calculates their
current worth – their present value - using a discount rate. The
higher the rate, the lower the present value of future benefits
or costs. Determining the appropriate discount rate is critical
to properly valuing future costs and benefits. There is,
however, also plain ignorance (lack of knowledge) concerning
many future values as explain by
With respect to public intervention
or production of public goods there is, however, an added
dimension to present value – politics. While future benefits or
costs may be significant they are politically discounted to
maximize election and re-election of politicians and
governments. Three examples demonstrate. First, with an
aging electorate politicians are more concerned with present
older voters than with future generations. Quite simply future
generations are not politically relevant unless the current
generation says so at the ballot box.
there is the political ‘edifice complex’. A new $100 million
bridge or building bearing a politician’s name is much more
valuable politically than an annual $20,000 paint job required
to preserve and maintain an existing structure for 100 years.
Arguably the much reported deterioration of public
infrastructure in the United States and Canada reflects this
political discount rate.
no matter political intentions about the future the reality is
we simply cannot know for certain what future generations will
want, need or desire from us today. This is especially important
when considering questions of sustainability. The concept of
sustainability is roughly analogous to the economic concept of a
‘steady state’ where the existing pattern of economic activity
continues through time. In the view of some economists resources
are highly substitutable or fungible. Technological change will,
in this view, provide a substitute for any resource that is
depleted through current use. Whether or not it is appropriate
to preserve a current resource for future generations thus
becomes a question of substitutability.
A related question is preservation
(non-use) versus conservation (wise use) of a natural resource.
Economist Joe Bain in his classic Industrial Organization
lays out the question:
For any of a group of industries
whose operations involve extraction of natural resources
(mining, petroleum production, agricultural cultivation,
lumbering, commercial fisheries) a significant dimension of the
market performance of the firms engaged involves how well they
do in the matter of “conservation” of resources. To paraphrase
the popular literature on this matter, conservation in an
economic sense of course does not mean non-use or simple
deferment of use, but “wise use” of the resources being
exploited. In technical terms, good conservation requires a
choice of technique of exploitation, time pattern of production,
and time pattern of investments and other costs, which together
yield an optimal net social benefit relative to costs over all
future time periods in which society is interested. In
determining this optimum, distant future benefits and costs
should be appropriately discounted by whatever rate of “time
preference” society wishes to assign in assessing the relative
importance of current as opposed to future benefits and
sacrifices. And conservation performance is poor to the extent
that enterprises deviate from this abstract ideal.
An adequate operational definition of ideal
conservation performance is extremely complex and next to
impossible to apply fully in the evaluation of actual
performance. Using the definition just given as a guide,
however, it is possible to identify certain types of gross
departure from good conservation which would have to be censured
under any acceptable criterion. These include:
Exploitation of resources by a technique that raises both
present and future costs above the obtainable minimum while
reducing or not increasing the amount of resources ultimately
recovered, or the amount of use obtained from resources over
Unduly rapid or intensive current use of resources which has the
result of impairing (or eliminating) future use of the resources
to a degree not compensated by current additions to output.
Pinching on current costs or investments in the use and
development of resources in a way that curtails future use or
raises future costs of use to a disproportionate degree.
What of the actual performance of industries
in regard to conservation? Of course, only a minor proportion of
all industries are sufficiently involved in extraction to make
conservation an issue, and for these we do not have highly
organized, systematic information on which to base an overall
appraisal. However, a broad scattering of evidence on individual
cases suggests that, among extractive industries, conservation
performance is or has very frequently been poor.
Thus we observe in petroleum production in
the United States a history of gross elevation of recovery costs
coupled with a substantial reduction of ultimate recovery of
available petroleum, attributable largely to the selection of
techniques in the context of competitive exploitation of
individual oil pools by antagonistic interests. In both
lumbering and commercial fisheries, and in some agriculture, we
find that a serious long-run depletion of resource productivity
has resulted from overintensive immediate rates of extraction or
exploitation of the available resources. In much of agriculture,
a history of pinching on current costs for or investments in the
preservation of the land (against erosion or reduction in
fertility) has resulted in long-run losses in soil productivity.
These deviations from reasonably good
conservation performance seem in large part attributable to four
things: (1) antagonistic exploitation of resource deposits by
competing interests, in which a competitive race to capture the
resource or its output before others do results in a disregard
of long-run yield considerations; (2) an inherent
“short-sightedness” of firms engaged in exploiting resources -
firms that attach much less importance to distant future
production than society would, or than they do to immediate
profits; (3) competitive conditions which bring about such low
returns to firms in some extractive industries that they cannot
afford to invest in the long-run maintenance of resource yields;
and (4) stupidity. Whatever the cause, poor market performance
in the matter of conservation has evidently been chargeable
against firms in many extractive industries. It is encouraging,
in the light of this, that in the past twenty or thirty years
there has been a rapidly increasing body of governmental
regulations designed to encourage or require better conservation
performance on the part of these industries.
Bain 1968, 425-427
Cost-benefit analysis involves
calculation of the probability and magnitude of costs and
benefits associated with a new technology, public intervention
in the market place or production of public goods and services.
If probable benefits outweigh probable costs it is approved; if
not it is rejected.
Applying the ‘precautionary
principle’, however, means that if a new initiative has any
chance of generating irreversible harm, no matter its short-term
benefits, it is rejected in spite of any positive cost-benefit
ratio. In fact, the precautionary principle is both an economic
and moral criterion. It invokes a social responsibility to
protect the public from harm if scientific investigation finds a
plausible risk. In the Rio Convention and in the European
Union, the precautionary principle has been made into a
statutory requirement. Its application is most apparent with
respect to genetically modified foods. In the Anglosphere
cost-benefit analysis has consistently found them to be a good
investment. In most cases natural and genetically modified crops
and animals are treated as equally safe. In the European Union,
however, the remote possibility of irreversible harm to human
health or the environment has led to significant restrictions on
the use of genetically modified foods including labeling of all
products. Some observers argue that this ‘plant protection
racket’ is fuelled by a Veblen Effect, named after economist
who introduced the concept of ‘conspicuous consumption’.
Please see: my
Environmental, Natural Resource & Ecological Economics -
Externalities & Public Goods
Until now we have assumed that
market price includes or ‘internalizes’ all relevant costs and
benefits. This means the consumer captures all benefits and the
producer pays all the costs. An externality refers to costs and
benefits that are not captured by market price for whatever
reasons, i.e., they are external to market price.
In effect, the market demand
curve reflects only
marginal private benefits
(MPB) (R&L 13th
16-1) of consumers but not the external benefits accruing to
society. When such external benefits are added, vertically, we
marginal social benefit curve
(MSB) inclusive of both private and public benefits.
Similarly, the market supply
curve reflects only
marginal private costs
(MPC) but not costs external to the firm’s accounting, e.g.,
pollution that society must pay. When social costs are added,
vertically, to the supply curve we derive the
marginal social cost
(MSC) curve inclusive of both private and public costs.
The standard model of market
economics is thus based on the assumption that all relevant
costs and benefits are internalized in market price, i.e.,
there are no externalities. If this assumption holds then ‘X’
marks the spot. If, however, there are externalities then market
equilibrium must be adjusted (R&L
17-7). External or social costs and
benefits must be added to private costs and benefits reflected
in the market supply and/or demand curves. The point is that
such external costs must be paid and external benefits accounted
for if the appropriate price/quantity equilibrium is to be
established. The agency to do so is not the market but rather
government. Put another way, the market ‘X’ solution is
superseded by a social ‘X” marking the spot and it is up to
government to correct the miscalculation of private agents to
a new socially optimal equilibrium.
This is a controversial view. It is expressed in the tradition
of both welfare economics (a sub-discipline) and the Keynesian
On the other side are those arguably
including the Austrian school of economics - von Hayek and von
Mises being leading protagonists - who argue: Let the market do
it! If consumers are willing to pay then providers will be
willing to supply. If a sufficient number are not willing to
pay, for example, because of the ‘free rider’ problem associated
with public goods, to make it profitable to suppliers then there
will be no provision, no market and people will get what they
rivalrousness distinguish private from public goods. If I buy a
car I can exclude others from using it by lock and key. I alone
extract its utility. Similarly, if I am driving no one else
can, i.e., driving is rivalrous. Public goods, on the
other hand, are non-rivalrous in consumption, i.e. my
consumption does not reduce the amount available to you. If I
watch a fireworks display it does not reduce the amount
available to you. Similarly, public goods are non-excludable,
i.e. a user cannot be easily prevented from consuming a
public good. This creates the ‘free-rider’ problem. Extending
the fireworks example, while not willing to pay to enter the
stadium I can still watch the display from the balcony of my
apartment at no charge.
externalities (discussed above) there is in fact a spectrum of
goods ranging from pure private to pure public in nature. The
more public a good the less likely it is that private producers
will be willing to supply a socially optimal output and the more
likely that only government will be willing to do so, e.g.,
national defense, the Census or inoculation against infectious
The response of the
government to problems presented by public goods varies
according to the nature of the good. Non-market benefits and
costs may be considered sufficiently important to justify public
action. In the case of benefits, such goods are called “merit
goods”. In the case of costs, they are called “demerit” goods.
There are thus times and situations in which a democratic
government decides that the free market is not producing
socially or politically acceptable outcomes and chooses to
override the marketplace.
The modern environmental
movement was born with publication of
by Rachel Carson in 1962. The 1960s & 1970s were a pre-revolutionary period
characterized by radical new ideas on campus and a general stirring up of
society’s status quo. A materially satisfied and educated middle class,
specifically its younger generation, awoke to a new spectrum of needs.
It appeared to some that material success was paid
for with environmental degradation plus international, racial and gender
inequity. Cities burned; riots and protests plagued campus; presidents fell;
civil, environmental and gender rights became slogans of mass movements. And
into the headlines were propelled pacifism, a.k.a., hippies, Woodstock
and the anti-war/anti-draft movement, as well as extremist groups, e.g.,
the Yippies, Weathermen, Black Panthers, et al.
It was in this context that economics met ecology
with publication in 1967 and 1968 (the year of the Democratic Convention in
Chicago and the down fall of President Johnson together with his dream of a
‘Great Society’) of two very different yet related texts.
In December 1968, Garrett Hardin, a biologist, published
Tragedy of the Commons”. The article was
based on his presidential address to the Pacific Division of the American
Association for the Advancement of Science in June 1968. Hardin demonstrated
that unfettered competition for natural resources within and between countries
was destroying the natural commons, a.k.a., the environment or biosphere
including the air, water, land and biodiversity living therein. Given such
resources belong to everyone yet to no one, i.e., they are ‘public
goods’, competitive self-interest dictates getting for oneself as much as
possible as quickly as possible with no consideration for others – past, present
or future. This is “The
Tragedy of the Commons”. Unfortunately,
a variation on this theme also plagued Second World or communist command
economies resulting in even greater environmental damage, debilitation and
If a public good belongs to everyone but to no one then one way to solve
the problem is to assign ownership to someone. That someone will then have a
vested interest to ‘conserve’ the resource. This is the approach taken in the
Conventions on the Law of the Seas and on Biodiversity (CBD) and the Kyoto
Accord. In the case of the Law of the Seas and CBD ownership is vested in the
Nation-State. In the case of Kyoto it is similarly vested in the Nation-State
but some have transferred ownership to private agents – both natural and legal
persons, e.g., using
carbon auctions and even
personal carbon credits.
Public Goods, ;'Common' Natural Resources, Knowledge-Based Industries
Ethics & Moral Sentiments
With respect to Equity in Law we have seen it
is justifies market interventions by government, e.g.,
agriculture, minimum wage and rent control. Arguably it also
applies in cases of market failure where consumer surplus is
appropriated by producers. In the Standard Model of Market
Economics such intervention to approximate the outcome under
perfect competition is also accepted.
With respect to Ethics #8 of the Ten
Humorous Reasons for studying economics reads: Although ethics
teaches that virtue is its own reward, in economics we get
taught that reward is its own virtue
In the Benthamite tradition, however, maximizing pleasure was
restrained by the tenets of Ethical Hedonism, a very Protestant
Ethic. This ethic, beyond concern with the moral value of work,
also involved social inhibitions against conspicuous consumption
(Veblen 1899). Such ethical or moral restrictions were
reinforced by the lingering effects of feudal sumptuary
legislation which made “status forgeries illegal and created the
disincentive of trial and punishment” (McCracken 1988: 33).
However when the Protestant ethic collapsed during the
Industrial Revolution, only hedonism remained -- in all its
unrestrained, irrational incarnations (Bell 1976: 20-22).
Without a generally accepted moral code, the law became the
accepted social institution to moderate individual
pleasure-seeking. Benthamite traditions concerning crime and
punishment in fact continue to guide both the law and economic
research, e.g. Bentham's famous and seemingly plausible
dictum `the more deficient in certainty a punishment is, the
severer it should be' (Becker 1968).
While self-interest or ‘Me-ism’ lays at the heart of the
Standard Model Economics itself is in fact qualified by moral
considerations. Thus while Adam Smith is remembered as the
founder of modern economics with the 1776 publication of his
the Wealth of Nations some 17 years
earlier in 1759 he published
The Theory of Moral
(1759) providing the
underpinnings to all his later works. Today such concerns are
summed up in expressions such as ‘market sentiments’. Such
sentiments include, among other things, trust. Overtime buyers
and sellers, producers and suppliers, employers and employees
develop trust reducing what are called transactions costs.
Without such trust every exchange must be carefully and
expensively scrutinized to insure all terms of a contract are
fulfilled by both parties. In times of severe recession, such
as now, relations tend to break down with producers and/or their
suppliers going out of business, employees laid off, etc.
Like a rug or woven sweater relations unravel and if this last
long enough new supplier or new employees must be engaged who,
at the beginning of the relationship, are subject to uncertainty
and a lack of trust raising transaction costs.
Benthamite tradition also places limits on what phenomena are
considered legitimate subjects of economic investigation. It
continues to blind mainstream economists to the cultural context
of economic behaviour. Daniel Bell, quoting the author of the
most widely read economics textbook in history observed:
Samuelson has noted that many economists would “separate
economics from sociology on the basis of rational or irrational
behavior, where these terms are defined in the penumbra of
utility theory.” Utility is defined as egoism, or
self-interest, and rationality is defined as consistency - that
is, preferences are transitive ....
crucial question is whether the obverse of the rational is the
irrational rather than the non-rational, and whether or not
non-rational motivations can provide a valid assumption for an
understanding of economic behaviour, i.e. to behavior
which seeks to enhance the wealth and welfare of mankind (Bell
another way, can non-rational motivations provide the foundation
of an inclusive or
economics to balance the
materialistic, protestant, exclusionary rationality of
contemporary economics? In this regard, Tibor Scitovsky (1972,
1976, 1989) has gone further than anyone in re-tooling economics
to account for `irrational' behaviour, e.g. cultural
activities including the arts. Where Bentham used the
associationist psychology of his, day to define pleasure and
pain as the ultimate principles of behaviour, Scitovsky, after
investigating contemporary clinical psychology, substitutes
`comfort and stimulus'. Among other things he uses this
distinction to differentiate consumption in the United States
(comfort) from what is now the European Union (stimulus). His
model, however, still uses marginal utility (Scitovsky 1989).
His work is in the tradition of welfare economics
From a welfare
economist's perspective, there are two types of social
behavior. The first are onerous activities not performed for
inherent satisfaction but for what they yield, i.e.
work. Thus the disutility of work is theoretically to be
compensated by a pay check. Second, there are activities that
are the opposite of work. They give satisfaction to those
performing them. In turn there are two types of such
activities. The first are antisocial activities that give
pleasure by inflicting pain or suffering on others. Social
costs usually outweigh benefits because benefits are transitory
while suffering is often long lasting or permanent. Third,
there are 'social' activities that impose no physical burden or
harm on anyone yet can give satisfaction or pleasure to all.
They include the most benign and valuable of human activities
such as love, learning and the Arts (Scitovsky 1989).
Yet another attempt to grasp the
ethical and moral dimensions of economic behaviour is developing
in two new sub-discipline: behavioural and experimental
economics. While providing meaningful insights into economic
behaviour they do not, at least yet, offer any basis for
modelling of the economy as a whole.
4.6 National Innovation System
Phillips and Khachatourians (2001), quoting
Metcalfe, define the national system of innovation (NSI) as
“that set of distinct institutions which jointly and
individually contribute to the development and diffusion of new
technology and which provides the framework within which
governments form and implement policies to influence the
innovation process. As such it is a system of interconnected
institutions to create, store and transfer the knowledge, skills
and artifacts which define new technologies.” The OECD
formalized the concept the knowledge-based economy in
1996 and then a blue print
for its members called National Innovation Systems (OECD 1997).
Governments around the world are now
consciously designing NIS’s in an effort to enhance their
competitiveness (Pagan 1999). Intellectual property rights
regimes can arguably be considered a critical part of the NIS.
The biotech sector is one of the chief objects of such NSI.
However, the role of multinational corporations is generating
stresses and strains on its successful operation in many
countries (Patel and Pavitt 1998).
For my purposes, the NIS can be defined a
nonprofit academic institutions partnering with government and
private for-profit actors to create networks of specialized
research centres in priority knowledge domains, disciplines,
sub-disciplines and specialties. Such centres are intended to
facilitate commercial exploitation of new knowledge and enhance
the competitiveness of the nation. In the process, three
important structural changes are taking place.
mandate of the university is changing. The medieval university
was focused on interpretation of old knowledge. This mandate
changed little following the Scientific Revolution of the 17th
century. With religious wars waging, the university –
Protestant and Catholic – were busy defending religious
doctrines and resisted the new experimental philosophy. In
effect, the university remained a training ground for elites in
traditional and proper ways of knowing. It was not until 1809
that the first research university was founded in Berlin
transforming the mandate of the university - traditional and
conservative heartland of Western knowledge - from
interpretation of old to the generation of new knowledge. Today,
the mandate of the university is arguably being enfolded within
the NIS transforming it to generation and commercial
exploitation of new knowledge (Nagy Nov. 3, 2005). As
predicted, this has produced a significant clash of cultures
within the university itself (Chartrand
1989). In turn this clash is causing the birth of the
third age of the university - from interpretation to generation
to commercialization of knowledge - including the teaching
2008). Biotech has been a major change agent in this
process producing a new breed - the entrepreneurial scientist.
The process itself, however, began in the USA with a change of
government policy concerning the use of federally funded
research. Until 1980 (the year of the first biotech patent),
the federal government held all rights to to results of such
research; after with passage of the Bayh-Dole Act, the
university and its employees - the professoriate - retained such
patron of the national knowledge-base, Government fosters and
promotes production of knowledge through arm’s length
institutions. Such institutions generally direct funding
according to peer evaluation. In Canada, for example, during
the last decade the federal government has endowed a number of
quasi-public foundations to support knowledge production,
e.g., “Canada Health Infoway Inc., received $500 million
from the federal government; others have received multiple
payments amounting to, for example, $300 million to Genome
Canada and $250 million for the Green Municipal Funds” (Auditor-General
of Canada Status Report, April 2002, 1.9). In the
past foundations, endowments or grant-giving councils were
involved in the production of knowledge for knowledge sake.
Today, however, as part of the national innovation strategy
these new foundations are concerned with ‘knowledge for
profit’. This means that commercial confidentiality veils many
of their activities from public scrutiny. This, in turn, raises
serious questions about the accountability of private interests
serving the public purpose, i.e.,
Government by Moonlight:
The Hybrid Parts of the State (Birkinshaw, Harden
and Lewis 1990) [Also see
my book review].
date, the NIS has been restricted to the natural & engineering
sciences. There is, however, no reason why it cannot be
extended to other knowledge domains and practices. For example,
national cultural policy corresponds to NIS in the Sciences.
The practices, with the notable exceptions of medicine and
related engineering, have not, however, been the subject of
NIS. Accounting and legal praxis are applied to develop NIS.
They have not themselves, however, been subjected to comparative
advantage analysis, nor networked into NIS nor held accountable
for their contributions – positive and negative – to
competitiveness. I suspect they will, formally or informally,
shortly be enfolded within the NIS framework. Arguably, heated
political debate in the United States concerning tort and
product liability represents the opening move towards seeing
national legal systems from a competitiveness perspective.
Similarly, the accounting profession in the United States is,
under the terms of the Sarbanes-Oxley Act of 2002, now subject
to oversight unknown before the Enron scandal and the collapse
of Arthur Anderson & Co. This too may be but a first step in
enfolding accountancy within the NIS web.