A Companion to the History of Economic Thought - Chapter 36 pps

Earlier, it was necessary for economic thought to enter policy discussion through either another discipline, such as philosophy or theology, or debate over current events.. Distinctive c

C H A P T E R T H I R T Y - S I X

Economics and

Economists in the

Policy Process

Craufurd D W Goodwin

36.1 ECONOMICS AND POLICY IN THE PREHISTORY OF ECONOMICS

Economists have usually been anxious to influence policy, varying only in their ability to do so and their willingness to admit it Before the development of a recognized economic science and an economics profession, they had difficulty being taken seriously Until perhaps the eighteenth century no separate body

of economics or applied economics literature was recognized Earlier, it was necessary for economic thought to enter policy discussion through either another discipline, such as philosophy or theology, or debate over current events It was soon discovered that unlike the physical or biological sciences, where policy could be based upon confident predictions about the behavior of key variables, the main economic actors were both difficult to predict and likely to change their behavior over time

Prior to the eighteenth century, the economy was thought to be less a potential source of progress and advance in human welfare than a cause of retrogression and danger Humans were seen as vicious and passionate creatures that could be

at their worst in the economy Unless restrained, they could do damage to others and to themselves Greek philosophers feared that human selfishness could lead

to monopoly, exploitation, maldistribution of income, envy, corruption, and the downfall of a just and efficient city–state devoted to the good life of its citizens Humans, therefore, had to be constrained in their economic activity Even rule

by a benevolent aristocracy could change quickly under economic pressures to tyranny or to mob rule

In the Middle Ages, Christian theologians added to the political hazards the danger that free-wheeling economic actors would encourage sin among selfish,

jealous, and misguided humans, and preclude salvation Economic activities seen today as efficient were viewed as sources of social conflict and injustice: in par-ticular, free market exchange, the taking of interest, and the accumulation of wealth without limit

Distinctive characteristics of the early policy process must be considered when assessing the impact of economic ideas on policy Until the nineteenth century, with few exceptions, government was personal and authoritarian, and the policy process consisted of a monarch, aristocrat, or tribal chieftain deciding how to solve a problem and taking action Representative legislatures and bureaucracies were unimportant Economic thinking could enter the policy process when someone was able to get to the key decision-maker and present a persuasive case This was done successfully by Plato and Aristotle through education (one of Aristotle’s students was Alexander the Great) and through a philosophic liter-ature that had economic policy injunctions embedded within it The Greek philo-sophers also acted as consultants to the state on various economic questions The Christian Church later looked to the Greek philosophers for answers to economic questions, and theology replaced philosophy as the primary trans-mission belt for economic ideas, through papal edicts, the confessional, treatises

such as Thomas Aquinas’s Summa Theologica, and direct intervention by

indi-vidual clerics Attention was directed to property rights, the taking of interest, and how to achieve a “just” price in the market The notion of all-encompassing laws, whether eternal, natural, or human, lay behind the policy judgments of the

“Scholastic doctors” of this era

During the late Middle Ages and the Renaissance, policy problems due to consolidation of nation–states and growing international trade faced economic thinkers, and their involvement in policy-making became close Indeed, most could not have imagined why anyone would engage in economic inquiry other than to seek influence Commentators, including self-interested participants in the controversies of the moment and personal advisers to political authorities, extended understanding of the economy by exploring tariffs, subsidies, colonies, public transport, monopoly, paper money, and different forms of taxation These topics were more macro than micro, embedded in issues of growth, national security, price stability, and employment

Some early literature has been called a “mirror for princes,” because it was constructed to tell a prince what he wanted to see, in all its implications Ideas did not begin in science and move to policy They went the other way Later com-mentators gave these early economic writers the title “mercantilist” and viewed them with distaste and suspicion Pioneering insights from such authors as Bernard Mandeville, Thomas Mun, and Dudley North have been clouded by the perception that they mixed inappropriately economic self-interest with policy debate

36.2 CLASSICAL ECONOMICS AND POLICY

During the eighteenth-century “Enlightenment,” the first coherent formulations

of an economic system emerged, without qualification for time and place The norm underlying these systems, in contrast to earlier concerns with state-building

and salvation, was the production of goods and services for the satisfaction

of human wants, consistent with individual and social morality It now became possible to discern policy implications and construct policy instruments with specific reference to a system Charges against earlier thinkers that proposals

were too ad hoc, too entwined with advocates’ self-interest, or dependent on

meta-physics or religion to be persuasive could now be answered with the argument that good economic policy was rooted in scientific economic theory

An early expression of such a system came from the French physiocrats, led by the Court physician François Quesnay and A R J Turgot The physiocratic eco-nomic model emphasized uninterrupted flows of funds throughout the system

and the interconnectedness of all sectors, as illustrated in the Tableau économique.

It emphasized the distribution of the economic surplus (produit net) from agricul-ture, the accumulation of capital (avances), economies of scale (grand culture), taxes that would not interfere with production (impôt unique) and suitable market prices (bon prix) The physiocrats denounced feudal and mercantilist restrictions,

especially taxes that distorted flows of funds They wanted state revenue to come from landowners, the only ones that commanded a surplus The physiocrats happily accepted positions of influence within government, as their mercantilist predecessors had done But to a greater degree they mistrusted the state and made famous the celebrated and enduring injunction to leave markets alone:

“laissez faire, laissez passer.” The physiocrats impacted numerous policy areas,

including international trade, the administration of colonies, and even the debate over the constitution for the new United States of America Like the earlier Scholastics, the physiocrats looked for actions and policies in the economy that were “just” and “natural.”

Another great Enlightenment vision of a distinct economic system appeared in Scotland, first in the essays of David Hume and then in the great treatise of

Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776).

This Scottish vision drew heavily on the physiocrats, especially for an under-standing of the role of capital, but it focused more on how individual buyers and sellers in unregulated markets unintentionally achieved social goals Smith pro-vided an answer to the question posed by economic thinkers of the previous century about how the natural selfishness of humans could be reconciled with the common good Smith’s answer was that competition in the marketplace dir-ected selfish suppliers to produce goods at least cost and in quantities desired

by demanders Smith also studied complex “noneconomic” social forces, such as the “sympathies” of its members, and he insisted that these too needed to be included in policy-making Smithian doctrine implied a role for economic advisers in the state, but a more detached and consultative role than an activist one Economists, or “political economists,” challenged innumerable inherited practices and institutions that prevented market efficiency: monopolies, colonies, guilds, protective tariffs, subsidies, and endowments for education The concep-tion of a scholar of the economy newly emerged, removed somewhat from the world of affairs but able to extract policy lessons from a generalized model In principle, this advice was uncorrupted by personal self-interest or superstition of any kind The practice was rather different Smith himself was far from being a

hermit He was a close observer of public affairs, an enthusiastic clubman, and a willing adviser to government But his influence came from his detachment from the particularities of issues and his evident commitment to the public interest His appointment as commissioner of customs came after his reputation as policy sage was well established

The tradition of close attention to, but scholarly distance from, the hurly-burly world of public policy continued, in principle at least, into the nineteenth century

A seeming paradox persisted, however: despite the classical economists’ commit-ment to principle and to detachcommit-ment from activities that might corrupt their policy judgment, they were not ivory-towered scholars With few exceptions, they were not engaged in full-time research or teaching, but were fully embed-ded in the institutions that made up the economy, and about which they wrote:

T R Malthus as well as James and John Stuart Mill with the East India Com-pany, David Ricardo as a successful stockbroker, Henry Thornton a banker, Robert Torrens a Member of Parliament, Richard Whateley an archbishop, and so on They seldom functioned as modern professional economists in, or at the ear of, government Their response to any charge of partiality was that they explored questions from first principles and thought of themselves as having no client, except perhaps the broad community of producers and consumers The diverse locations of classical political economists mirrored the milieu in which policy was then formed There was no large centralized government; makers of policy were embedded mainly in the private sector of agricultural producers and financial corporations, the professions, the aristocracy, the Church, and local government The apparent dispersion of classical economists throughout economy and society reflected this prevailing dispersion of political power

The policy subjects that interested the classical economists, and on which they advised government, grew from their theories: population and emigration, land settlement, monopoly, commercial restriction and subsidy, money supply, public finance, national security, and empire They also had valuable things to say on other current issues, from public education to the Factory Acts and treatment of paupers

During the classical period, several important devices emerged by which polit-ical economists might influence policy Decisions that influenced the economy were made in both Parliament and institutions such as local councils, guilds, the army, and the Church Policy influence required that these institutions be reached

in the best ways possible The political economists gave serious attention to issues and ideas through discussion groups with eclectic memberships – the Political Economy Club of London, the London Statistical Society (later the Royal Stat-istical Society), and The British Association for the Advancement of Science, to mention only several of the most prominent Many periodicals began to mobil-ize the educated middle classes to think seriously about the economy and other subjects The most influential paper on economic topics was the weekly London

Economist , published still today, but there were also daily papers (The Morning

Chronicle, The Scotsman, and so on) that specialized in economic policy discussion, and monthlies and quarterlies that addressed subjects in greater depth, often

from varied ideological or methodological perspectives (the Westminster Review,

Quarterly Review, Blackwood’s, North British Review, and so on) For the lower

reaches of society, fiction – as in the novelettes of Harriet Martineau – conveyed policy lessons on economic questions: whether to join a trade union, how much

to work and save, or how many children to bring into the world Fiction was used also by the critics of classical economics, such as Charles Dickens and Thomas Love Peacock Throughout most of the nineteenth century, the Church remained sympathetic to many of the policy conclusions of classical political economy, and Church materials of various kinds were another medium through which eco-nomists could be heard

36.3 FROM THE ART TO THE SCIENCE OF POLITICAL ECONOMY

The great classical political economists – Smith, Bentham, Ricardo, Malthus, Torrens, and the two Mills – viewed the construction of economic policy as an art They appreciated the complexity of the process The objectives might be several; there were innumerable parties at interest to be taken into account; vari-ous actors had to be mollified or foiled; and new policy mechanisms had to be imagined Colonial policy is an example Here was the problem of balancing the interests of the metropolis and the colonies against each other Political eco-nomists agreed that the large monopoly companies had been deeply problematic and they recoiled at more bureaucracy Yet there was little inclination to give up India or the possessions still governed by companies How about the American colonies? Where exactly was their benefit to the mother country? The classical economists answered “in trade,” but that trade did not require a dependent relationship Smith envisioned something like the loose British Commonwealth that ultimately emerged to unite metropolis with dependencies But there were competing visions Bentham saw the colonies as an exciting laboratory for reform Some disciples of Malthus welcomed a haven for excess population The Ricar-dians worried about a diversion of scarce capital to the colonies Edward Gibbon Wakefield discerned a fortuitous symbiosis between old and new countries, through which the excess people and capital in one could find outlet in the other All of these ideas required creative policy thinking that went beyond any simple interpretation of a single model that demonstrated the gains from trade

The mid-nineteenth century presented economists with exciting policy chal-lenges that required vision and imagination Several young economic theorists sought to transform economics into a more serious science, self-contained and rigorous, in the image of the physical and biological sciences, which were them-selves then being transformed Aspects of this transformation from classical polit-ical economy to what would come to be known as neoclasspolit-ical economics included academicizing the subject via enclosure within colleges and universities Curricula, departments, chairs, textbooks, faculties, and arcane terminology were used to define the subject And just as the tradition had been long established that lawyers talk only to lawyers, so in economics noneconomists were increasingly excluded from “serious” conversation No more, as with classical political economy, could archbishops (Whateley) or postmasters general (Fawcett) become pillars of the

profession This transformation had at least three outcomes for economic policy First, the range of policy issues perceived as legitimate for scientific discussion was narrowed For example, consumer tastes now lay outside the limits of scient-ific inquiry in economics, as did population growth and relations among social classes Economists thought they had much to say about how production and exchange could achieve maximum efficiency; but how the product was then used was somebody else’s business Secondly, in the English-speaking world at least, with memories of the mercantilists, leaders of the profession insisted that eco-nomists not become dangerously close personally to policy areas where they offered advice Their recommendations must remain untainted by special interest

In particular, they should not normally seek or take up posts in government The situation in the German-speaking world was somewhat different Responsible economic advisers elsewhere might serve on special committees or commissions

of inquiry, testify before the legislature, and occasionally deliver carefully bal-anced public utterances But they should not become co-opted or reach a position where their scientific judgment might become clouded or silent Thirdly, eco-nomists should expect that since they have all supposedly mastered the same analytic tools, and they all have access to the same data, they should all reach the same policy conclusions The cacophony of voices and free-wheeling debate with noneconomists on almost any topic during the classical period could no longer

be tolerated In the English-speaking world, Alfred Marshall did much to specify this new stance His own position was that the competitive market system could solve most economic problems spontaneously and without outside intervention, and that many of the system’s most serious problems came from meddlers, either self-interested rent-seekers or well-meaning government officials Professional economists should not worsen the situation with their own meddling Marshall’s successor at the University of Cambridge, Arthur Pigou, developed the field

of welfare economics that attempted to specify the limits within which eco-nomists might contemplate intervention in markets The notion of utility that was central to the new neoclassical economics, the very personal objective of the self-interested economic actor, played an important part in constraining market interference Since it could not be demonstrated that individual utilities were in any way commensurable, beyond an efficiency condition that came to be known

as Pareto optimality, no legitimate case could be made using economic theory for governmental intervention or for redistribution of income and wealth This restrained posture toward policy was extended by disciples of Marshall and others, notably leaders of the University of Chicago tradition such as Henry Simons, Frank Knight, Milton Friedman, George Stigler, and Gary Becker

36.4 A MORE ACTIVE ROLE FOR THE ECONOMIST

IN ECONOMIC POLICY

While the restrained Marshallian role for government and the economist was refined during the late nineteenth and early twentieth centuries, other attitudes emerged among economists

Ironically, disciples of the revolutionary thinker Karl Marx, most of whom had

a deep interest in public affairs, were enjoined by their master from contributing

to policy that was incremental, remedial, and directed to problems of the moment The Marxian view was that inexorable change was always taking place in the means of production, and therefore the capitalist market system, like all systems before it, was becoming increasingly obsolete, and indeed was beyond repair The mounting “contradictions of capitalism” would necessarily lead sooner or later to the only real solution to economic problems, revolutionary change in the system A good Marxist economist should not become involved in policy that might impede the onset of the revolution by ameliorating the conditions that would impel the change The Marxian policy agenda was to watch problems become worse in the short run so that they could become better in the long run But this left the Marxian economist out of the policy loop

Beside the Marshallian and Marxian postures toward the appropriate place for economists in public policy, both of which coached restraint, other positions emerged that counseled a stronger role for the economist One tradition came to

be associated with the politics of social democracy, which claimed that the cap-italist market system was unfair to many of its members Economists, therefore, had a responsibility to work with politicians and bureaucrats to rectify imbalances and injustices On the European continent, this tradition led to experiments with national health insurance and what is now called in the United States “social security.” In Britain, detailed surveys of conditions of poverty during the depressed 1890s provided the impetus for the Fabian Society, which included economists among its members, to call for various programs to change the patterns of income and wealth distribution – to “level up and level down.”

A substantial number of economists during the nineteenth century approached the “economy” as a concept limited to a particular time and place, and continu-ally changing because of technological and cultural movement as well as accidents

of history The potential role for the state, and for the economist as a guide for the state, seemed virtually limitless These “historical” economists called for care-ful empirical study of particular circumstances and the preparation of proposals for reform This tradition was given impetus in both Germany and the United

States by Friedrich List’s National System of Political Economy (1841) It supported

varied policies toward economic development through a series of “stages,” each requiring distinct treatment The German historians’ position implied a rich and creative role for economists in government, and they served as central bankers and ministers of finance, identified in a derogatory way by their critics as “socialists

of the chair.”

In the United States, a distinctive body of economic thought emerged in the twentieth century that called for an active role for economists in policy, influ-enced by both the ideas of the German historical school and an evolutionary perspective on economic change generated by Thorstein Veblen and his disciples These American institutionalists, as they were called, suggested that just as

a physician treated diseases and genetic faults in the human body, so they as physicians to the body politick should work with governments to make the economy better Wesley C Mitchell, John R Commons, Clarence Ayres, Rexford

Tugwell, John Kenneth Galbraith, and other economists in the institutionalist tradition advised legislators and bureaucrats and accepted short-term assign-ments in government Much complex economic legislation on such topics as labor relations, farm price supports, worker health and safety, and anti-trust, as well as the institutional infrastructure that emerged from President Roosevelt’s New Deal, bore the stamp of these economists’ work FDR’s “Brains Trust” was one of the first advisory bodies to a head of state that contained prominent economists

36.5 THE POLICY CHALLENGE OF

TWO WORLD WARS AND DEPRESSION

Two developments in the twentieth century prompted economists to rethink their participation in the making and implementation of economic policy: conflict

on a massive scale between highly complex market economies, and global stagna-tion that seemed unwilling to disappear on its own

World War I was fought mainly without the participation of professional eco-nomists in positions of real power Businessmen, personified in the United States

by the financier Bernard Baruch, were the main advisers to government, and as a result they took much of the blame for the inflation, ineffectiveness, and corrup-tion that seemed to characterize economic aspects of the war effort World War II was very different; then economists took much of the credit for success Similarly, the Great Depression was initially little understood by economists Businessmen, especially those in the Hoover administration and to some extent also in the Roosevelt administration, were again given the first opportunity to find a solution

By the time their efforts failed, some economists, at least, were confident that they had the answer

A critical factor in the new positions and reputations gained by economists

in government by the onset of World War II was the theoretical contribution of John Maynard Keynes Keynes’s macroeconomics emphasized the importance and possibility of controlling, or at least affecting, aggregate demand to restrain inflation in wartime and to sustain employment in recession Many economists were uncomfortable with what seemed an entirely new perspective Others found

it an exhilarating new policy frontier and perceived that they might be useful as never before Most importantly, few other economists had good ideas to chal-lenge the Keynesian position on how to mobilize the economy successfully for war and how to keep the workforce employed when war ended The Keynesians insisted that government needed to determine both how to manipulate the com-ponents of aggregate demand and precisely how much manipulation should be undertaken To the extent that these questions had previously been asked in government at all, they had been addressed mainly by central bankers and min-isters of finance The Keynesian economists’ argument was that these questions could best be answered by professional experts, who were detached from polit-ical controversy Some insisted that the voting public should participate in this inquiry that affected them so much Keynes postulated an economic system that

depended heavily on economic actors’ psychological behavior throughout inter-locking markets, and readily conceded that this could not easily be understood Humans were not some kind of rational automatons responding to utility and pro-duction functions in easily predictable ways Rather, they were a heterogeneous mass, or herd, responding to various behavioral imperatives, some of which, like King Midas’s thirst for gold, might lead to their self-destruction Keynes portrayed

a system with serious pathological flaws, but one that was correctable through judicious public intervention in what the prominent journalist and interpreter of Keynes in America, Walter Lippmann, called “the compensated economy.” Between the two world wars, several private philanthropies actively supported economists’ early efforts to discover ways of restoring prosperity and reducing the likelihood of war Even before World War I, The Carnegie Endowment for International Peace had started a program on the relationship between the eco-nomy and conflict, headed by the distinguished Columbia University economist John Bates Clark The Rockefeller Foundation, in attempts to make economics more useful to society, supported projects across Europe and America to under-stand better the nature of business cycles In the United States the economics discipline responded enthusiastically to these offers of financial support, and sev-eral professional bodies mobilized to manage the resources, notably the National Bureau of Economic Research, the Social Science Research Council, and the American Council of Learned Societies The business magnate Robert Brookings endowed his Brookings Institution in Washington, for research and the training

of economists directed to such priority areas as improved government budgeting and foreign economic policy These philanthropic initiatives by the private sector led to more involvement of economists in government: for example, Wesley Mitchell, founder of the National Bureau, helped to sort through the pros and cons of some centralized economic planning; and Leo Pasvolsky, head of the research program at Brookings on international economic relations, became an important senior adviser to Secretary of State Cordell Hull, who was active in planning the new United Nations

36.6 WAR AND DEPRESSION CONCENTRATE THE ECONOMIC MIND

In the prosecution of World War II – and in contrast to that of World War I – economists were employed throughout government: in both macroeconomic agen-cies such as the Federal Reserve, the Treasury, and the Budget Bureau, where Keynesian notions of demand management seemed demonstrably useful; and in many new institutions created specifically to wage war, where the problems were mainly microeconomic in nature, such as how to arrange for the production and distribution of strategic materials, and how to ease back into an unregulated market economy when war ended Some of the most enthusiastic young converts

to macroeconomic doctrine, exposed to Keynes’s ideas in Alvin Hansen’s seminar

at Harvard University and elsewhere, quickly found themselves in positions of great policy influence: for example, Lauchlin Currie at the Board of Governors of the Federal Reserve, and later in the Roosevelt White House; and John Kenneth

Galbraith as deputy director of the Office of Price Administration In the military services, wartime also revealed new roles for economists, in the formulation of strategy and even in the selection of targets for air raids, a task assigned to the young international economist Charles Kindelberger, among others Micro-economics as the study of optimization subject to constraints demonstrated how

it could offer valuable, even counterintuitive, guidance on such prosaic questions

as how to aim a machine gun

The onset of serious recession in both Europe and America in the 1920s and 1930s, decades bracketed by the world wars, provided an auspicious moment for economists to claim a stronger voice in policy-making These years yielded a stream of questions about which they, more than any others, could be expected

to have some answers But there was not the steady progress in making their voice heard that happened later in World War II In both Britain and the United States, various committees and commissions were appointed on which eco-nomists sat to seek an end to the depression: for example, the Committee on Social Trends appointed by President Hoover, on which Wesley Mitchell was an influential member; and the Economic Advisory Committee appointed by British Prime Minster Ramsey McDonald, that included Keynes The problem then may have been, in part, that economists were far from speaking with one voice At one extreme, some economists concluded that no action should be taken and that the economy would heal itself; at the other extreme, other economists insisted that the depression had demonstrated that the capitalist market system was hope-lessly flawed, and it would be only through radical structural reform, such as that proposed under the National Recovery Administration, introduced as part

of the first New Deal, that the system could again be made to work It would take the new status gained by economists during World War II and the increasing authority of Keynesian doctrine to cause their ideas about employment, inflation, and growth to be taken very seriously

In the 1930s and 1940s, in addition to questions of war and depression, worries persisted about the treatment of natural resources Over all hung the image of the dust bowl, with clouds of topsoil drifting away from the farm belt forever, contrasted with devastating floods that every year hit the Midwest and South Americans saw the closing of the real and symbolic frontier and came to appre-ciate that they no longer had the option of dealing with destruction of the land-scape through the slogan “Go West, young man.” Worries about the potential loss of natural resources forever were reflected in the creation of national parks, dam construction, land reclamation, and planning in the context of river valleys,

as in the case of the Tennessee Valley Authority The presence of many special interests in these developments strengthened the case for independent experts, and economists presented themselves as prime candidates Nagging questions were asked repeatedly in debates over natural resources, in which increasingly the economists took part, including the following: Were the nation’s resources being squandered by a careless society? Would there be enough farmland, water, petroleum, coal, and rare minerals for the current generation’s children and grand-children to live the good life? Could we ever fight a world war again after so many of our key resources had moved offshore? Could we now be held up by