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post-autistic economics
review In this issue: Forum on
Economic Reform In recent decades the alliance of neoclassical
economics and neoliberalism has hijacked the term - Erik S. Reinert - Matthew McCartney Symposium on Reorienting Economics (Part III) Dialogue on the reform
of economics with Tony Lawson’s Reorienting Economics as focal
point - Jeroen Van Bouwel - Bruce R. McFarling |
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Development and Social
Goals: Balancing Aid and
Development to Prevent ‘Welfare Colonialism’[1] Erik
S. Reinert (The Other Canon
Foundation, Norway & Tallinn University of Technology, Estonia) This paper was prepared for the
High-Level United Nations Development Conference on Millennium Development
Goals, New York, March 14 and 15, 2005. ’…just as we may avoid widespread physical desolation by
rightly turning a stream near its source, so a timely dialectic in the
fundamental ideas of social philosophy may spare us untold social wreckage
and suffering.’ Herbert S. Foxwell,
Cambridge economist, 1899. Stating that creating economic development and employment always has
been the best social policy may appear to be a particularly silly statement.
However, today – with the Millennium Goals – the world community
is approaching the social problems in the poor countries in a way which in my
view makes this statement highly relevant. The Millennium Goals are noble
goals for a world which sorely needs action to solve pressing social
problems. Compared to how the world has solved problems of poverty over the
last 500 years, however, the Millennium Goals represent completely new
principles, the long term effects of which are, in my view, neither well
thought through nor well understood.
In this paper I shall attempt to explain why I do not think the
Millennium Goals represent a good social policy in the long run. The novelty in the Millennium Goal approach lies in the large emphasis
on foreign financing of domestic social goals rather than
developing/industrializing countries so they themselves, internally, can
solve their own problems of redistribution. Disaster relief used to be of a
temporary nature. Now, with the disastrous lack of economic development in
many countries, disaster relief finds a more permanent form in the Millennium
Goals. In countries where already more than 50 per cent of the government
budget is financed through foreign aid, huge additional resource transfers
are planned. One big question mark is to what extent this approach will put a
large group of nations permanently ‘on the dole’, a system
similar to the ‘welfare colonialism’ which will be discussed at
the end of the paper. The question is similar to that of starting foreign
wars: what is our exit strategy? Several UN Development Decades were only of limited success. In this
perspective the Millennium Goals may appear as the United Nations
institutions abandoning the project of developing the world poor, abandoning
the effort to treat the causes of
poverty and instead concentrating on an effort that to a large extent attacks
the symptoms of poverty. In this
paper I shall argue that in my view too much of the development effort has
been abandoned: to a considerable extent palliative
economics has taken the place of development
economics. Indeed the balance of
development economics – radically changing the productive structures of
poor countries – and palliative economics – easing the pains of
economic misery – is, in my view, the key issue, and I think we are
planning for a serious imbalance where the extremely high costs will be much
less important than the long term negative effects. There is little debate
around key issues. It is unfortunate that the Millennium Goals have acquired
the proverbial status of motherhood and apple pie, institutions that no one
in their right mind will speak against. I shall still make an attempt.
How we used to deal with
problems of development
In terms of the number of nations and number of people lifted into
relative wealth, this re-industrialization plan was probably the most
successful development project in human history. The fundamental insight
behind the Marshall Plan was that economic activities were qualitatively
different, those of the countryside (which we could call diminishing returns
activities, or agriculture and raw materials) differed from those of the
cities (which we could call increasing returns activities, or industry). In
his famous June 1947 speech at Harvard, US Secretary of State George Marshall
(who was later to be awarded the Nobel Peace Price) stressed that ‘the
farmer has always produced the foodstuffs to exchange with the city dweller
for the other necessities of life’. This division of labour, i.e.
between increasing returns activities in the cities and the diminishing
returns activities in the countryside, was ‘at the present
time…threatened with breakdown’. He then made a remarkable
recognition of the cameralist and mercantilist
economic policy of previous centuries: ‘This division of labor is the basis of modern civilization’. Civilisation requires increasing
returns activities, something that economists and politicians from Antonio Serra (1613) to Alexander Hamilton, Abraham Lincoln and
Friedrich List had already been saying for a long time. The principles behind
the toolbox used by nations going from poverty to wealth through the creation
of ‘city activities’ (Appendix 1) have been surprisingly stable
from when they were first used by Henry VII of England starting in 1485 until
their use in Korea in the 1970s. I claim that many of today’s problems
are due to the conditionalities of the Washington
Institutions classifying the toolbox needed to create increasing returns
activities – a toolbox employed by all countries that developed after
Venice and Holland – as ‘illegal activities’. After World War II, the toolbox did not produce the same success in
every country. The most successful countries temporarily protected new
technologies for the world market under competition.(e.g. Korea). The least
successful permanently protected mature technologies for often small home
markets under limited or no competition (typically the small countries of
Latin America). However, the key fact here is that – from Mongolia to
Russia and Peru – this inefficient industrial sector produced higher real wages than these same
countries enjoy today when this structure has been considerably weakened[2]
(See Figure 1 http://www.btinternet.com/~pae_news
/ReinertFigure1.htm). For centuries it
was understood that having an ‘inefficient’ industrial
(increasing returns) sector produced higher real wages than no industrial
sector at all, and that this ‘business inefficient’ sector ought
to be made more efficient rather than being closed down. In its most simple form this argument is born out of the inclusion of
both increasing and diminishing returns in trade theory, as the starting
points respectively of virtuous and vicious circles of growth or poverty. A
praxis ignoring these mechanisms may cause factor price polarization rather
than factor prize equalization. Increasing returns, virtuous circles, and
large economic diversity were first established as necessary elements for
wealth by Serra (1613), who specifically says these
mechanisms are not available in the agricultural sector. The principle thus
created was understood almost continuously – with brief interruptions
– up until and including the Marshall Plan, but was in practice
abandoned with the Washington Consensus. Deindustrialisation used to be
something one would impose on a vanquished enemy, like on France after the
Napoleonic War. Since the 1980s, ‘structural adjustment’ produced
this same effect in many poor countries. Ruling theory at the time said this
would not matter, to the contrary, a free trade shock would – in the
vision of first WTO Secretary General, Renato Ruggieri – unleash
‘the borderless economy's potential to equalise relations between
countries and regions’. In the 1930s, placing the gold standard (Keynes’
‘barbarous relic’) and budget balances as the untouchable core of
economic theory and practice locked the world into a sub-optimal equilibrium,
for a long time preventing Keynes’ policies to be carried out with the
approval of mainstream economics. In a similar way, placing free trade as the
ideological centrepiece of development policies – to which all other goals become subservient – since the
fall of the Berlin Wall has locked the non-industrialized countries into a
very sub-optimal equilibrium. In my view, rather than continuing world
policies based on the most simplistic version of mainstream trade theory, we
must again take the conflict between free trade and real wages in
non-industrialised countries seriously. A specialisation in diminishing
returns activities with increasing population pressures also has serious
environmental consequences.[3] In my opinion the poverty we can observe in so many countries in the
Third and former Second World is not caused by transitory problems, but by
permanent features of nations having different economic structures. When the
US started industrialising, few (although some) had the ambition for the
country to be as wealthy as England. They just wanted to create a less
efficient copy of the kind of production structure they could observe in
England. This required tariffs. Successful industrialisation under
protection, however, carries the seeds of its own destruction. By the 1880s
US economists – using the same arguments based on scale and technology
that were used to protect US industries in the 1820s – now argued for
free trade. The same tariff that for a while created manufacturing industry,
was now hurting the same industry.[4]
This is why List, the protectionist, was also the first visionary of global
free trade: when all countries had achieved a comparative advantage outside
the diminishing returns sector.[5]
The disagreement is not over the principle of free trade as such, only over
its timing. If one, instead of accepting Adam Smith as an icon of free trade and
laissez faire under any circumstances, reads what he says about economic
development at an early stage, one will find that he is very much in line
with classical development economics, where industrialization is the key
recommendation. In his early work, The Theory of Moral Sentiments (Smith
1759/1810), Adam Smith argued passionately for ‘the great system of
government’ which is helped by adding new manufactures. Interestingly,
Smith argued that new manufactures are to be promoted, neither to help
suppliers nor to help consumers, but in order to improve this ‘great
system of government’. In fact, it is possible to argue that Adam Smith was also a
misunderstood mercantilist, someone who firmly supported the mercantilist
policies of the past, but then argued that they were no longer necessary for
England. In other words, Adam Smith played the same role later played by Schoenhof (see above, footnote 3) in the United States.
He praises the Navigation Acts protecting English manufacturing and shipping
against Holland, arguing ‘they are as wise… as if they had all
been dictated by the most deliberate wisdom’ and holding them to be
‘perhaps, the wisest of all the commercial regulations of
England’ (Smith 1776/1976: I, 486-487). All in all, Smith described a
development that had become successfully self-sustained, a kind of
snowballing effect, originating in the wise protectionist measures of the
past. Only once did Smith use the term ‘invisible hand’ in the Wealth of Nations: when it sustained
the key import substitution goal of mercantilist policies, when the consumer
preferred domestic industry to foreign industry (Smith 1776/1976: 477). This
is when ‘the market’ had taken over the role previously played by
protective measures, and national manufacturing no longer needed such
protection. If one cared to look, Adam Smith also argued for tariff
protection at an early stage as a mandatory passage point to development as
did Friedrich List. Studying economic policy without discussing the context
is one of the destructive vices of economic practice. The praxis of economic development has been to assimilate and produce
less efficient ‘copies’ of the economic structure of wealthy
nations. The key features of the economic structure of wealthy nations have
been a large division of labour (a large number of different industries and
professions), an important increasing returns sector (industry and today also
knowledge–intensive services). This understanding was made into
economic theory by economists who codified what actually took place in
wealthy countries: Antonio Serra (1613), James Steuart (1767), Alexander Hamilton (1791) and Friedrich
List (1841). These principles are at times unlearned when the natural harmony
of physics-based economics totally takes over, as in France in the 1760s, in
Europe in the 1840s, and in the world in the 1990s. These periods come to an
end because of the great social cost they create. Physiocracy
in France created shortages and scarcity of bread, and started the process
that led to the French revolution.[6] The free trade euphoria of the 1840s met
its backlash in 1848 with revolutions in all large European countries, with
the exception of England and Russia. Every time Ricardo’s trade theory
is proven wrong when applied asymmetrically to increasing and diminishing
return industries[7],
Ricardo is proven right that the ‘natural’ wage level is
subsistence. The free trade euphoria of the 1990s has again backlashed and created widespread poverty, but this time
our response is wrong. We are too much attacking the symptoms rather than the
causes of the problem. The
situation today Today’s standard economics tends to see development as largely
being driven by accumulation, by investments in capital, physical and human.[8]
Standard economic theory which underlies today’s development policies
is normally unable to recognise qualitative differences between economic
activities. I have argued elsewhere that globalization in the periphery
therefore has had the effect of a Morgenthau Plan in
many of the world’s small and poor countries: ‘removing the basis
of modern civilization’. If we look at the list of today’s failed
or failing nations, we will find that they all fail George Marshall’s
test for what creates modern civilisation: They have very weak manufacturing
sectors, unable to create the virtuous exchange between city activities and
countryside activities that Marshall recognised. They also have a very
limited diversity in their economic base, a very limited division of labour,
and are specialised in diminishing returns activities. Historically, modern democracy was born in the nations where the
civilising trade between urban and rural areas had already been established, in
the Italian city states. A key feature of the most successful city states was
that power was not in the hands of the landowning (diminishing returns)
class. The scarcity of arable land made this easy in Venice and The Dutch
Republic, and the fact that the few islands of wealth in Europe also
geographically tended to be islands was not lost on the early economists. In
other areas this was only achieved through constant political fight. In
Florence, 40-odd landowning families had been banned from political life
already in the 13th century, enabling what we later in this paper
shall call Schumpeterian cronyism: political and economic interests
‘colluded’ in a way that created widespread wealth. Dependency on
raw materials would create feudalism and/or colonialism, neither of these
situations leading to political freedom. If we wish to establish genuine
democracies, we may also here at the moment be starting at the wrong end of
the problem, attacking symptoms rather than real causes of political freedom.
The US Civil War was essentially a war between landowners with vested
interest in agriculture and cheap labour (the South) and those with a vested
interest in industrialization, what the most visionary of the 19th
century US economists called ‘a high wage strategy’ (the North).
The history of Latin America is in many ways the history of a group of
countries where the South won the Civil War. The alternative paradigm, which we could broadly call evolutionary and
historical – which I refer to as The Other Canon of economics –
the key force in development is assimilation: learning to do what
more advanced countries are doing, ‘copying’ not only their
institutions, but more importantly their economic structure.[9]
In fact institutions like patents and protection, scientific academies and
universities were key elements in the strategy to change national economic
structures in order to assimilate that of the wealthier countries. In this
tradition, economic growth tends to be activity-specific, tied to
clusters of certain economic activities exhibiting increasing returns and
rapid technological progress. This process requires capital, but the
difficulty lies in transferring and mastering the skills and, above all, in
creating a viable market for the increasing returns activities in nations
where the absence of purchasing power and massive unemployment tend to go
hand in hand, each factor reinforcing the other in a deadlock. By generally
insisting on using models assuming full employment, the Washington
Institutions avoid facing a key factor in the mechanisms that lock nations
into poverty: the lack of formal employment. Historically, since 16th
century Holland and Venice, only nations with a healthy manufacturing sector
have achieved anything close to full employment combined with a lack of
sizable rural underemployment. Today’s reigning economic theory represents what Schumpeter
called ‘the pedestrian view that it is capital per se that propels the capitalist engine’: development is
seen as largely driven by the accumulation of capital, physical or human.
‘The premise of neo-classical theory is that, if the investments are
made, the acquisition and mastery of new ways of doing things is relatively
easy, even automatic’, as Richard Nelson says. Even more important, the
core thesis of standard economics, albeit seldom expressed, is that economic
structure is irrelevant, capital per se
will lead to economic development regardless of the economic structure into
which the investment is made. In the alternative Other Canon theory, economic
activities exhibit very different windows of opportunity as carriers of
economic growth. An intuitive example: Bill Gates is not likely to have
achieved his present economic success specializing in herding goats or
growing broccoli: the technological wave that created Microsoft is not
replicable in a company or country specialising in goat herding or growing
broccoli. In other words we have to get rid of what James Buchanan calls
‘the equality assumption’ in economic theory, probably the most
important and the least discussed assumption.[10]
The ability to absorb innovations and new knowledge – and consequently profitably
to absorb investments – at any time varies enormously from one
economic activity to another. The
problem: As a result of seeing
capital per se as the key to growth, loans are given to poor nations
which their productive/industrial structure is unable to absorb profitably.
Interest payments will often very fast exceed the rate of return on the
investments made. ‘Finance for Development’ may therefore take on
the characteristics of a pyramid game or a chain letter fraud: the only ones
to gain are those who started the scheme and are close to the door.[11]
Correspondingly on the human side: Investments in human capital are made without
corresponding change in the productive structure that creates a demand for
the skills acquired. As a result education may tend only to promote
emigration. In both cases Gunnar Myrdal’s ‘perverse backwashes’ of
economic development will be the result: more capital – both monetary
and human – will flow from the poor to the rich countries than the
other way around. My claim, based on the study of 500 years of
history’s laboratory, is that the main explanation for this lies in the
type of economic structure – locked into a vicious circle of lack of
supply and lack of demand and the absence of increasing returns – that
characterises poor nations. This circle cannot possibly be broken unless we
again listen to 500 years who speak in favour of the set of policies listed
in Appendix 1. Abraham Lincoln stands out as a proud representative of this
type of national economic strategy, and US industrial policy from 1820 until
1900 is the best example for the Third World to follow today until – as
the US was towards the end of the 19th century – these
nations are ready to participate fully in and benefit truly from
international trade. Recommendation: As
was the case with the Marshall Plan, financial funds must be matched with the
establishment of industrial and service sectors that profitably can absorb
both the physical and human investments. A diversification out of raw
material production is absolutely indispensable in order to create a basis
both for democratic stability and increased welfare. Initially these sectors will not be able to survive world market
competition. As this process always has required, since England’s
ascent to industrialization starting in 1485, this incipient
industrialisation needs special treatment of the kind the Marshall Plan afforded
after 1947. This requires interpreting the Bretton
Woods agreement as it was done in the post-WW II era, not as it is presently
interpreted. Part of the problem also lies in neo-classical economics’ poor
understanding of successful business. It is almost curiously amusing that at
the core of the economic theory behind capitalism is a situation of perfect
competition and equilibrium, a situation where no one makes any money to
speak of. In standard economics successful businessmen like Bill Boeing and
Bill Gates – who both contributed importantly to the wealth of Seattle
– are ‘rent-seekers’, generally an odious term. In fact it
is the poverty-stricken Third World that most closely corresponds to the
conditions assumed in international trade theory, diminishing returns and
perfect competition. The rich countries, whose export items are produced
under Schumpeterian dynamic imperfect competition, are ‘rent
seekers’ whose rents, spreading through society as higher wages and a
higher tax base, are what we call ‘economic development’. This
failure to understand development as Schumpeterian imperfect competition is
at the root of the present arguments against an industrial policy. Anything
which causes imperfect competition tends to be seen as
‘cronyism’. Keynes saw investments resulting from what he called ‘animal
spirits’. Without this ‘animal spirit’ – without the
initiative to invest in uncertain conditions – capital is sterile, both
in the world of Joseph Schumpeter and in that of Karl Marx, each representing
one side of the political spectrum. The motivating force behind this animal
spirit is to make profits, to break the equilibrium of perfect competition. From this businessman’s point of
view the very simple explanation for the lack of investments in poor
countries is the lack of profit opportunities. He does not invest because
he sees no opportunity to make profits outside the extraction of raw
materials. This lack of opportunities for profitable investments is largely
tied to the extremely low purchasing power and the very high unemployment
rate. Subsistence farmers do not represent profitable customers for most
producers of goods and services. Tariffs create incentives to move production
into the labour markets of the poor. Historically, this has been seen as a
conscious trade-off between the interest of man-the-consumer and
man-the-producer. The idea that industrialization would cause a rapid
increase in employment and wages that more than offset the temporary higher
cost of manufactured goods was at the core of the Prebisch
import-substitution industrialization, but also of US economic theory around
1820.[12] The idea that greater ‘openness’ in any way should improve
the situation of the poor countries is both counterintuitive and contrary to
historical experience. If anything, the first effect of sudden
‘openness’ in a backward society is likely to kill off what
little manufacturing activity that might exist, making the situation worse.[13]
In effect historical experience shows that opening up for free trade between
nations of very different levels of development tends first to destroy the
most efficient industries in the least efficient countries (The Vanek-Reinert Effect), from the unification of Italy in
the 19th century to the integration of Mongolia and Peru in the
1990s. Figure
1 visualizes how the highly successful export increases that followed the
opening up of the Peruvian economy were accompanied by falling real wages. In
Peru, as in many other Latin American countries, real wages peaked during the
period of ‘inefficient’ import substitution. The ports, airports,
roads, power stations, schools, hospitals, and service industries that were
created by this inefficient industrial sector, led by rent-seekers, were real and could not have been created
without the demand for labour and infrastructure that this inefficient
industrial sector generated.[14]
Economic theory must again open up to understanding synergies of this type,
where temporary ‘business inefficiency’ in certain sectors
activates more efficient activities and/or the upgrading of human capital in
other sectors, in the end leading to increased welfare. The timing of the opening of an economy is crucial. Opening up the
economy too late will seriously hamper growth. Opening up an economy too
early results in de-industrialization, falling wages[15]
and increasing social problems. An anonymous traveller who in 1786 observes the
effects of economic policy in different European countries reaches this same
conclusion: ‘Tariffs are as harmful to a country after manufacturing
industry has been established there, as they are useful to it in order to
introduce this industry’.[16]
In Southern Mexico we can observe the destructive sequence of
de-industrialization, de-agriculturalization[17]
and de-population. That large numbers of subsistence farmers should be made
‘uncompetitive’ by subsidized First World agriculture is a
relatively new, but alarming, trend that may persist even if the subsidies
are removed. There are around 650 million farmers in India, and a large
proportion of them are as ‘uncompetitive’ as their Mexican
colleagues if and when free trade opens up, but without the possibility to
migrate to the US. In the poorest countries today a trade-off exists between
maximizing international trade – which is what present policies achieve
– and maximizing human welfare (Figure 1).
In my view we must address this trade-off in a different way than trying to
compensate the losses of the poor countries through increased aid. More than five centuries of history – from England’s
ascent starting in 1485 – show that there is only one point where the
complex deadlock of vicious circles of poverty and underdevelopment can
effectively be attacked: by changing the productive structure of the poor and
failing states. This means increasing diversification away from the diminishing
returns sectors (traditional raw materials and agriculture) into an
increasing returns sector (technology intensive manufacturing), creating a
large division of labour and the synergies and social structures which emerge
from this structure. This is also the only way to make it possible for
subsistence agriculture to break away from its chains: creating an urban
market for their goods, which will induce specialization and innovation,
bring in new technologies and create alternative employment. Foreign markets
cannot play the same role, they break economies into advanced and backward
sectors and regions: the key to cohesive development is a national[18]
interplay between increasing and diminishing returns sectors. The arguments against
industrial policy: Malthusian vs. Schumpeterian cronyism. 2005: A Filipino sugar producer uses his political influence in order
to achieve import protection for his products. 2000: Major Daley in Chicago does not listen to the Chicago economists,
but provides subsidies to already wealthy high-tech investors through an
incubator. 1950s and 1960s: Swedish industrialist Marcus Wallenberg uses his
close political contacts with Labour Party Minister of Finance, Gunnar Sträng, to achieve political
support and favours in order to carry out his plans for companies Volvo and
Electrolux. 1877: Steel producers in the United States use their political clout
to achieve a 100 per cent duty on steel rails.[19]
1485: Industrialists use their political connections to King Henry VII
in order to achieve subsidies and an export duty on raw wool that will
increase the raw material prices for their competitors on the Continent,
slowly killing the wool industry elsewhere, e.g., in Florence. These are all blatant examples of crony capitalism, very far from the
nice perfect level playing field we are all supposed to prefer. These are all
rent seekers that purist economic theory tends to abhor. There is, however, a
crucial difference between the first example and the rest. The Filipino crony
differs from the other cronies in that he gets subsidies in a diminishing
returns raw material that competes under perfect competition on the world
market. He is a Malthusian crony leading his country down the path of diminishing
returns (in spite of technological change which counteracts this). The others
are Schumpeterian cronies, producing under what Schumpeter calls historical
increasing returns (a combination of both increasing returns and fast
technological change). If we couple this to trade theory we see that the
tilted playing fields providing Schumpeterian cronyism produce widely
different results than those of the Filipino crony. Bismarck used to say that there are two things whose production
process one should better not watch: sausages and government budgets. We
should probably add industrial policy to this group of aesthetically
unpleasant production processes. We can live without sausages, but not
without government budgets or industrial policy. And, as Keynes said,
‘the worse the situation, the less laissez-faire works’. If we
insist that we cannot have industrial policy because moving away from perfect
competition will cause some cronies to get rich, we have totally
misunderstood the nature of capitalism. Capitalism is about getting away
from perfect competition; this is what people spend years at business schools
learning. Economic development is caused by structural change which breaks
equilibrium, creating rents. Insisting on the absence of rents is insisting
on a steady and stationary state. This is the reason why tariffs in many ways
are the least crony-friendly of the policy tools. However, there is still the
need to choose which activities to protect, which almost by definition will
create cronies. Abraham Lincoln protected the steel cronies, and he was very
proud of it. He saw that by paying a little more for steel[20],
he managed to create a huge steel industry with many jobs paying high wages
that also provided a base for government taxation. Economic development
strategy is about getting the public interests of the nation lined up with
the private vested interests of the capitalists. As stated above, the failure
of standard economics to understand the dynamics of the world of business is
a serious problem. This also leads to a failure to understand the economic
essence of colonialism. At its economic core colonialism is a technology
policy: the colonies were not allowed to have manufacturing industries. The
economic activities with high potential for economic growth and mechanization
were to remain in the metropolis, the diminishing returns activities went to
the colonies. The immense transfers that accompany The Millennium Goals process will
necessarily also lead to cronyism. Some people will get wealthy through this
initiative, and a huge aid industry-cum-lobby is working very actively.
Crony-free economics only exists in neo-classical models. My choice is that
we go for Schumpeterian cronyism more than aid-based cronyism, because in
this way we also make it possible for the poor countries to free themselves
from economic dependency. Is it because the apparent motivation of the
businessman is greed and avarice, while the apparent motivation of the aid
lobby is charity that the presently preferred solution tilts so heavily in
favour of charity rather than development? Again we may have unlearned our
basic Adam Smith: it is not by the charity of the baker, but by his greed
that we get our daily bread. We also seem to have unlearned the logic behind policy tools for
economic development. Patents and modern tariffs were created at about the
same time, in the late 1400s. It is crucial to understand that these
rent-seeking institutions were created by the very same understanding of the
process of economic development. To create protection and rents in order to
produce new knowledge (in the case of patents) and to make it possible to
move the new knowledge in order to produce with this new knowledge in new
geographic areas (the case of tariffs) are two aspects of the same
understanding of Schumpeterian economic dynamics. From the point of view of
those who think that perfect competition is the ideal economic situation,
both patents and tariffs represent legalized rent seeking in order to promote
goals that are not achievable under perfect competition. I suggest looking at this set of problems
as the poor countries might look at them. Why is the rent seeking and crony
argument not applied also against patents, only against tariffs and other
policy instruments used in poor countries? Why does the economic profession
accept legalized rent-seeking by pharmaceutical companies and by Bill Gates,
but abhor the rent-seeking of an industrialist who tries to set up a small
business in Lima, Peru? The poor countries may, with some justification, say
that the wealthy countries are establishing rules that legalize constructive
rent seeking in their own countries, but prohibit them in the poor countries.
Over time industrialization has proved as beneficial to mankind as many
highly protected drugs. The
Washington Consensus and sequential single issue management. By the time of what The New Yorker
appropriately called the ‘triumphalism’
following the fall of the Berlin Wall, neo-classical economics with its variations
had become the only game in town. The logic of the post-WW II years that had
built wealth along the belt bordering communism, from Norway to Japan, was
gone, and economics had fossilized into a war between two utopias: the
communist utopia that promised that each should give according to ability and
receive according to need, and the neo-classical utopia that promised that
under capitalism everyone would receive the same wages world-wide (Paul
Samuelson’s factor-price
equalization). Both of these theories, the communist planned economy and
neo-classical economics, were based on David Ricardo’s theories (1817).
Ricardo and his successors show a disregard for economic structure, for
technology and innovations, for entrepreneurship and leadership, and for the
fact that economic activities are qualitatively as different as carriers of
economic welfare. In both its communist and its liberalist forms Ricardian economics sees no need for a state (Marx’
‘withering away of the State’). However, neo-classical economics was, to
use Nicholas Kaldor’s term, an un-tested theory. Neo-classical
theory had provided an effective ideological shield during the Cold War, but
no nation had ever been built on this type of theoretical framework. In its
most extreme form, as it was practiced around 1990, the only predicament was
that nations should ‘get their prices right’ and economic growth
would follow automatically, disregarding economic structures. Because it is
so counterintuitive (why should stockbrokers and shoe-shine boys get the same
wages just by being put in different nations??), Paul Samuelson’s
theory of factor-price equalization had long been the pride of the economics
profession. Now, by 1990, policy recommendations were formulated as if this
‘law’ of factor-price equalization was comparable to the law of
gravity. This neglected not only important theoretical contributions pointing
elsewhere (Krugman, Grossman, Helpman,
Lucas, etc.), key insights of the founding father of neo-classical economics,
Alfred Marshall, were also neglected. Alfred Marshall not only describes
taxes on diminishing returns activities in order to subsidize increasing
returns activities as a good development policy, he also emphasizes the
importance for a nation to produce where most technical change is found, and
the role of synergies (industrial districts). These are the principles behind
all successful catching up since Henry VII started the industrialization of
England by taxing diminishing returns activities (an export tax on raw wool)
in order to subsidize industry manufacturing woolen
cloth. These elements, representing first successful practice and then sound
theory over more than 500 years, have disappeared from the policy space. In the 1990s, as the world economy failed to
deliver results corresponding to the crudest version of Samuelson’s law
of free trade, the search began for other explanations. This search was, and
still is, always based on the premises of neo-classical economics, the search
is for a factor which in addition to neo-classical economics would set
free the magic of the market in providing factor-price equalization with
instant global free trade:
The vision of ‘the borderless
economy's potential to equalise relations between countries and
regions’ was based on the wrong theory. This theoretical fantasy
developed into a practical nightmare in many poor countries. None of the
sequential focuses on single issues will unleash a magic of factor-price
equalization under instant free trade; this never existed in history nor will
it ever exist. Economic growth is by the very nature of things an uneven
process, and only wise political intervention can even out the factor-price
polarizations which are the natural results of an unrestrained market. The latest fad in the sequence, attributing
poverty to a lack of entrepreneurship, comes across as being particularly
uninformed. As contrasted to most people in the wealthy countries who can
safely live within their mostly routine jobs, the poor of the world have to
prove their initiatives and entrepreneurship every day in order to ensure
physical survival for themselves and their families. The problem is that the sequence of
theoretical fads for policy fails to address the fundamental blind spots of
neo-classical economics: a) its inability to register qualitative
differences, including the different potentials of economic activities as
carriers of economic growth, b) its inability to register synergies and
linkages[21],
and c) its inability to cope with innovationists and novelties, and how
differently these are distributed among economic activities. Together, these blind spots of present-day
mainstream economics prevent many poor countries from developing. The
successful ones, like China and India, have, both for more than fifty years,
followed the recommendations of the Marshall Plan: creating a division of
labour between urban and rural activities. Learning is a key element in development,
but learning may spread in the economy also simply as falling prices to
foreign consumers. The key insight of Schumpeter’s student Hans Singer
was that learning and technological change in the production of raw
materials, particularly in the absence of a manufacturing sector, tend to
lower export prices rather than to increase the standard of living in the raw
material producing nation.[22]
Learning tends to create wealth to producers only when they are part of that
finely knit network that was once called ‘industrialism’: a
dynamic system of economic activities subject to increasing productivity
through technical change and a large division of labour. The absence of
increasing returns, dynamic imperfect competition, and synergies in the raw
material producing countries are all part of the mechanisms that perpetuate
poverty. Part of the explanation is also that only
‘industrialism’ gives the necessary critical mass and political
clout to create the countervailing power of labour unions. What the French
Regulation School economists call ‘fordism’,
that workers’ pay raise parallel to productivity improvements, was an
important part of industrialism. Further explorations along the mainstream
route taken since 1990 are in my view rapidly running into diminishing
returns. Huge resources are employed by well-intentioned governments along a
largely sterile path of inquiry, a main problem being that radically
different alternative theoretical approaches are not financed or explored. In
my opinion the only way to raise the standard of living in the poorest
countries of the world is to follow the only successful formula that ever
worked, from England in 1485 to Europe and the Asian Tigers in the 1960s and
70s and China today. This formula is included as Appendix 1. The best social
policy is to create development, not by the rich creating subsidized
reservations where the poor are kept, largely underemployed and
‘underproductive’. The Indian reservations in North America are
sad examples of a policy of the kind that subsidizes without changing
productive structures. In short, the Millennium Goals are in my view far too
much biased towards palliative economics rather than structural change,
towards treating the symptoms of poverty rather than its causes. I am not
denying they could be an unavoidable emergency measure under the present
critical conditions, but without confronting the deeper roots of the problem
it is simply poor social policy. Conclusion:
Are we creating ‘welfare colonialism’? Present policies
run a risk of creating serious imbalances between the efforts to create
development and the palliative efforts of aid. What we may be creating is a
system that could be described as ‘welfare colonialism’. This
term was coined by anthropologist Robert Paine to describe the economic
integration of the native population in Northern Canada. [23] The essential features of welfare
colonialism are: 1) The often observed colonial drain of the old days is
reversed, the net flow of funds is to the colony rather than to the mother
country, and 2) the native population is integrated in a way that radically
changes their previous livelihood, and 3) they are put on the dole. In Paine’s
view, welfare colonialism identifies welfare as the potential vehicle for a
stable internal ‘governing at a distance’ through the exercise of
a particularly subtle, ‘non-demonstrative’ and dependency-generating
form of neo-colonial social control that pre-empts local autonomy through
‘well-intentioned’ and ‘generous’ – but
ultimately ‘morally wrong’ – policies. Welfare colonialism
creates paralyzing dependencies on the ‘centre’ in a peripheral
population, a centre exerting control through incentives that create total
economic dependency, thus preventing political mobilization and autonomy. The
social conditions in which the native inhabitants of Arctic North America
find themselves today, show us that in their case the final effect of massive
transfer payments was to create a dystopia rather than a utopia. We already see aid and transfers creating passivity and disincentives
to work in poor nations. My Haitian colleagues point to family transfer
payments from the United States creating disincentives to work for a going
rate of 30 US cents an hour in Haiti. A Brazilian research project on the
highly laudable Zero Hunger project, carried out at different government
levels (national, state and local) on different programs targeted to fight
hunger, concludes that to a large extent these projects are ineffective,
since they treat symptoms of poverty either by distributing food or by
subsidizing food prices, rather than creating situations where the poor are
converted into breadwinners.[24]
These are welfare colonialism type effects: results of treating symptoms
rather than causes of poverty. The idea of nations producing under increasing returns (industrialized
nations) paying an annual compensation to nations producing under constant or
diminishing returns (raw material producers) is not a new one. It is a
logical conclusion from standard trade theory once both increasing, constant,
and diminishing returns are included, and this recommendation – a
forerunner of the Millennium Strategy – is present already in a US
college textbook from the 1970s. [25]
Until very recently, however, the favoured option was to industrialize the
poor countries, even if it meant that for a long time these industries would
not be competitive on the world market. Making free trade the linchpin of the
world economic system – one to which all other considerations must
yield – has made a type of welfare colonialism appear as the only
option. We must compensate the poor for the welfare loss from free trade,
seems to be the underlying idea. The other option, to develop the poor world,
is not there because we do not wish to abolish free trade as the core of the
world economic order. However, the long term and cumulative effects of having
groups of nations specializing in pre-industrial economic structures will be
staggering. In my view the policies successfully followed between 1485 and
the 1960s are – in spite of their being decidedly out of fashion
– still the better alternative. There are also neo-classical tools that could be used with great
benefits. The Washington Institutions should stop using models assuming full
employment also in countries like Haiti, where only between 20 and 30 per of
the potential workforce have a job. By using shadow prices they will find
back to the original logic of the Bretton Woods
Institutions and their rules as they were interpreted in the 1950s and 60s,
making possible the reconstruction of Europe. This will mean that we temporarily must let the principle of
free trade yield to the principle of economic development and structural
change. Both after 1848 – in order to solve the perennial ‘social
question’ in Europe – and in 1947, political pressure from the
spectre of communism unleashed successful development practices. Few are
aware that Karl Marx stated that the only reason he was in favour of free
trade was that it hastened the revolution. In 1947, the free traders in
Washington had to yield to the political need for protectionist development
policy around the communist block. This Marshall Plan was a truly astonishing
success. It is perhaps a faint hope that today’s terrorist threat will
unleash a similar situation where free trade is temporarily abandoned in
order to create development as a political,
rather than as a social, goal. During the Enlightenment, civilization and democracy were understood,
through the analysis of people like Montesquieu and Voltaire, as products of
a specific type of economic structure. We find the origins of this
understanding already in Francis Bacon more than 100 years earlier: ‘There is
a startling difference between the life of men in the most civilised province
of Europe, and in the wildest and most barbarous districts of New India. This
difference comes not from the soil, not from climate, not from race, but from the arts.’[26] When German economist Johan Jacob Meyen in 1770 stated ‘It
is known that a primitive people does not improve their customs and
institutions later to find useful industries, but the other way
around’, he expressed something which could be considered common sense
at the time. We find the same idea – that civilisation is crated by
industrialisation – in the 19th century in thinkers across
the whole political spectrum from Abraham Lincoln to Karl Marx.
Industrialisation ‘draws all, even the most barbarian, nations into
civilization’ as Marx puts it.
We ought to use our understanding of
successful policies in past history, which is the only laboratory economics has,
in order to create something brand new and adequate for solving today's
challenges. We should attempt to create something as brilliant and practical
as did the visions and accompanying policy recommendations of Alexander
Hamilton and Abraham Lincoln, but firmly grounded in an understanding of the
present technological and historical context. We ought to be as enlightened again in understanding the connection
between production and civilization, by moving our theoretical focus away
from trade and on to production. Compared to Meyen’s
statement above, our present understanding has reversed the arrows of
causality, and we therefore risk creating an increasing number of failed
states. We now ought to focus on how differently technological development
hits different economic activities, creating huge variations in the windows
of opportunity to innovate, and how this makes it possible for nations to
specialize in being poor and uneducated. We should focus more on core issues
like economies of scale, scope, speed and specialization, on avoiding the
negative effects of diminishing returns and lock-in effects, on the assimilation of knowledge rather than
the accumulation of capital, on changing the economic
structures of poor countries so they become more like those of the rich ones.
We should read not only Schumpeter on technical change, but also
Schumpeter’s essay on imperialism. Read not only Schumpeter on
‘creative destruction’, but also open our eyes and minds to the
type of ‘destructive destruction’ that can be observed. Appendix 1. ‘Mercantilist’ Economic Policies of the Generic Developmental State.…the
fundamental things apply, as time goes by. Sam, the pianist,
in ‘Casablanca’. 1. Observation of wealth synergies clustered
around increasing returns activities and continuous mechanization in general.
Recognition that ‘We are in the wrong business’. Conscious targeting,
support and protection of these increasing returns activities. 2. Temporary monopolies/patents/protection
given to targeted activities in a certain geographical area. 3. Recognizing development as a synergetic
phenomenon, and consequently the need for a diversified manufacturing sector
(‘maximizing the division of labor’, Serra 1613 + observations of the Dutch Republic and
Venice) 4. Empirical evidence accumulated showed that
the manufacturing sector solves three policy problems endemic to the Third
World in one go: increasing national added value (GDP), increasing
employment, and solving balance of payment problems. 5. Attraction of foreigners to work in the
targeted activities (historically religious prosecutions have been important) 6. Relative suppression of landed nobility
(from Henry VII to Korea). (Physiocracy as a
landowners’ rebellion against this policy) 7. Tax breaks for targeted activities. 8. Cheap credits for targeted activities. 9. Export bounties for targeted activities. 10. Strong support for agricultural sector, in
spite of this sector clearly being seen as incapable of independently
bringing the nation out of poverty. 11. Emphasis on learning/education (UK
apprentice system under Elizabeth I, Child (1693) 12. Patent protection for valuable knowledge
(Venice from 1490s) 13. Frequent export tax/export ban on raw
materials in order to make raw materials more expensive to competing nations
(starting with Henry VII in late 1400s, whose policy was very efficient in
severely damaging the woolen industry in Medici Florence). Source: Reinert E. & S. ‘Mercantilism and Economic Development: Schumpeterian Dynamics,
Institution Building and International Benchmarking’, in Jomo, K. S. and Erik S. Reinert
(editors), Origins of Economic Development, London, Zed Publications, forthcoming
2005. Endnotes 1. This paper was prepared
for the High-Level United Nations Development Conference on Millennium
Development Goals, New York, March 14 and 15, 2005. 2. This analysis is complicated by the fact that wages
and the income of the self-employed as a percentage of GDP are falling in
most countries, whereas the FIRE sector (finance, insurance, real state)
increases. In Norway this wage/self
employed share of GDP has been close to 70 per cent, in Peru it was around 23
per cent when the national statistical office stopped publishing this figure
in 1990. 3. Reinert, Erik S.
‘Diminishing Returns and Economic Sustainability: The dilemma of
resource-based economies under a free trade regime.’ Published in Hansen,
Stein, Jan Hesselberg and Helge
Hveem (Eds.), International
Trade Regulation, National Development Strategies and the Environment:
Towards Sustainable Development?, Oslo, Centre for Development and the
Environment, University of Oslo, 1996. 4. Schoenhof, J. The destructive influence of the Tariff
upon Manufacture and Commerce and the figures and facts relating thereto. New York, published for the New York Free
Trade Club, 1883. 5. Reinert, Erik ‘Raw
Materials in the History of Economic Policy; or, Why List (the Protectionist)
and Cobden (the Free Trader) Both Agreed on Free Trade in Corn.’, in
Parry, G. (editor), Freedom and Trade.
1846-1996. London, Routledge, 1998. 6.See the works of Steven Kaplan, e.g. The Bakers of Paris and the Bread Question,
1700-1775, Durham, Duke University Press, 1996. 7..This asymmetry is the core of te
argument in Frank Graham’s 1923 article, a basis for Krugman’s New Trade Theory. 8.This discussion builds on a recent paper by Richard
Nelson, ‘Economic Development From the Perspective of Evolutionary
Economic Theory’, draft, Sept. 18, 2004. 9. Historical evidence for this practice in the
European theatre is found in my paper ‘Benchmarking Success: The Dutch Republic (1500-1750) as seen by
Contemporary European Economists’, in How Rich Nations got Rich.
Essays in the History of Economic Policy. Working Paper Nr. 1, 2004, SUM - Centre for
development and the Environment, University of Oslo. Downloadable on http://www.sum.uio.no/publications 10. At its core, the Enlightenment project was one of
ordering the world by creating taxonomies or classification systems, of which
that of Linnaeus is the best known. Neo-classical economics achieves its analytical
accuracy precisely because it lacks any taxonomy: everything is qualitatively
alike. Therefore its conclusions, like factor-price equalization, are
essentially already built into the assumptions. 11. See Kregel, Jan,
‘External Financing for Development and International Financial
Stability, UNCTAD G-24 Discussion Paper Series ,
No. 32, October 2004. Downloadable at www.unctad.org 12. See e.g.
Raymond, Daniel, Thoughts on political economy,
Baltimore, Fielding Lucas, 1820. 13. I have showed this effect in ‘Globalisation
in the Periphery as a Morgenthau Plan: The
Underdevelopment of Mongolia in the 1990s’, in Reinert,
Erik (editor), Globalization, Economic Development and Inequality: An Alternative Perspective,
Cheltenham, Edward Elgar, 2004. See also my paper ‘Increasing Poverty in a Globalised World: Marshall
Plans and Morgenthau Plans as Mechanisms of Polarisation
of World Incomes’, in Chang, Ha-Joon
(editor), Rethinking Economic Development, London, Anthem, 2003. 14.I am grateful to Carlota Perez for having
formulated this insight. 15. But not
necessarily falling GDP/capita. See footnote 1. 16. Anonymous (1786).
Relazione di una scorsa per varie
provincie d’Europa del M. M.... a Madama G.. in Parigi. Pavia: Nella Stamperia
del R. Im. Monastero di S. Salvatore. p. 31. I am grateful to Sophus Reinert for this
reference. 17. As imported and subsidized US food takes over
from local maize and wheat production. 18. Essentially within the same labour market. 19. Taussig, F.W. The Tariff
History of the United State, New York, Putnam’s, 1897, page 222. 20.That the steel tariff later got as high as 100 per
cent, was a result of technological change and rapidly falling prices in a
situation where the tariff was not based on value, but determined in dollars
per ton. 21. The slogan ‘get the national innovation
systems right’ proves an exception, because it does refer to a
synergetic phenomenon. However, this does not lead very far because of the
theory’s inability to recognize the different windows of opportunity
for innovation in Microsoft, under hugely increasing returns, and in a goat
herding firm in Mongolia, under critically diminishing returns. In standard analysis Schumpeterian
economics tends to be added like a thin icing on a thoroughly neoclassical
cake. 22. Singer, Hans W. ‘The Distribution of Gains
between Investing and Borrowing Countries’. In International
Development: Growth and Change.
McGraw-Hill, New York. 1964 (1950) 23. Paine, Robert (editor), The White Arctic. Anthropological Essays on Tutelage and Ethnicity, Institute
of Social and Economic Research,
Memorial University of Newfoundland, 1977. 24. Lavinas L and
Garcia E. (2004) Programas Sociais de
Combate à Fome. O legado dos anos de estabilização econômica,.Rio de
Janeiro, editora UFRJ/IPEA, Coleção Economia e Sociedade, 2004. 25. ‘Thus the country which eventually
specializes completely in the production of X (that is, the commodity whose
production function is characterized by increasing returns to scale) might
agree to make an income transfer (annually) to the other country, which
agrees to specialize completely in Y (that is, the commodity whose production
function is characterized by constant returns to scale’ (Chacholiades, Miltiades, International Trade Theory and Policy, New
York, McGraw-Hill, 1978, p. 199; see also Reinert
1980) 26. Francis Bacon, Novum Organum,
1620. MA degree at Tallinn University on
Technology and Other Canon Economics ___________________________ Game Theory: a Refinement or an Alternative to
Neo-classical Economics?
Neo-classical economics, Game Theory and General Equilibrium The
intellectual centrepiece of neo-classical economics is general equilibrium.
“The view of the economy central to microeconomics is that it is an
interrelated system of markets through which one particular resource
allocation is achieved out of infinitely many which are possible. Until now3
we have been considering the constituent elements of this system: households,
firms, goods markets, and factor markets. We now have to synthesise all these
elements into a model of the equilibrium of the economy as a whole.” (Gravelle and Rees, 1992, p438). There
is nothing inherently neo-classical about general equilibrium. For example
Keynesians postulate that an economy may become stuck in an underemployed
equilibrium. An equilibrium in game theory may be equivalent to one in
general equilibrium. In the example (fig one) below (Up, Left) represents a
Nash Equilibrium, a Dominant Strategy Equilibrium and we could suggest, a
General Equilibrium of a simple two-person economy.
|
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Player Two |
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|
Left |
Right |
Player One |
Up |
(3,3) |
(0,0) |
|
|
Down |
(0,0) |
(0,0) |
The key assumption that
distinguishes a game theory world from a neo-classical economy is that of
interdependence. In game theory the payoffs or utilities of any strategy depend
on the strategy of the other player(s), or even the expectations of the
strategy of the other player. In the above example the possibility of player
one getting a payoff of 3 from choosing Up is contingent on the choice of
Left by player two.
There are a variety of
assumptions in the neo-classical version of general equilibrium necessary to
prove the existence, the uniqueness
and stability of equilibrium. Important
among those assumptions is independence. For the stability of
equilibrium, “if all goods in the economy are gross substitutes, then
the time path of prices, p(t), determined by the tatonnement
adjustment process…converges to an equilibrium.” (Gravelle and Rees, 1992, p450). An equilibrium may not
exist in the case of goods that are complements. If there is excess demand
for a particular good such as CDs the price in a Walrasian
type economy will rise. This will have the undesirable (from the perspective
of equilibrium) effect of reducing the demand for CD players. Such
complications from interdependent markets may prevent the economy converging
to a stable equilibrium. For uniqueness the
neo-classical version of general equilibrium likewise demands that choices be
independent. What happens otherwise can be best illustrated by another
example of a game.
Figure Two
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Player Two |
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Left |
Right |
Player One |
Up |
(3,3) |
(0,0) |
|
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Down |
(0,0) |
(3,3) |
In
this example (fig two) there are multiple equilibria4 . Once the utility
from a strategy or choice by one individual depends on the strategy or choice of
another individual, any presumption of uniqueness of equilibrium breaks down.
This then is the crucial difference. Game theory drops the assumption of
independence. The implications of this are profound: they open the door for a
completely different way of analysing the stability and efficiency of an
economy, the role of the state, expectations, and the role of conflict in
economic exchange. I will return to this later. First I will try to make the
case that so completely has game theory been colonised and smothered by
neo-classical economics that these implications may escape us.
I would argue that game theory is perfectly entitled to stand alone as a theory of how economies behave in a situation of interdependence in decision making. Game theory is though commonly presented as an appendage. “Game theory by itself is not meant to improve anyone’s understanding of economic phenomena. Game theory (in this book) is a tool of economic analysis, and the proper test is whether economic analyses that uses the concepts and language of game theory have improved our understanding.” (Kreps, 1990b, p6). Kreps (1990b) further argues that game theory comprises “formal mathematical models that are examined deductively” (p6), and “a taxonomy for economic contexts and situations” (p37), to “ask questions about the dynamics of competitive interactions” (p87).
Despite game theory being a “representation of a situation in which a number of individuals interact in a setting of strategic interdependence.” (Mas-Colell et al, 1995, p219) there is still a heavy bias towards the methodological individualism of neo-classical economics. “Thus it is easy to portray game theory as an extension of a theory of rational decisions involving calculated risks to one involving calculations of strategies to be used against rational opponents, competitors or enemies; that is, actors who are also performing strategic calculations with the aim of pursuing their goals and, typically, attempting to frustrate ours”. (Rapaport, 1970, p45).
Game theory has been subjected
to the same formalism common to much of neo-classical economics, in fact
“game theory (as developed by people who have come to be recognised as
game theorists) is properly a branch of mathematics” (Rapaport, 1970, p49). Like neo-classical economics game
theory has been heavily saturated by the concept of rationality: it is
“the branch of mathematics concerned with the formal aspect of rational
decision.” (Rapaport, 1966, p16). Likewise
any reading of a basic game theory text reveals the central, almost defining,
importance of equilibrium. With this it clearly shares with neo-classical
economics a “slavish devotion to the concept” (Keen, 2001, p164).
Glancing
through Mas-Colell et al (1995), chapters seven to
nine reveal the exclusive emphasis of its exposition of game theory on
formalism, rationality and equilibrium. The basic elements of game theory are
outlined with relevant definitions, proofs and corollaries (formalism). The
exposition runs through dominant strategies, rationalisable
strategies, sequential rationality, backward induction, reasonable beliefs
and forward induction (rationality)5. These rationality
assumptions are extreme. The combination of consistent alignment of beliefs
and common knowledge of rationality implies that instrumentally rational
individuals with the same information sets must converge in their
expectations. The remainder is
concerned with Nash equilibrium, Bayesian Nash equilibrium and Subgame perfection (equilibrium). The notion of
equilibrium refinement is an important avenue in game theory (see for example
Kreps, 1990b, p108-128). In the narrow world of
neo-classical game theory this trinity contrasts with the other in general
equilibrium, the sacred truths of existence, uniqueness and stability.
Gravelle and
Rees (1992) do not deal explicitly with game theory, but use it to model the
behaviour of oligopolies (Chapter 12). Their treatment is a specific example
of all of these general points. They seek a “precise prediction of the
market equilibrium” (p298); it is certainly mathematical and formal.
“Each firm is assumed rationally to think through the consequences of
its choices, in the knowledge that the other firm knows the situation and is
also thinking things through.” (p302). Happily for the non-mathematical
reader “the general issues of existence, uniqueness and stability of equilibria are not dealt with.” (p300)6.
Like neo-classical economics,
game theory as it exists places an immense and rarely questioned burden of information
on individuals. “A central concept of game theory is the notion of a
player’s strategy. A
strategy is a complete contingent plan, or decision rule, that specifies how a player will act in every
possible distinguishable circumstance
in
which she might be called upon to move.” (Mas-Colell
et al, 1995, p228). The information requirements become even more burdensome
when we consider ideas such as iteration of dominated strategies or rationalisable strategies. These require that we
“assume that all players are rational and that this fact and the players’
payoffs are common knowledge (so everybody knows that everybody knows
that…everybody is rational)” (Mas-Colell
et al, 1995, p239).
Game theory cleanly and simply
models a number of situations very different from neo-classical economics and
its corollary general equilibrium. Those that are discussed here include the developmental
role of the state in both its ‘market failure’ and
‘political conflict’ guises and also the role of expectations and
multiple equilibrium.
The Developmental State
Fine and Stoneman
(1996) suggest there have been two broad approaches to the developmental
state - the economic and political
schools7. The first focuses on the role of the state
as correcting market failures, such as externalities, economies of scale,
infant industries, asymmetric information, etc. The second examines the
political capacity of the state to identify and implement growth promoting
interventions. Game theory can help present these two approaches in a very
straightforward manner and capture key points of both arguments. The two
relevant generic approaches are co-ordination games (the economic role of the
developmental state) and chicken games (the political role of the
developmental state)8.
a)a. Co-ordination Games
A very interesting implication
of a game theory economy is that of multiple equilibria.
Only if we share such a narrow neo-classical view of the world can we accept Kreps (1990b, p95-105) that the presence of multiple equilibria in game theory is a problem. With multiple
equilibrium we can have no presumptions of efficiency in a market economy. In
Fig three below there are two (pure strategy) mixed equilibria,
(Not Invest, Not Invest) and (Invest, Invest). While the latter is Pareto
optimal there is no necessary reason why an economy stuck in the inferior
equilibrium should move there. This is an example of a strategic complementarity (Cooper and John, 1988); there are Pareto
ranked multiple equilibria. In a decentralised
system there is no incentive for a single firm to increase production because
it will take the actions of other firms as given. The externality is
generated by demand linkages that firms do not internalise.
In terms of a practical
example (fig three) from development we could consider firm one to be a steel
industry and firm two to be a ship-building industry. The steel industry supplies inputs for the
ship-building industry. The two firms are only jointly profitable in the case
of simultaneous investment. Investing alone will create excess capacity for
the steel producer and losses of (-5), while lonely investment for the
shipbuilder will create a shortage of steel inputs, driving up their price
and leading to losses of (-5). This is an example of a co-ordination failure.
Figure Three
|
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Firm Two |
|
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|
Not Invest |
Invest |
Firm One |
Not Invest |
(1,1) |
(0,-5) |
|
|
Invest |
(-5,0) |
(3,3) |
The problem was theorised by Rosenstein-Rodan, Scitivsky in the 1940s
and 1950s as the ‘Big Push’ approach to economic development.
With interdependence change (industrialisation) would not be automatic. Only
simultaneous investment across a wide range of industries would be viable. It
could be possible for investors in a complementary project to agree to a
contract though this will be costly to draw up and monitor, (Chang, 1999).
Such transactions cost considerations would be particularly relevant in the
case of a large upstream industry supplying inputs to a large number of
firms. This could be the case with a railway system that would then be used
by a host of small firms, (Murphy et al, 1989). The takeover mechanism could
provide a solution but profound capital market imperfections during the early
stages of development are likely, (Bardhan, 1999).
Foreign investment in crucial sectors may be seen as an unacceptable loss of
domestic economic sovereignty. In East Asia the state played an important
role in resolving this kind of co-ordination failure. Such interventions can
be simply modelled using game theory. Intervention in the capital market to
subsidise credit, changes the payoffs in the game to make (Invest, Invest)
more likely9. The organisation of Chaebols
in South Korea can be thought of in a stylised manner as a merger of the two
firms in this game. The choice for the single firm would be straightforward
Invest for a profit of 6 or not invest for a profit of 210. The
state itself may undertake the investment, as in Taiwan, which largely
retained crucial large-scale upstream industries in the state sector.
Indicative planning exercises may provide a focal point for private sector
co-ordination between such complementary investment projects. (Chang, 1999)11.
b. Chicken Games
A Chicken game is represented
in Fig four. Individuals can be
aggressive or concede. The two positions that optimise the social surplus
(Concede, Aggressive) and (Aggressive, Concede) require that one player
concede. The worst outcome is mutual aggression, which leads to a negative
outcome for both players. There is an inherent conflict because outcomes are
unequal; for both to gain, one player must resign himself to an inferior
position.
Figure Four
|
|
|
B |
|
|
|
|
Aggressive |
Concede |
A |
Concede |
(2,5) |
(0,0) |
|
|
Aggressive |
(-2,-2) |
(5,2) |
The chicken game can
illustrate an aspect of the second issue facing the developmental state noted
by Fine and Stoneman (1996). The political capacity
of the state to identify and implement policies, specifically that conflict
over income distribution can prevent reforms or perpetuate inefficient
institutions over time.
This game captures nicely the
notion that development is an inherently conflictual
process. Chang (1999) notes that development is the process of shifting
resources from low to high productivity areas. Less mobile assets are likely
to become obsolete, leading to unemployment and income inequality. Those with
a vested interest in the status quo will resist such changes. The diffusion
of technology may be blocked in order to protect economic rents. This need
not occur solely through opposition from those likely to be displaced12, but
because new technology and economic change may simultaneously affect the
distribution of political power. Acemoglu and
Robinson (1999) propose a ‘political losers’ hypothesis - groups
may resist technological change that would otherwise erode their political
power (rather than more typically economic rents). The market failure is the
lack of any credible commitment to compensate political losers after economic
changes have occurred. In the game above there is no mechanism to allow a
credible commitment to compensate the player who concedes. In a dynamic
political economy context, the resulting income inequalities may be
perpetuated over time. The wealthier player may be able to institutionalise
influence on the state and bias future changes to his own benefit. This
approach has been followed by Knight (1992), who explains the development of
institutions not in terms of responses to collective goals or benefits but
rather as a product of distributional gains. The main goal of institutional
development is to gain a strategic advantage over other actors. This view of
institutions introduces the concept of power. There are numerous practical
examples of this in the development literature. Sokoloff
and Engerman (2000) argue initial inequalities in
Latin America and the Caribbean in the early years of colonisation were
perpetuated over time, resulting in the slow spread of the voting franchise,
literacy and education. Harriss (2002) gives an
example of agrarian institutions in Eastern India as inefficient institutions
that have persisted over time. Usury and speculative trading in food grains
were privately profitable for a small class of landowners to the extent that
there was little incentive to make productive investments in agriculture.
These inefficient institutions supported and were supported by the power of
the landowning oligarchy with a strong vested interest in the reproduction.
The chicken game can also help explain the paradox of land reform, Bardhan (1999). Without significant scale economies in
farm production and problems of monitoring hired labour, the family farm is
the most efficient institution for production. Land reform has been fiercely
resisted by landowners despite possible efficiency gains. Landowners have
tended not to lease or sell land to family farmers to secure the surplus from
expanded production. There are problems of monitoring, insecurity of tenure
and fear the tenant will gain occupancy rights. Imperfect credit markets and
insecure property rights mean small farmers are frequently unable to afford a
market price. More generally we could consider the game as representing the
overall process of industrialisation. This requires the allocation of
property rights to form a class of capitalists, either player A or B must
concede and become a worker. Industrialisation will lead to an improvement in
aggregate income (2,5) or (5,2) but also to increased levels of inequality.
Political opposition to increasing inequality, especially if it is structured
on regional or ethnic lines, may lead to conflict and an outcome of (-2,-2)
instead.
Game theory can easily model
how expectations can have a fundamental impact on the real economy and any
efficiency properties of the market economy disappear. Keynes assigned an
important role to expectations as an autonomous causal factor. Woodford (1991)
shows that changes in beliefs become important in generating fluctuations in
circumstances in which they tend to become self-fulfilling. A lot of the
literature emphasises particular economic structures which enable revisions
of expectations to become self-fulfilling.
Figure Five
|
|
|
B |
|
|
|
|
Hold |
Sell |
A |
Hold |
(5,5) |
(-2,2) |
|
|
Sell |
(2,-2) |
(1,1) |
Fig five shows a situation in
which the optimal social position is for both players to hold (retain possession
of a share, currency or other financial asset). If either player has any
expectation that the other is likely to sell the best thing to do is to sell,
avoid a loss and settle for a positive if lower payoff. Negative expectations
can become self-fulfilling without any change in the underlying economic
fundamentals. A lot of the literature about the 1997 Asian Crisis is framed
in just these terms. Herd-like behaviour can be important; fund mangers would
be faulted for not getting out when others do but not for making losses when
everyone else does. The effect will be
compounded by imperfect information, when entry or exit by one actor is
interpreted as his having access to superior information. As Krugman says:
“The lesson for the real
world is that your vulnerability to the business cycle may have little or
nothing to do with your more fundamental economic strengths and weaknesses:
bad things can happen to good economies.” (1999, p10).
The problem of multiple
equilibrium is not a fault of game theory but a justifiable reflection of how
a real economy works. The particular
structure outlined above was created by financial liberalisation in East and
South-East Asia in the early 1990s. Inexperienced domestic banks were able to
take out large dollar denominated loans from foreign lenders. Deregulation of
the domestic economy allowed these loans to be on-lent for construction and
real estate investment and speculation. The inflow of short-term capital
created a game-like scenario in which investors had to consider the decisions
of other investors. The reintroduction of capital controls by Malaysia in
1998 effectively removed the sell option. Wade (1998a+b) criticises the IMF for pushing for bank closure in countries without
full deposit insurance - in effect raising the cost of being caught holding
when the other player sells. The IMF stand-by
credits and loans would, it was hoped, mitigate this effect by reducing the
cost of not selling early.
Conclusion
Game theory can and should be
a theory that stands on its own to model economic processes that occur in a
situation of interdependence. It offers a radical alternative to
neo-classical economics. Game theory illustrates just how non-robust are the
efficiency properties of neo-classical economic theory, it provides a neat
framework in which to model and justify a developmental role for the state
and can neatly illustrate how expectations can, contrary to neo-classical
economic theory have an important impact on the real economy. Game theory
deserves better than to be emasculated by the obsessions of neo-classical
economics, its formalism, rationality and its slavish devotion to
equilibrium. Perhaps there is a case
to be made for a heterodox Microeconomics text book that begins with game
theory as the standard case and introduces general equilibrium as a special
case?
Endnotes
1. Many thanks to Alan for invaluable
editorial assistance.
2. Matthew McCartney, “Dynamic versus Static
Efficiency: The Case of Textile Exports from Bangladesh and the Developmental
State”, post-autistic
economics review, issue no. 26, 2 August 2004, article 4, http://www.btinternet.com/~pae_news/review/issue26.htm
3. This is chapter 16.
4. More precisely three, two pure strategy and one mixed strategy equilibria. The latter are not considered here.
5. Kreps (1990a) is little different but does have
several pages dealing with ‘irrationality’ (p480-9). Such value-laden terms
in supposedly positive economics is evident. If players do not play the way
the equilibrium of the game says they should they are
‘irrational’. The theory is correct by its by its own definition.
6. The “interested reader is directed to the more specialised
references at the end of the chapter for a fuller treatment” (p300).
7. See also Fine (1999
8. Grabowski (1994) attempts a synthesis of these two approaches using game
theory, Fine and Stoneman (1996) are not
particularly complementary about his efforts.
9. Gerschenkron (1962) emphasised the importance of
state supported development banks among late industrialisers
in Europe.
10. The combined profits of the two independent firms.
11. An otherwise sterile analysis of ‘focal point equilibria’
can be found in Kreps (1990a, p554).
12. Most famously the Luddites, skilled weavers who attempted to block the
introduction of new machines
References
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Development’, September, mimeo.
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Conflicts, Collective Action, and Institutional Economics’,
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(1996), ‘Introduction: State and Development’, Journal of
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Gerschenkron,
A. (1962), ‘Economic Backwardness in Historical Perpective’,
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D. M. (1990a), ‘A Course
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D. M. (1990b), ‘Game
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(Oxford, Clarendon Press).
Krugman, P. (1999), ‘The
Return of Depression Economics’, (New York, W. W. Norton).
Mas-Colell,
A. M. D. Whinston and J. R. Green (1995), ‘Microeconomic Theory’,
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and R. M. Vishny (1989), ‘Industrialisation
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Rapoport,
A. (1966), ‘Two-Person
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A. (1970), ‘N-Person
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Wade, R. (1998a), ‘The Gathering World Slump
and the Battle over Capital Controls’, New Left Review, 23, Sep/Oct.
Wade, R. (1998b), ‘The Asian
Debt-and-Development Crisis of 1997-?: Causes and Consequences’, World
Development, 26:8.
Woodford, M. (1991), ‘Self-Fulfilling
Expectations and Fluctuations in Aggregate Demand’, ‘In New
Keynesian Economics’, Volume 2, Coordination Failures and Real
Rigidities – ed. N. G. Mankiw and D. Romer,
(Cambridge, MIT Press)
_________________________
SUGGESTED CITATION:
Matthew McCartney, “Game Theory: a Refinement or an
Alternative to Neo-classical Economics? ”, post-autistic
economics review, issue no. 30, 21 March 2005,
article 2, http://www.btinternet.com/~pae_news/review/issue30.htm
Symposium on
Reorienting Economics (Part
III)
Towards a Framework for
Pluralism in Economics
Jeroen Van Bouwel[27] (Ghent
University, Belgium)
Introduction
In her contribution Pleas for Pluralism to this journal, Esther-Mirjam Sent (2003) suggests that the plea for pluralism, as found in many contributions to the post-autistic economics movement, has a strategic motivation. Although I tend to agree that this is true of some contributions, it seems necessary to spell out the non-strategic motivations by which one can defend plurality and pluralism before we evaluate whether (heterodox) contributions are not really pluralistic.
Discussing the idea of pluralism, and elaborating a framework in which the different aspects of the concept are located, will be a fruitful step to deepen the heterodox standpoint, as many heterodox pleas (e.g., many contributions to this journal) do refer to plurality and pluralisms. It might take away the unease some people feel with the use of pluralism, cf. Jacques Sapir (2001): “Having gone so far in support to the post-autistic approach I must confess some unease about the widespread use of the term “pluralism” in the PAE-Newsletter.”
Motivations for pluralism
Let us start by making the various possible motivations underlying a defence of pluralism more explicit. I believe that at least five different motivations can be identified.
a. the ontological motivation
Firstly, there is the ontological motivation for pluralism, which appeals to features of the world, in particular, its complexity. An example can be found in Caldwell’s (2004) recent contribution to this journal: “Some may agree with Lawson and me that pluralism makes good sense; the complex nature of social reality may also mean that it is inevitable.” As such, ontological complexity or disunity results in the plurality of existing approaches.
Another example of this motivation in the economics literature is to be found in the contribution of Kurz and Salvadori (2000), as discussed by King (2004): “Economic reality, they note, is widely believed to be very complicated. (…) Since no theory can consider all relevant factors in any particular economic context, there is a strong prima facie case for theoretical pluralism. Different theories will often be complementary rather than alternative.” In this quote, economic reality is characterised as very complex, hence it might be impossible to be represented by a single theory, and as such it might be the source of pluralism. But this quote is slightly ambiguous, as you might deduce from it that the author considers our cognitive capacities to be too limited to get all relevant factors at once into one theory. If so, then the source of pluralism would be a different one, namely the following.
b. cognitive limitations as a reason for plurality
Pluralism can be motivated by the cognitive limitations of the human inquirers, cf. Esther-Mirjam Sent (forthcoming): “(…) when economists made the agents in their models more bounded in their rationality, they had to be smarter because these models became larger and more demanding econometrically. As macroeconomist Thomas Sargent (1993) explains: ‘Within a specific economic model, an econometric consequence of replacing rational agents with boundedly rational ones is to add a number of parameters’ (168) because we ‘face innumerable decisions about how to represent decision-making processes and the ways that they are updated’.”
Thus, the plurality we encounter in economics can be the result of the decisions qua focus or angle we have to take – due to cognitive limitations – in describing economic processes. These limitations can legitimise pluralism.
c.
historical and geographical situatedness as source
of pluralism
In
discussing arguments for pluralism, King also mentions the work of Geoff
Hodgson (2001), and his idea that: “the notion of a single,
‘general’ theory applicable to human behaviour in all societies,
at all points in time, is a dangerous delusion that has led astray not only
neoclassical economists but also many heterodox theorists.” (King,
2004) Hodgson warns us here of the dangers of theorizing that is too general:
“(…) the cost of excessive generality is to miss out on key features
common to a subset of phenomena.” (Hodgson, 2001:16).
Here, we can identify a third motivation for pluralism, namely one based on the realisation of the historical and geographical relativism of (economic) knowledge, namely that we develop our theories based on particular (historically, geographically and/or socially relative) and potentially transformable situations or positions; imposing or defending a universal and timeless monistic theory is inappropriate once you realise the perspectivism and relativism of our particular historical situation or reality (note that this does not imply that anything goes). Chick and Dow (2001) as referred to by King (2004), can be situated here as well.
d. the pragmatic
motivation
The fourth motivation for pluralism that can be identified is the pragmatic motivation. It rests upon the idea that one (economic or other) phenomenon can be legitimately studied from different perspectives, depending on our epistemic goals and interests. As there is no objectively correct set of goals and interests, there is not one correct (and complete) representation of or perspective on the world (cf. Kitcher, 2001:55-62). I have shown how this can be understood for explanatory pluralism in the social sciences (cf. Weber and Van Bouwel, 2002). Briefly put, we can allow different forms of explanation (e.g., structural explanations, rational choice explanations, etc.) in explaining one social phenomenon, depending on the explanation-seeking question asked about that phenomenon.
e. the strategic motivation
Finally, we have the strategic motivation, mentioned by Sent (2003) in relation to contributions in heterodox economics. The idea of strategic pluralism was introduced by Ron Giere (forthcoming) and refers to groups that advocate pluralism as “primarily just a strategic move in the game of trying to dominate a field or profession. Those in the minority proclaim the virtues of pluralism in an effort to legitimate their opposition to a dominant point of view. But one can be pretty sure that, if the insurgent group were itself ever to become dominant, talk of pluralism would subside and they would become every bit as monistic as those whom they had replaced.” Here, pluralism is being used as a kind of social lever, and we might question whether this motivation represents a really pluralistic stance (cf. introduction), or whether it will eventually lead to monism?
I want to stress that this list of motivations is not exhaustive, and that it may be that a combination of motivations underlie a defence of pluralism.
Forms of
pluralism
I am convinced that trying to identify which of these (or other) motivations underlie the different contributors to heterodox economics, will be a fruitful exercise in the development of a strong alternative to mainstream economics. But, merely mentioning the different possible motivations leaves unspecified the form of pluralism offered in particular cases. A second step – besides clarifying the motivations or sources of pluralism – should therefore be to specify which form of pluralism one is discussing when defending pluralism.
Tony Lawson, a pluralist?
I want to discuss some of the above questions in relation to the work of Tony Lawson, an important heterodox scholar, which gets a lot of attention in this journal.
In an earlier paper (Van Bouwel, 2004) I have argued that Lawson’s guidelines for the explanatory praxis of economists are based on a doubtful transcendental argument, which supports his a priori ontological framework. As such, Lawson commits the ontological fallacy (analogous to the epistemic fallacy committed by mainstream economists) and risks throwing out some of the handy instruments mainstream economists have to offer. For example, I have defended the view that explanations following the covering law model might be poor instruments to answer some explanatory requests (e.g., those motivated by therapeutic interests), but that they can provide us with information that Lawson’s contrastive explanations do not give us, such as information that enables us to predict whether and in which circumstances similar events will occur in the future. Although this kind of prediction is certainly not the only goal of the social sciences, it is one of them (e.g., to control social outcomes, to be confident that proposed measures will have the intended effects, etc.).
The way in which Lawson develops guidelines for explanatory praxis
and his rejection of the covering law model, give a good illustration of what
form of pluralism Lawson is defending. By presenting mainstream economics as a monolithic unity as is done
by Lawson, he invites critics to reject it en bloc.[28]
As is obvious in Lawson’s work, and which I have illustrated in considering
his proposals concerning explanation (cf. Van Bouwel,
2004), Lawson’s quest for heterodox economics is not so much focusing
on elaborating compatibility and complementarity
with mainstream (or neo-classical) economics, but rather creating his
own alternative, that would be the new (monist) standard.
If we call Lawson’s
contribution pluralist, as he does, we can distinguish two different forms or
conceptions of pluralism. Firstly, Lawson’s work is pluralist in the
sense that it provides us with an alternative to the mainstream, and as such
we have more than one alternative (hence we have plurality). Secondly, we can
understand pluralism as engaging in a conversation, as exchanging ideas, and
not merely developing different isolated (and essentially monist)
alternatives.
Lawson’s account does not defend this second kind of pluralism. He does not develop a form of pluralism that shows how the different schools or alternatives can be used for different occasions. He rejects the mainstream completely, without considering possible positive contributions. He does not elaborate a form of pluralism that might show the complementarity of the schools or make us understand the origin of the differences between and the plurality of schools. What is missing in general in Lawson’s work is a framework for pluralism in economics, including an account of the origin or motivation for pluralism (cf. the five possibilities mentioned above).
Conclusion
Using Tony Lawson as an example of heterodoxy in economics, I have illustrated that the heterodoxy’s account of pluralism should be made more explicit. I claim that a really pluralistic approach should engage in a conversation, in spelling out compatibilities and complementarities between the mainstream and the heterodox approaches (both sides should be engaged). The pluralism of Lawson risks leading us to an isolated diversity, to a lack of exchange of ideas. In order to avoid this risk, Lawson and the heterodoxy should be more explicit about the origins and motivations for pluralism, otherwise the suspicion that the plea for pluralism is merely strategic will remain. I hope spelling out the different possible motivations for pluralism is a good starting point to further elaborate the fascinating project of post-autistic economics.
References
Caldwell, B.
(2004). ‘Some Comments on Lawson’s Reorienting Economics:
Same Facts, Different Conclusions’, Post-Autistic
Economics Review, issue n°28, 25 October 2004, article 3, http://www.btinternet.com/~pae_news/review/issue28.htm
Chick, V. and Dow, S.C. (2001). ‘Formalism,
logic and reality: a Keynesian analysis.’ Cambridge Journal of
Economics 25 (6):705-21.
Giere, R. (forthcoming). ‘Perspectival
Pluralism.’ In: Stephen Kellert, Helen Longino, and Kenneth Waters (eds),
Scientific Pluralism. Minnesota
Studies in the Philosophy of Science.
Hodgson, G. M. (2001). How Economics Forgot History:
The Problem of Historical Specificity in Social Science. London: Routledge.
King, J.E.
(2004). ‘Three Arguments for Pluralism in Economics’, Post-Autistic
Economics Review, issue n° 23, 5 January 2004, article 2, http://www.btinternet.com/~pae_news/review/issue23.htm
Kitcher, Ph. (2001). Science, Truth, and Democracy.
Oxford: Oxford University Press.
Kurz, H.D. and Salvadori, N. (2000). ‘On Critics and Protective Belts.’
In Kurz and Salvadori (eds). Understanding ‘Classical’ Economics:
Studies in Long-Period Theory. London: Routledge,
pp. 235-58.
Sapir, J. (2001). ‘A
rejoinder to James K. Galbraith and a contribution to the ongoing
debate’ Post-autistic economics newsletter, n° 5, article 4.
Sargent, Th. J. (1993). Bounded
Rationality in Macroeconomics. Oxford: Oxford University Press.
Sent, E.-M. (2003). ‘Pleas for
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Sent, E.-M. (forthcoming).
‘Pluralism in Economics.’ In: Stephen Kellert,
Helen Longino, and Kenneth Waters (eds). Scientific
Pluralism. Minnesota Studies in the Philosophy of Science.
Van Bouwel, J. (2004). ‘Explanatory Pluralism in Economics: Against the
Mainstream?‘ Philosophical Explorations 7(3): 299-315.
Weber, E. and J. Van Bouwel
(2002).
‘Can we dispense with structural explanations of social facts?’ Economics & Philosophy 18:259-275.
___________________________
SUGGESTED CITATION:
Jeroen Van Bouwel, “Towards a Framework for
Pluralism in Economics ”, post-autistic
economics review, issue no. 30, 21 March 2005,
article 3, http://www.btinternet.com/~pae_news/review/issue30.htm
Finding a
Critical Pragmatism in Reorienting
Economics
Bruce R. McFarling (University of Newcastle,
Australia)
There is an "ology" that pervades
the essay in which Tony Lawson (2003) launches Reorienting Economics. The preface would lead us to believe it
should be ontology. However, while
ontology receives starring credit, it is epistemology that plays the starring
role.
This first essay is structured into four theses. In his first thesis (2003: 3-8), the focus
is on the mode of explanation of modern economics. This is argued to be deductivism,
defined as explanation in terms of event regularities. Lawson refers to systems exhibiting event
regularities as "closed", which can make his work difficult to read
for someone with a General Systems background. For someone more accustomed to
thermodynamic or causal closure, it is helpful to mentally translate
"closed" as "event-regular" everywhere Lawson uses the
term. The argument proceeds that this
mode of explanation in terms of event-regular systems leads to the peculiar
types of mathematical formalisms with which we are all familiar.
In his second thesis, Lawson points out the ill-health of the
"mainstream project" (2003: 8).
This consists in large part of remarks taken from mainstream
economists that reflect upon this poor state of health. It is conceded that they rarely lay the
blame on the peculiar type of mathematical formalism that forms the
touchstone of mainstream economics.
However, with respect to "ology"
sighting, the essential point is Lawson's conclusion:
" ... there is quite widespread
agreement that the modern discipline is not in too healthy a condition, and
that whatever explains the fact that the formalistic mainstream project has
risen to such dominance ..., it has little to do with this project's record
so far in explaining the social world in which we live. (2003: 11)"
In the first two theses, Lawson has been laying the foundation for the
critique presented as the third thesis.
Yet the foundation for his ontological turn in economics is
epistemological. He argues that it is
not the content of the theory in the mainstream content that is stable over
time, but rather its mode of explanation.
To justify an interest in the ontology to follow, he presents a
picture of the mainstream project in ill health. Yet the symptom of ill health is that it is
not succeeding in explaining.
In the third thesis Lawson
enquires what ontology is implied by event-regular systems, and how closely
does this match the ontology of social systems? Lawson argues (2003: 13-15) that there is
an extremely strong bias (although not an ironclad necessity) toward an
atomistic view of such systems, where the individual agents are simple and
react in at least stochastically deterministic ways in response to given
conditions. There is also argued
(2003: 15-16) to be a strong bias toward viewing systems as isolated
systems. This argument is easily
followed, since a system composed of nothing but deterministic, atomistic
agents will not be homeostatic, so that the state of such a system becomes
indeterminate if the system is exposed to indeterminate external influences.
Lawson (2003: 16-17) then claims a variety of characteristics of
social reality. For example, positions
in social reality are internally related, the social realm is structured, and
it contains value and meaning. As none
of the features in this list can be exhibited by a purely atomistic
and isolated system, it is concluded that much of what economics needs to be
explained is incompatible with its implicit ontology.
Lawson (2003: 18-20) argues that this incompatibility is responsible
for the constant appearance of the central fictions of mainstream
economics. These central fictions are
a familiar fixture. They bear a
surface similarity to the isolating fictions of scientific theory. For example, a natural scientist will adopt
the fiction of a weight dropping through a vacuum to eliminate the real
additional influence of wind resistance.
However, because deductivism is constructing
a theory in a fictitious world that is supposed to correspond to events in
the real world, it seems that its fictions cannot be restricted to the
absence of forces that are in fact likely to be present. They must also include the presence of
fictitious forces to take the place of real world influences that cannot be
expressed in an atomistic and isolated system.
While ontology is brought on stage here, it is certainly not appearing
solo. The essence of the argument here
is that the mainstream mode of explanation is not capable of explaining what
Lawson wishes to explain. Certainly,
it may be granted that Lawson's wish to explain particular aspects of reality
is an ontological concern. However,
the capabilities of a mode of explanation is an epistemological concern, and
that is certainly the crux of the argument.
Without the limited capabilities of the mainstream mode of
explanation, the critique falls over.
With the limited capabilities there is something of substance to the
critique, even if one differs with Lawson's ontology.
The final thesis is the conclusion of the critique. Adherence to a mode of explanation in terms
of event-regular systems is the reason for the lack of health, and is indeed
the constraint preventing mainstream economics from being scientific. It is argued that even where science
deliberately constructs event-regular systems in an experimental setting, it
does so to form a cause and effect theory applicable to non-event-regular
systems. (Lawson 2003: 22-26) The
argument may be seen as claiming that the mainstream mode of explanation is
not a scientific mode of explanation.
Here, too, the argument seems as much epistemological as ontological.
It should be stressed that this argument has substantial merit. Constructing a theory in an abstract
event-regular system is not, in fact, the same thing as constructing an
experiment – an artificial event-regular system in the real world. In the former case, the event-regular
system has no necessary connection with a real world non-event-regular
system. In the latter case, the fact
that it is constructed in the real world of real components provides the
connection with the same components interacting in a non-event-regular
system.
While the starring role of epistemology is the strength of the
argument, the anonymity of the star is a weakness. Possessing a mode of explanation that
implies an inadequate ontology is not necessarily a critical flaw. As long as the explanatory process allows
the worst mismatches to be replaced by less severe mismatches, one can hope
that the mode of explanation may evolve toward one that implies an adequate
ontology.
The central question, therefore, has not changed in a century, because
while theoretical stances within the mainstream project have proliferated and
shifted ground, essential aspects of its mode of explanation have not changed
in a century. That question is, why do
mainstream economists not engage in evolutionary science? (Veblen, 1898). Of
particular interest for the past 60 years is how a determined effort to
subject theories to statistical analysis have left the mainstream project
every bit as stalled as it was a century ago.
Lanis and McFarling (2004) point in the direction
of one flaw. We construct a highly
artificial, highly regular scenario in the context of explaining the degree
of disclosure of accountants in the context of different national accounting
and economic institutions. However,
the scenario we have constructed is non-functional. That is, legal, professional and commercial
institutions will establish norms for what must be disclosed to
provide an adequate report, what may be reported, and what ought to be
reported in exceptional circumstances, and what ought not to be reported.
Any mathematical relation connects elements from its domain to
elements from its range. In our
artificial scenario, we relate a score on a synthetic index of social
attitudes to the degree of disclosure within the accounting institutions of a
nation. A functional relation connects
either one or many elements from the domain to one element in the range. Any relation that connects either one or
many elements from the domain to multiple elements in the domain is therefore
non-functional. Regression analysis,
where it is used correctly, overcomes the problem of relating to multiple
scattered observations by constructing the function in terms of a probability
distribution, so that the scattered observations are interpreted as different
samples drawn from the same distribution.
However, the regularity in our scenario is on the bounds on reporting.
Even if one viewed this range of discretion as a probability distribution,
each shift in the bounds would result in a new probability distribution. The
degree of discretion, which will vary from one institutional context to
another, implies that the regularity is not functional – it is one
collection of institutional norms to many possible degrees of
disclosure. Therefore, any effort to
fit the best function will necessarily fail.
It appears that functional regularity is equivalent to Lawson's
event-regularity. We point out several
statistical techniques that may be used with better effect – techniques
which will only be picked up outside the mainstream project, if Lawson's
argument regarding the event-regular epistemology of the mainstream mode of
explanation is correct.
In any event, here is part of the answer to the puzzle of why sixty
years of determined empirical testing has left the mainstream project
stalled. If your tool for finding and
correcting mismatches with the real world fits functions to data, you will be
left blind when the problem involves a regular relationship that is not a
function.
A more specific epistemological query than the mode of explanation is
the unit of analysis. Any analytical
explanation will involve one or more units of analysis, so that the phenomena
to be explained are explained in terms of the unit of analysis. In McFarling
(2004), I find that the unit of analysis in a particular corner of the
mainstream project to be selection from alternatives, followed by
performance. It may be noted in
passing that this is essentially the same neoclassical unit of analysis that
is ably dissected and subjected to acid critique by Veblen
(1898) as part of an increasingly obsolete natural law approach, which he
contrasts with a modern, evolutionary approach. However, this unit of analysis was originally
unearthed in the work of Posner (1995).
Thus, even if much of the theory of the mainstream project is in a
state of flux, this unit of analysis clearly exhibits greater longevity.
I then pose the question whether it is possible to arrive at a theory
of culture with such a unit of analysis, and argue it is not. If culture acts in part as a restraint on
action, then situating culture in the selection will erode those restraints. And if culture is simply embedded in the
constraints on decisions, then culture is a deus
ex machina, affecting the outcome but not
explained by the unit of analysis.
Culture cannot be analysed with selection followed by performance as
the unit of analysis – it can at best be taken as a given.
What is the point of identifying the unit of analysis? Being informed that the mainstream project
is deductivist, based on presumed
event-regularities, may make it easier to identify a mainstream
economist. However, it does not go
very far in explaining how the mainstream economist is reproduced. The unit of analysis, on the other hand,
goes a long way toward explaining the reproductive process. The first thing a nascent researcher needs
to learn is what type of questions to ask.
And the unit of analysis provides a trio of questions that can be
asked about individuals in a wide variety of settings. What selections are faced by this
individual? Which one is likely to be
selected? And what performance is
likely to follow that selection?
The attraction of this unit of analysis is that there are always more
puzzles to solve. If you try to
provide a complete theory of the economy with a unit of analysis that is
blind to important aspects of the economy, each new trial solution will prove
to be a misfit when it encounters the affects of one or more excluded
aspect. And if the reaction to a
misfit is to start over with the same trio of questions, there will always be
a permutation of available selections and likelihood of occurrence that has
not been tried before.
Given this unit of analysis, a question that arises is whether
ontology can be used to reorient mainstream economics. Supposed this is your unit of analysis in
developing new explanations, and suppose econometrics is your tool for
finding out what the problem is with your explanations. How will you react when being told that
there are certain features of the social world that do not fit the ontology
implicit in your method? You will
interpret these features in terms of your unit of analysis.
Indeed, you may devise econometric tests to determine whether the
features as you have interpreted them are present in the data you have
available. If you get statistically
significant results, you may even publish the outcome in a respectable
mainstream journal. Yet you are not
likely to have made a step toward evolutionary science. When interpreting the features with your
unit of analysis, you will omit what is incompatible with your unit of
analysis.
Indeed, in McFarling (2004), I find hope in
New Institutional analysis. This comes
from the argument that the New Institutional unit of analysis is the
transaction, followed by performance.
Yet there is not necessarily an ontological advance here. Indeed, it may be that New Institutional
analysis maintains its credibility within the mainstream project in part by
adhering to the same flawed ontology as follows from the neoclassical unit of
analysis (though see David Dequech 2002). However, by placing the selection in the
context of a transaction between two individuals, the unit of analysis admits
questions regarding relationships between individuals that the neoclassical
unit of analysis does not admit. The
conclusion is not that New Institutional economics is an evolutionary
science, but rather that it is not prevented from being an evolutionary
science by its unit of analysis.
The dangerous face of epistemology is the invitation to focus on the
ways that we understand the ways that we understand things. And it is when I consider the mode of
explanation in this essay that I come upon a concern. Event-regular systems are classified as
closed systems. Everything else are
classified as open systems.
One thing this blinds us to is any other kind of regularity. Suppose that an individual has a regular response
to a cluster of events, where a response consists of one of a range of
actions that are meaningful in that context.
Response-regular systems are not necessarily event-regular, but it is
a form of regularity. Suppose that an
individual has a response that is within regular bounds, with clear
discretion within those bounds.
Boundary-regular systems are not necessarily event-regular, but it is
a form of regularity. Suppose that a
system is homeostatic, so that the response to an event is contingent on the
discrepancy between the current internal state of the system and the target
internal state. A homeostatic system
would only approach event regularity in a perfectly homogenous environment
where events are sufficiently infrequent so that the state prior to the event
closely approximates the target state.
Yet not only is homeostasis a form of regularity, but a collection of
homeostatic systems can create regularity in a wider system.
In other words, in this system of classification, we are to label
event-regular systems as closed and all other systems as open, whether or not
they exhibit one or several other forms of regularity. If you need event-regular systems to be a
reputable mainstream economist, this may suffice to tell us whether a person
is pursuing that status or rejecting it in favour of status with some other
peer group. However, suppose we accept
Lawson's argument that adequate economic theory will normally have to be
compatible with an "open" system.
We have a simple dichotomy here, and the positive category is the one
to be avoided. Reorientation is
required because the pursuit of theories of closed systems is and will
continue to be fruitless in generating effective explanations. Yet saying that the reorientation will take
open systems as the object of theory is to say that it will take
"not-event-regular" systems as the ultimate object of theory. It
is, in short, simply a restatement of the "though shalt
not" dictum, except that this time the "not" has been located
inside the term "open".
Thus in trying for a positive statement, Lawson must elaborate on what
kind of open system he means. That
elaboration appears to be whatever kind of open system is compatible with
social ontology and his realist transformational model of social activity. And it is here that the argument appears to
become controversial. As Vromen (2004) points out, there is a substantial
inconsistency between the qualifications with which Lawson wraps this model,
and the ultimate authority that Lawson grants it as a final arbiter between
properly and improperly oriented economic theory.
This is the crux of the question of whether ontology or epistemology
should have the starring role in this play.
If we have the "right" ontology, how did we discover that it
is the right ontology? And if we have
a way of discovering the right ontology, which is more fruitful to convey:
the method of discovery; or the ontology itself as received wisdom?
Of course, this is a counterfactual.
As strongly suggested by the qualifications that Lawson places on his
ontology – that it is "… practically conditioned, historical
and fallible" (Lawson 2003, 61) – it would appear that at most we
can say that our ontology seems to be the best we can do at the moment. As Vromen appears
to be arguing, this is a weak basis for launching a revolution.
The implicit recognition of this is built into the structure of
Lawson's first essay. Accepting that
the mainstream project is generating a flurry of explanations without
succeeding in explaining anything is supposed to generate interest in
considering the suitability of the underlying ontology. Epistemology is providing the wedge
intended to create an opening.
Lawson's particular social ontology is then supposed to enter the gap
that is created.
Yet how are we to discriminate between different explanations, once we
have reoriented ourselves to open systems?
I skip past the ontology of the second essay and the realism of the
third to the essay on explanations in social science. Lawson describes a method of forming
hypotheses in terms of relative contrasts that are to be expected if a
hypothesis is correct. He then argues
that "The hypothesis that performs best in terms of empirical adequacy
in this sense over the widest range of relevant conditions can, with reason,
be accepted as better grounded. (2003: 97)"
What we have here, of course, is a pragmatic criterion for judging the
epistemological fitness of a mode of explanation and unit of analysis –
or units of analysis, since the criterion accepts successful eclecticism as
readily as successful and rigorous modes of explanation. Note that this is a basis for a pluralism
that extends beyond those approaches that we agree with. We can accept that a mode of explanation is
progressing under this criterion even if we think its ontology is flawed and
that its conclusions are fallacious.
Indeed, one can hope that if it continues to pursue a broader range of
successful explanation, it will either eliminate the source of the fallacies,
or it will develop an explanation that shows why we have misunderstood the
question all along.
This, then, is Lawson's critical pragmatism. I naturally refrain from systematising it,
since in that case it would be my pragmatism rather than his. Its core is the epistemology that Lawson
works out as a side-effect of bridging the gap between his critical realism
and a potentially scientific practice of economics. I conjecture that it is narrower in scope
than the virtual blank slate offered by the concept of the open system, but
broader in scope than the social ontology constructed in terms of his realist
transformational model of social activity.
References
Dequech, David. (2002). "The demarcation between the "old" and
the "new" institutional economics: Recent Complications". Journal
of Economic Issues; June 2002, vol. 36, pp. 565-572.
Lanis, Roman and Bruce R. McFarling. (2004) " Healthy Economics Healing
Autistic Accounting Theory: Visiting a Neglected Area of Institutional
Economics." Journal of Economic Issues. Vol. 38 (1). March 2004.
pp. 59-83.
Lawson,
Tony. (2003). Reorienting Economics. Title in Economics as Social
Theory, Tony Lawson, ed. London: Routledge.
383pp.
McFarling, Bruce R.
(2004) "The Clarence Ayres Memorial Lecture: An Institutionalist
Reconstruction of Culture." Journal of Economic Issues.
Vol. 38 (2), June 2004. pp. 339-52.
Posner, Richard A.
(1995) "The New Institutional Economics Meets Law and Economics." Overcoming
Law. Harvard University Press: Cambridge, Mass. pp. 426-443.
Veblen, Thorsten.
(1898) "Why is Economics Not an Evolutionary Science" The
Quarterly Journal of Economics. Vol. 12 (4), July 1898. pp. 373-397.
Vromen, Jack. (2004)
“Conjectural Revisionary Ontology ”, post-autistic economics
review, No. 29, 6 December 2004. article 4, http://www.btinternet.com/~pae_news/review/issue29.htm
___________________________
SUGGESTED CITATION:
Bruce R. McFarling, “Finding a Critical
Pragmatism in Reorienting Economics
”, post-autistic
economics review, issue no. 30, 21 March 2005,
article 4, http://www.btinternet.com/~pae_news/review/issue30.htm
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[1]The author is grateful to Carlota
Perez, Wolfgang Drechsler and Rainer Kattel for constructive comments. The usual disclaimer
applies.
[2] This analysis is
complicated by the fact that wages and the income of the self-employed as a
percentage of GDP are falling in most countries, whereas the FIRE sector
(finance, insurance, real state) increases.
In Norway this wage/self employed share of GDP has been close to 70 per
cent, in Peru it was around 23 per cent when the national statistical office stopped
publishing this figure in 1990.
[3] Reinert,
Erik S. ‘Diminishing Returns and Economic Sustainability: The dilemma of
resource-based economies under a free trade regime.’ Published in Hansen,
Stein, Jan Hesselberg and Helge
Hveem (Eds.), International
Trade Regulation, National Development Strategies and the Environment: Towards
Sustainable Development?, Oslo, Centre for Development and the Environment,
University of Oslo, 1996.
[4] Schoenhof,
J. The Destructive Influence of the
Tariff upon Manufacture and Commerce and the Figures and Facts Relating Thereto. New York, published for the New York Free
Trade Club, 1883.
[5] Reinert,
Erik ‘Raw Materials in the History of Economic Policy; or, Why List (the
Protectionist) and Cobden (the Free Trader) Both Agreed on Free Trade in
Corn.’, in Parry, G. (editor), Freedom
and Trade. 1846-1996. London, Routledge, 1998.
[6] See the works of Steven
Kaplan, e.g. The Bakers of Paris and the
Bread Question, 1700-1775, Durham, Duke University Press, 1996.
[7] This asymmetry is the core
of the argument in Frank Graham’s 1923 article, a basis for Krugman’s New Trade Theory.
[8] This discussion builds on a recent paper by Richard Nelson, ‘Economic Development From the Perspective of Evolutionary Economic Theory’, draft, Sept. 18, 2004.
[9] Historical evidence for
this practice in the European theatre is found in my paper ‘Benchmarking Success: The Dutch Republic
(1500-1750) as seen by Contemporary European Economists’, in How Rich Nations got Rich. Essays in the
History of Economic Policy. Working Paper Nr. 1, 2004, SUM - Centre for
development and the Environment, University of Oslo. Downloadable on http://www.sum.uio.no/publications
[10] At its core, the
Enlightenment project was one of ordering the world by creating taxonomies or
classification systems, of which that of Linnaeus is the best known.
Neo-classical economics achieves its analytical accuracy precisely because it
lacks any taxonomy: everything is qualitatively alike. Therefore its
conclusions, like factor-price equalization, are essentially already built into
the assumptions.
[11] See Kregel, Jan, ‘External Financing for Development and International Financial Stability, UNCTAD G-24 Discussion Paper Series , No. 32, October 2004. Downloadable at www.unctad.org.
[12] See e.g. Raymond, Daniel, Thoughts
on Political Economy, Baltimore, Fielding Lucas, 1820.
[13] I have showed this effect in ‘Globalisation in the Periphery as a Morgenthau Plan: The Underdevelopment of Mongolia in the 1990s’, in Reinert, Erik (editor), Globalization, Economic Development and Inequality: An Alternative Perspective, Cheltenham, Edward Elgar, 2004. See also my paper ‘Increasing Poverty in a Globalised World: Marshall Plans and Morgenthau Plans as Mechanisms of Polarisation of World Incomes’, in Chang, Ha-Joon (editor), Rethinking Economic Development, London, Anthem, 2003.
[14] I am grateful to Carlota
Perez for having formulated this insight.
[15] But not necessarily falling
GDP/capita. See footnote 1.
[16] Anonymous (1786). Relazione di una
scorsa per varie provincie d’Europa del M. M.... a Madama G.. in Parigi.
Pavia: Nella Stamperia
del R. Im. Monastero di S. Salvatore. p. 31. I am grateful to Sophus Reinert for this reference.
[17] As imported and subsidized
US food takes over from local maize and wheat production.
[18] Essentially within the same
labour market.
[19] Taussig,
F.W. The Tariff
History of the United State, New York, Putnam’s, 1897, page 222.
[20] That the steel tariff later got as high as 100 per cent, was a result of technological change and rapidly falling prices in a situation where the tariff was not based on value, but determined in dollars per ton.
[21] The slogan ‘get the
national innovation systems right’ proves an exception, because it does
refer to a synergetic phenomenon. However, this does not lead very far because
of the theory’s inability to recognize the different windows of
opportunity for innovation in Microsoft, under hugely increasing returns, and
in a goat herding firm in Mongolia, under critically diminishing returns. In standard analysis, Schumpeterian economics
tends to be added like a thin icing on a thoroughly neoclassical cake.
[22] Singer, Hans W. ‘The Distribution of Gains between Investing and Borrowing Countries’. In International Development: Growth and Change. McGraw-Hill, New York. 1964 (1950)
[23] Paine, Robert (editor), The White Arctic. Anthropological Essays on
Tutelage and Ethnicity, Institute of Social and Economic Research, Memorial University of Newfoundland, 1977.
[24] Lavinas L and Garcia E. (2004) Programas
Sociais de Combate à Fome. O legado dos anos de estabilização econômica,.Rio
de Janeiro, editora UFRJ/IPEA, Coleção Economia e Sociedade, 2004.
[25] ‘Thus the country which eventually specializes completely in the production of X (that is, the commodity whose production function is characterized by increasing returns to scale) might agree to make an income transfer (annually) to the other country, which agrees to specialize completely in Y (that is, the commodity whose production function is characterized by constant returns to scale’ (Chacholiades, Miltiades, International Trade Theory and Policy, New York, McGraw-Hill, 1978, p. 199; see also Reinert 1980)
[26] Francis Bacon, Novum Organum,
1620.
[28] Contrary to Lawson, Ester-Mirjam Sent (forthcoming) illustrates the failure to
achieve monism on the part of mainstream economics.