Part Three: The Problems of Economics as a Science

To begin with a brief and historic example, consider two situations. In the first situation person A and B (Alfred and Bumblehurst) have $1 and $100 respectively. In the second scenario person A and B have $2 and $95 respectively. In the first scenario overall quantitative money is the highest. In the second scenario it is lower by $4; however, person A has doubled his money. On a purely quantitative metric the first scenario is better. By purely quantitative I mean just examining the situation that leads to most dollars created. Considering what is ‘best for society’ might lead someone to argue scenario two is better. This epitomizes the trade-off between capital and labor. Re-appropriation of capital can destroy efficiency, but maximize societal welfare. Most economists have eschewed the extreme sides of the argument. The first being that free-markets are always the best, and the second being that complete redistribution is always the best. However, I will now present an argument from each (extreme) side from Bastiat and Marx. These two pieces are not in ‘conversation’ with each other though. Each one will have some strong points and some faults or over-simplifications. What is more rampant is a failure to consider situations that don’t fit well into their models. My end goal and argument in the following part of my paper is to focus on how these two perspectives, from intelligent economists, are not based on core economic differences. Each writer, Bastiat and Marx, think that their argument is grounded in economic theory. However, I believe they are each coming to different economic conclusions based on their assumptions of what constitutes an optimal efficient society. In my initial example they would each choose a different scenario based on what they believe is best for society.
My argument might sound overly ambitious and choosing just Marx and Bastiat is not a proper sample of theorists. However, my broader point is that the differences in finding socially optimal efficiency is typically not based on a strong purely scientific theory, which is detached from ethics and morality. Rather, different individuals, demographics, and societies, start with different assumptions on ethics and morality, right and wrong, and from this starting point their economic analysis leads them to different conclusions. Both Marx and Bastiat were brilliant economists. It was their drastically different ethical and moral assumptions which led them down such different paths.

Marx built his critique on capital off of Ricardo’s economics. Often he used Ricardo’s theory as a premise, but his extrapolations did not logically follow. The Labor Theory of Value was an argument made by Ricardo that has since been discarded. Marx built a large part of his argument off of this theory. However, the arguments Marx made, which were supposed to logically follow this already incorrect theory, were tenuous. His lament was that the surplus value created by production was kept by the capital and not shared with labor. Since the workers didn’t control the means of production they were paid a pittance whilst they made those who owned the capital rich. In the academic fields of Political Economics and Economics this idea has long been considered wrong. Some fringe scholars still hold on to this belief, or derivatives of the theory, but there are not many of them.

Marx’s core failure was that he did not appreciate that capital helps money and labor find new and more efficient uses, and that labor derives its value from the work done and doesn’t deserve a share of the capital from the means of production. However, social stratification and income inequality were rampant during Marx’s time. The idea of a poor proletariat ever having the opportunity to invest capital was difficult to grasp. Income inequality is rising again, and as a result groups of frustrated workers, who identify as labor, are very frustrated.

Frederic Bastiat was an Economist in the 19th century. Around the same time as Marx he wrote an accessible and clear piece on the uses of Capital. While his piece counters many of Marx’s arguments, he and Marx would agree on many topics as well. He primarily built his argument upon the writings of Adam Smith and, more importantly, Ricardo. However, he embellished on their ideas and was more adept at defending criticism. His essays on machinery and credit are the strongest at arguing for the importance of capital in production. The arguments are simple and clear. In the following paragraph I will heavily draw from his work.

Marx and Bastiat would both agree that machines are the most powerful embodiment of capital and the true “means of production” in the industrial age. Bastiat’s arguments often start by quoting an imaginary opponent of his, and he uses these prompts to explain his theories. He starts with a quote from an imaginary opponent of his that states, “A curse on machines! … depriving persons of work, and therefore of wages and bread.” And then quickly talks about how he is puzzled anyone could possibly believe such a statement. His lack of modesty aside, he is correct. Bastiat starts by explaining the wonders of man and steers into a remark, “Men have a natural propensity to make the best bargain they can…that is, they like to obtain as much as they possibly can for their labour.” Bastiat argues that because of this trait, man might turn to a foreign or mechanical producer to obtain the most he can for his labor. Often a legislator will prohibit foreign or mechanical competition. This is most certainly misguided though. Imagine a capitalist named James B. He has two francs and pays two workmen. However, he discovers a way to get rid of one worker through machinery. Or imagine a more relevant example; James B., the owner of a firm, outsources a job to India. What is seen is an American worker is discharged. Bastiat then imagines criticisms James B. (or a Wal-Mart) might receive:

“See how misery attends civilisation; this is the way that liberty is fatal to equality. The Human mind has made a conquest, and immediately a workman is cast into the gulf of pauperism. James B. may possibly employ the two workmen, but then he will give them only half their wages, for they will compete with each other, and offer themselves and the lowest price. Thus the rich are always growing richer, and the poor, poorer.”

These imaginary frustrations sound nearly identical to those of modern day labor. Only instead of fearing machinery, they fear having their job being ‘outsourced.’ The argument Bastiat creates is similar to ones made daily by public figures. Even people who might accept these arguments as being reasonable often fail to make the connection when it happens outside of an economic textbook. And even those who study the topics and will argue in favor of Bastiat all their lives will quickly find ways to rationalize and make exceptions when their poor and elderly parents are the ones who lose their employment due to outsourcing. Now Bastiat explains why, despite a worker losing his job or working at lower pay, James B. made a smart choice. James B. now saves one franc on labor. So there is now a capitalist somewhere with an unused franc, along with an unemployed worker. The relation between supply and demand has not changed.

To continue, the final result is increasing advantages for all parties. The capitalist, who successfully invests in new machinery or finds cheaper labor in a foreign country, benefits and is rewarded. The savings he gains are now spent in other ways: either as more investments or as more consumption. Soon competition ‘obliges him to lower his prices in proportion to the saving itself.’ As a result the consumer of his goods, the public, and labor are now benefiting. Bastiat does not go into detail here, but consider the following scenario: At first firm A begins outsourcing and saves lots of money while still charging the same amount. However, once all firms start outsourcing, they bid each other down since they are all saving money. As a result the general public now receives a cheaper good. And the savings that these consumers now have “creates a fund whence wages may be supplied, and which replaces that which the machine has exhausted.” In other words, the benefits from their savings outweigh the costs of the machines. And to be clear, the machines do have a cost. A worker lost his job in the short-run.

The truth is that this is the part where the theory has always failed. Not logically, but it has failed to be convincing. What Bastiat wrote was a compelling argument that, while not all encompassing for the more nuanced variables, certainly is sufficient to defeat the majority of arguments against outsourcing or automation. So let’s consider a couple scenarios that fall into each of the categories. Imagine a call center is set up in the US. The firm realizes that if they outsource the call center to India they can lower the price of the product that they are supporting from $100 to $95. Based on their market analysis their average consumer would prefer this option. Now an entire call center has fired all their employees. However, the customers of the firm have saved money. This is a more efficient outcome. While it can be difficult to understand how these small savings are worthwhile in a huge economy. I think it is also difficult to imagine how 20 unemployed workers is significant in a huge economy. However, as we have seen in our general economic success over the past couple centuries, allowing for efficiency and cost-cutting to exist does work in the long run.

So the question becomes if Bastiat is so smart and correct, and Marx is so wrong, why are the same arguments made about the efficiency of capital two centuries later? This is a difficult and vague question. I will go over a few of the more well understood and reasonable causes. Imagine you are a running for president of a state. Similar to a previous example there is a call center. Everyone lost their jobs due to outsourcing. The benefits of this outsourcing are lower costs for consumers and the costs are jobs in your state. In the long run innovation and overall consumer satisfaction is destroyed if firms aren’t allowed to pursue efficiency with trade. To take this thought experiment a step further; imagine all the savings you realize every day due to outsourcing. It’s easy to not appreciate all the personal savings you otherwise wouldn’t have if firms couldn’t pursue efficiency. This is why Bastiat calls it the ‘unseen.’ It’s easier to see someone losing a job than small savings across a large population.

But in the short-run it’s easy to not appreciate small savings. Imagine if you enact a fee for firms that outsource, to encourage them to keep telemarketing jobs in the US. By doing that you will gain a huge block of votes from telemarketers who want their jobs back. By not doing it you will likely not lose any votes from people who will now need to pay a couple more dollars each year. To take this example a step farther, consider that while the gains for consumers are greater than the losses for unemployed workers. The consumer gains are also spread across all 50 states whereas the losses are centralized in just the state. So even for a hyper-rational and perfectly informed populous in a state it might still be to their benefit to prohibit outsourcing.

In the year 2012 we have many more amenities than in Marx’s and Bastiat’s time. During Marx’s time as an author and political-economist the industrialization of the world drastically changed the labor and capital markets. The opulence of the bourgeois and the abject poverty of the working class could not have appeared correct. And often it still strikes us as wrong when we walk on the streets and see so much suffering as sky-scrapers controlling billions of dollars of capital do not drop a cent on to the sidewalk. I was walking in the city today and passed a homeless teenage girl with blood smeared on her face and a mentally ill man below a building with firms that manage billions of dollars daily. This is normal for me, and the dichotomy is even more terrifying in the emerging markets factories that produce goods and services consumed by the developed world. This is where Marx pulls on the pathos of an audience captivated by centuries of pain, even if his thoughts on capital are logically wrong. It is difficult to think of a subject that more divides economists. However, followers who embrace free-markets as being separate from government and believe these markets should not be influenced by the general will of the people and their morality live in an equally false world. Ayn Rand was one philosopher who made this argument. Whether it is Marx or Rand though, the issue ends up being to what extent government should attempt to re-appropriate market goods.

Marx was utopian. He believed human nature wasn’t confined to the assumptions of Economists (and so many others). It is possible Marx’s beliefs and ideals would work if human nature were more altruistic. Economists assume people will cheat, steal, and act as greedily as possible; and that a good system will prevent them from harming others and let them put their greed to business that benefits all. Using past information it is reasonable to say that Marx’s hopes were too lofty and that the assumption of Economists is correct. But could Marx have been partially correct? One of Marx’s reasonable demands was that children receive free education and not be forced to work in factories (a less reasonable demand was abolition of private property). Child labor was acceptable in the industrializing US and we now have laws prohibiting it. It is important to question if our morality truly has shifted, or there are other variables that explain why we now use taxpayer money to educate our children.

A simple answer is that the utility function of ‘societal maximization’ changed. In other words, it is now more worthwhile to society to educate children instead of having them perform hard labor. Whereas in the past there were so many new factories that needed labor, and since education was less important, it didn’t make sense to educate children – they were more useful in factories. This was also a time when those children would have likely working on a farm just a couple decades earlier. Their parents couldn’t support an entire family without the children working as well. The purely ‘Economic Textbook’ answer is wrong. While it is the primary factor, it is not the only factor. To any person who has felt the sting and frustration of poverty. To any person who has lost a job because of the color of their skin or gender. To a family of immigrants who has had to work twice as hard and been denied employment due to a racist manager. For college students who have worked tirelessly and done everything they felt was right, only to graduate into unemployment. For all these people this answer is cruel. And it turns them against the field of Economics. The beauty of rational agents and labor markets graphs does not sooth the sting of crippling debt from hospital visits for a spouse with a chronic illness. The world is not so simple.

2 thoughts on “Part Three: The Problems of Economics as a Science

  1. Wow. Best one I have read yet. Very balanced, I like the contrast of Bastiast and Marx. I think you made a very fair analysis. I was under the impression that Smith coined the Labor Theory of Value though..

    • They all built on each other. Ricardo added its substance. I’ll double check though–perhaps I’m mistaken.

      My next part is on Schumpeter who wonderfully combined the two 🙂 thanks for reading!

      Sent from my iPhone

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