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American Compass and Strategic Economics

Introduction

The emergence of China as a major strategic challenge, the acute problem of the Covid-19 pandemic, and issues of social cohesion and economic inclusion, have prompted policy makers to consider their strategy – to the extent that they have one – and the policies to pursue it. Economics as a discipline and occupation has also been challenged, with respect to both theory and practice. American Compass (AC) emerged in May 2020 as a think tank and intellectual forum that aimed to reorient economic policy, including the economics underpinning it, with a particular focus on the ‘right’, which AC claims has been too sympathetic to ‘free markets’ for too long. 

This post examines and takes AC seriously, not simply because it is a fresh new voice, but because it aims to address important social and economic issues, and re-examine the key aspects of economics that underpin economic policy.    

The post examines AC’s foundational documents and statements in order to understand and discuss its perspective and agenda. Later posts may examine specific AC projects, such as its ongoing project on Corporate Actual Responsibility.

Summary of American Compass’s perspective and agenda

American Compass aims to ‘restore an economic consensus that emphasizes the importance of family, community, and industry to the nation’s liberty and prosperity’. It aims to:

  • shift the political focus from ‘growth for its own sake to widely shared economic development that sustains vital social institutions’.
  • ‘set a course for a country in which families can achieve self-sufficiency, contribute productively to their communities, and prepare the next generation for the same’, and
  • ‘help policymakers navigate the limitations that markets and government each face in promoting the general welfare and the nation’s security.’

American Compass outlines its perspective in three foundational essays. Each essay explores one of three perspectives of their approach: tradition, theory and practice.

Tradition

American Compass Research Director, Wells King, provides a history of government intervention in the American economy, arguing there was a distinct American School of economics whose grand project was an American System – the Hamiltonian project of active, government-led nation-building. The American School treated ‘the nation—rather than the individual—as the principal unit of economic analysis’, and incorporated ‘social and geo-political factors that today might seem beyond the scope of economics’. The American School was a critique of the more laissez-faire school of economics from Britain. King goes on to detail the many different government projects that built the nation. The main emphases of the project were infrastructure, banking and infant industry support.

Theory

Julius Krein, editor of American Affairs, wrote the foundational theoretical essay for American Compass. Therein, he pushes back on the concept that seems to most justify laissez faire: the knowledge problem. Posed by Friedrich Hayek, it holds that planners cannot gather information for economic planning ‘as efficiently as decentralized participants’, who respond to information and incentives conveyed by prices in a market system.

Krein argues that less information is needed for government economic planning than free market advocates realise, pointing to successful examples of industry policy in east Asia, and government-led innovations such as radar, the internet and the space program, which did not involve the information and calculations that laissez faire advocates assume are needed and near impossible to gather and perform. On the contrary, government planning ‘becomes more necessary when less market and industry knowledge is available’. Investors may find it too difficult to raise capital given such degrees of uncertainty, necessitating governments lead in ‘critical areas like basic research and the development of infant industries’.

Krein also argues that Hayek’s rationale for decentralised decision making – that markets enable the ‘unconscious coordination of many decentralized individual plans, despite the imperfect knowledge and intentions of each actor’ – to be faulty. The fault lies in the secondary assumption that market participants don’t need to know why prices change, only that they do change, which provides information. Krein argues that this view confuses rationing and investment. Prices, regardless of their cause, may be sufficient for making rationing decisions, but they are not sufficient for investment decisions. Krein contends that no actual business person actually thinks like a Hayekian (in terms of not needing to know why prices change). Allocating capital requires understanding more than simply the price of a good. Not knowing the reasons for a price change can also cause problems when the price signal is caused by subsidies from a foreign government. Prices change due to interventions as well as changes in fundamentals. Following price signals in the case of foreign subsidies will lead to the domestic industry failing while the foreign competitor gains market share. This, economists argue, is fine, as the foreign competitor is harming themselves by wasting money in inefficient sectors. However, this ignores strategic considerations, such as the need for self-sufficiency as insurance against a hostile competitor.

What differentiates governments from the private sector, Krein argues, is not the extent of knowledge available to the decision makers, but that governments ‘are not constrained by internal profits or external market forces’. They can pursue things that are ‘important’ but ‘highly prospective endeavors’. While he concedes that public choice issues arise, this is a separate issue from issues of knowledge. Knowledge is ‘simply not a useful metric for evaluating the soundness or unsoundness of any particular government plan’.

Hayek ignores practical reality. His theories were useful anti-Soviet propaganda, but they are ‘completely useless as a guide for policy’, Krein argues.

Practice

Oren Cass wrote the foundational essay from the perspective of practice, or public policy. He wants the blinders of free market doctrine, which holds that government intervention impedes voluntary exchange and leads to inefficiency and slower growth, to be shed in favour of viewing markets as contingent upon their environment, and economic policy as playing an active role in shaping that environment with respect to the national interest.

Economic policy is generally concerned with maximising living standards. However, Cass argues that people value things other than living standards, such as security and family, which should inform goals for economic policy. This is a ‘critical task of the political process, though one that American politics regrettably has abdicated.’ Cass suggests that conservatives would likely consider the following outcomes to be important goals:

  • Security: resources and capacity to assert and defend the country’s interests.
  • Resilience: establishing spare capacity and stabilisers so that unforeseen events do not cause crises or excessive damage
  • Pluralism: an economy that generates broad-based prosperity for people of different abilities and locations, which may not be consistent with free markets, which tend to concentrate activities in certain areas under a specialised division of labour.
  • Justice: access to work opportunities, perceptions of a legitimate social order, confidence in expectations of equitable treatment, and strong social fabric,

Cass calls for policy that delivers on these goals, which requires examining the conditions in which markets operate and how those conditions could be made better by public policy. Instead of focusing on tax policy – the obsession of the free market right – policy should focus on four policy channels:

  • Institutions: ‘Economic policy can shape the structure and foster the growth institutions critical to the market’s operation, such as systems of public education and organized labour, the military, social welfare, and the family.
  • Investments: ‘Economic policy can direct public resources toward socially valuable ends and induce private actors to dedicate their resources to the same.’
  • Rules: ‘Government regulations can strengthen the market by altering its conditions and directly mitigating socially harmful effects.’
  • Public Finances: Fiscal and monetary policy. These influence the economy, but should not be obsessed over.

Discussion

The following discussion is structured into background (‘Setting the scene’), ends (‘Policy objectives’), and means (‘Policies’).

Setting the scene

What is the current objective of economic policy?

Governments have what appear to be multiple economic objectives. Price stability. Full employment. Stability of the currency. Prosperity. An equitable distribution of income. Ultimately, the first three objectives are means to achieving the fourth objective – prosperity, which is the ultimate objective. For reasons both moral and self-interested, governments aim to achieve shared prosperity, which is a combination of the fourth and fifth objectives. Australian economists often talk about the tradeoff between equity and efficiency. There’s a constant tussle between these two objectives in economic policy discussion. It seems to me that equity is a secondary economic objective behind economic efficiency in the West. Not coincidentally, this is the perspective economics has taken for many years. Economic efficiency effectively equates to a goal of maximising material living standards, or the size of the economic pie. The pie is then redistributed to achieve equity goals.

It’s interesting to consider why the goal of economic efficiency has been so dominant, and for so long. The widely accepted definition of economics – maximising utility given scarce resources – naturally leads to efficiency as a policy objective, as efficiency relates to maximising the gain from finite resources. Similarly, the aim of maximising utility in economics effectively equates to human satisfaction through material accumulation. This is because the subject matter of economics is that of the market for economic goods and services. When economics came to dominate policy, the progress of society was thus to be achieved through economic efficiency and improvements in material living standards. This is a ‘value-free’ policy objective, one that avoids needing to form a consensus on a common purpose. The dominance of economics in policy may also be attributed to its perceived rigour and use of quantification, its objectivity, its relatively advanced state as a social science, and its clear and utilitarian framework. One of the most prominent proponents of maximising growth is Professor Tyler Cowen. He argues that policy should aim to maximise long-term growth, as economic growth is responsible for many great things in the world. Small changes in growth compound over time, leading to substantial differences in wealth and human progress in the long-term. However, growth should not come at the expense of human rights, and my understanding is that Cowen values environmental quality highly in this regard as well.

Policy objectives

High-level goals

AC’s high-level goals have one thing in common – they include values and considerations that are not typically valued or considered in economics or economic policy discussions. For example, social institutions, community and national security are all incredibly important in any society, yet do not have much of a place in economics or economic policy, despite their importance in sustaining people and society. Just as natural capital allows people to live but is not a specific economic resource in a specific production process, social capital and domestic and national security each contribute to a strong economy and individual welfare. However, these are not often considered, or are assumed away, in economics. It seems that AC is trying to embed economics in a broader set of considerations of things we value.

This is an important step, and reflects a maturity in economic policy thinking and the application of economics to real-world issues. Economics is often taught and practiced in a narrow way. It focuses on understanding economic models in terms of theory and less in terms of practice. Economic models feature simplifying assumptions in order to focus on specific aspects of the model. This is fine, but they are then often transplanted into the real world without consideration for the validity of the model’s assumptions. Economic models in theory assume away institutional and contextual realities. The outcomes of the model are dependent on the assumptions, so if the assumptions no longer hold, the model doesn’t work in that context. As Dani Rodrik has so beautifully argued in Economics Rules, we need to choose the right model for the right situation. It seems that, so often, proponents of laissez faire promote economic policies supported by models that are not appropriate for the situation.

Secondly, economic policies are proposed that are based on economic models that aim to increase economic efficiency. This may not always be appropriate, as governments have a broader set of objectives than simply economic efficiency; there are other objectives that people value. Economics may need to limit their role to the provision of advice on the costs and benefits of different policies. Economics is a science of means – of evaluating the tradeoffs involved in different policies, market structures, etc. – and not of ends. The ends or objectives of policy making need to include other important values. But economics has gained primacy in policy making, with economic efficiency often becoming the ‘value-free’, ‘neutral’ policy objective. Grow the pie, and later, redistribute it as needed. However, this appears to be an overreach.

It is also the wrong way to think about policy because non-economic goals, such as family and community, may actually, in the long-run, be consistent with economic efficiency. In seeking to support and sustain these important, non-economic aspects of society, the economy may be supported to become more efficient in the long-run, even if there are short-term costs. This is certainly true for national security. A nation that is torn apart by civil war or invaded by a foreign power cannot maximise the size of the pie in the long-run. Instead, it is like the person in the Talebian tale who gets rich in the short-run and buys the car and the house and struts around before ending up on the street. It is also true if economic policy can achieve outcomes in terms of family, community and social cohesion. Workers would be happier, more productive and less prone to social ills, which are a drain on the taxpayer, constituting an opportunity cost in terms of foregone government spending on productive projects, or lowering taxes. In other words, there is arguably less conflict between long-run economic efficiency and broader societal objectives than is usually thought. 

In short, I think AC is right to be raising the status of non-economic considerations and criticising the practice of economics and economic policy. 

Four policy outcomes – security, resilience, pluralism, justice

AC proposes four policy outcomes in its foundational essay on practice: security, resilience, pluralism and justice. I focus most of my attention on the first two outcomes.

Security and resilience are often regarded by economists as having an efficiency cost, as they require the government to support less efficient industry or build inefficient levels of redundancy. This is true, in the short-run at least. However, the incorrect thing for an economist or economic policy maker or pundit to then do would be to argue against national security or resilience measures because of the impact on economic efficiency. As I argued above, there may be less of a trade-off involved than thought. Mitigating risk and building redundancy will help in surviving shocks, attacks and conflict. Short-run economic efficiency may need to be sacrificed to support other goals, especially if these other goals allow the country to continue growing the pie in the future because it has been able to survive an external shock or attack. Therefore, economic policy needs to consider security and resilience. Ultimately, the degree of risk and redundancy a society should take on should be the judgment of democratically-elected officials, informed by society’s values and risk tolerance and the advice of well-informed experts.

One of the major shortcomings of economics is its ignorance of strategic issues. Economics typically assumes away these issues, as well as the presence of supportive institutions such as police, government, and national defence. This is fine, to a degree. It is necessary to understand the operation of an economy, and the relationships between different players, at a basic level, before adding complexity. Indeed, simplifying by exclusion can clarify key relationships and outcomes in markets. However, there are several important considerations for economics. Firstly, economics needs to better consider security issues. Geoeconomics – the study of the use of economic power and leverage to pursue geopolitical goals – appears to be mainly housed in strategy and international relations departments, not in economics departments. Secondly, when working in areas of economic policy that relate to strategy and security, economic models need to consider these typically assumed-away issues. Third, it should not be a goal of economic policy to achieve economic efficiency in the short-run, as such policies may be inconsistent with long-run economic efficiency. Policy makers need to be aware of geoeconomic issues, grand strategy and the need to build domestic capability.

In The Jungle Grows Back, Robert Kagan uses the metaphor of a garden that is inclined to the chaos of weeds in the absence of maintenance. He applied this to the global order since 1945, which he argues may seem like an organic or emergent outcome but is instead an order purposefully and actively maintained, and done so largely by America. For the order to continue, constant maintenance is required, just as a garden requires consistent attention and pruning. (This  argument is similar to that of American Compass with respect to markets, and indeed, even prominent laissez-faire advocate Ludwig von Mises argues that natural law only emerged because people took up arms against authoritarians, won, and imposed it through the force of government. We should not underestimate the degree to which order is the product of deliberate action by government. We should not take peace and security for granted.) Kagan argues the global garden is at risk of becoming overgrown and chaotic. America’s retreat from its global leadership role has coincided with the rise of authoritarian governments that threaten territorial aggression and thereby the international order. America must re-engage in the role of sustaining the global international order. Just as the natural state of the garden is overgrowth, the natural state of the world is corruption, violence and chaos. Intervention is needed to maintain peace and trade.

Kagan’s argument is something economic policymakers need to consider, especially economists. Taking up the question of strategy shouldn’t mean different economic theory. Instead, it may mean building models that consider strategic consequences and events, and quantifying the trade-offs involved in gaining extra economic and strategic security. While this is no doubt done by governments, governments operate with economic frameworks informed by mainstream academic economics, which mostly ignores this issue. Departments of government with responsibility for trade and economics may not consider geoeconomics or strategic issues. There appears to be conflict within government about the threat from China and its implications for economic policy, though this may be slowly changing. Bottom line, however, is that the practice of economics needs to either consider strategy, or stick to the economic tradeoffs involved in pursuing strategic goals.

Pluralism as a policy goal is one that, on the surface, is desirable, as it recognises the diversity of society and aims to allow people to pursue the things that satisfy them. This is appropriate given the open society is one that allows people to pursue their goals, as long as they play by the rules that are consistent with the maintenance of that society. Hayek would approve of pluralism as a policy goal.

However, American Compass has framed pluralism in a peculiar way. AC implies that pluralism is threatened by the ‘agglomeration’ that occurs in the free market, which ‘tends to concentrate economic activity in narrow geographies’, and scale and specialisation favours the ‘distant conglomerate over the local provider’. The pluralism that is missing in the free market, it seems, and that AC values, is geographic and business diversity, while free markets promote what AC may consider to be the wrong diversity: specialisation. 

While there’s no doubt that the market has had geographic and distributional winners and losers, the pluralism valued by AC appears to have significant costs and a difficult path to its achievement. Just how AC proposes this objective would be achieved is an intriguing question. I have some ideas but this is something to look into further in the future.

Justice is a human virtue and fundamental value. Any policy should consider justice, but the type of justice pursued is important to get right. AC sees economic opportunity and support as important in achieving justice, as well as perceptions of legitimacy in the social order and fairness. This relates to how people earn their money and whether people are receiving what’s fair. This is a tough standard to reach in a complex, open society where the instincts of the tribe can override the logic of the market, and with the rise of zero marginal product workers. Justice is an important objective, although the concept of justice can be abused and distorted, leading to undesirable sub-objectives, and corresponding policies.

Conclusion: This section has examined the policy objectives of American Compass, and criticised economics and economic policy as being too focused on narrow economic concerns. The discussion now turns to the issue of policies (means of achieving the policy objectives). While AC’s foundational documents are not rich in policy detail, the theory essay criticises the idea that free markets are an appropriate means of achieving economic prosperity. 

Policies and their underlying theory

The theory essay by Julius Krein is a good critique of the main justification for laissez faire economics: Hayek’s knowledge problem. The essay makes several points: that less knowledge is needed in planning than Hayek recognised, and that the price signal is inadequate in informing economic decision making because more information is needed than simply the current market price of a good or service. The causes of price changes are important, argues Krein, for investment decisions. Prices alone, on the other hand, are important in rationing decisions. The causes of price changes are important to understand if price changes are being driven by a foreign government’s industrial policy. If the domestic government does not recognise and respond to this, domestic industry policy is effectively determined by the foreign government. Finally,Krein argues, government planning can be done, has been done, and needs to be done. It needs to be done because government is not bound by profit and loss, and can therefore take on larger, more speculative but potentially more beneficial projects. 

Krein’s essay makes interesting points. I’ve been enamoured with Hayek’s knowledge problem since I first encountered it. However, I’ve never seen it as a winning argument, one that would close the debate against planning. It’s a valid point, and one the other side must contend with, but it’s not decisive. Hayek seemed to consider the issue of the transmission and use of knowledge in a large society being, if not the ultimate issue, then certainly being one of the most important. I agree, and I find his analysis profound and important. But I find Krein’s distinction between investment and rationing to be a useful one. I’m not sure of the degree to which Hayek considered strategic issues, but it strikes me as important that price changes due to strategic actions taken by foreign governments are important to understand and may be justification for our government to take action. Channelling the Theory of the Second Best, the presence of price distortions may require further ‘distortions’ in the form of strategic intervention to pursue security and resilience goals that are aligned with long-run economic prosperity. Indeed, AC Oren Cass has made this point, arguing that intervention is justified in such a situation. 

He also argued that what countries choose to invest in will determine their comparative advantage, rather than countries discovering their comparative advantage. If a competitor chooses to specialise in a certain line of production that is strategically important, and our government allows ‘market forces’ to allocate resources, our country loses strategically. But by intervening and choosing to specialise in important strategic lines of production, a country can become efficient and achieve strategic goals. 

I find this latter point on comparative advantage to be thought-provoking, but perhaps overcooked. He seems to be implying that there will be no efficiency tradeoff by choosing a specialty. While I have argued above that there may be no, or less of an, efficiency tradeoff in the long-run from pursuing security objectives, there will be limitations in the degree to which each country can do this. 

Moreover, with respect to Krein’s other points – that governments require less information and knowledge than is assumed and that they are better placed to carry out blue-sky projects – I don’t feel equipped to comment on these points, which seem to be an empirical issue that I’m not familiar with. I’ll keep this in my mind as I continue to engage with AC’s ideas.

Hayek’s knowledge problem is but one of several issues that need to be considered to assess the suitability of a laissez faire approach to economics. Therefore, even if Krein’s arguments were to carry the day, there would be other arguments to win. I don’t think Krein saw his piece as the ultimate checkmate against free marketeers, but it was a useful critique of a major piece of intellectual capital used by his opponents.

Conclusion

There was much to consider from AC’s foundational documents about the practice of economics and the goals of economic policy. While the initial essays and founding goals were fairly general, there was much to either agree with or want to pursue further, and the specific application of AC’s ideas will be interesting to observe going forward. Overall, I’ve found AC’s entry into the policy debate in America to be a useful one and I hope it is taken seriously by others.

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Fully Grown: Why a Stagnant Economy is a Sign of Success by Dietrich Vollrath (2020)

Short summary

The decline in growth in per capita real GDP since the turn of the century is mainly attributable to demographic change, as baby boomers retire. A fall in the growth residual is the remaining significant contributor, which is mainly caused by a shift to consumption of services, which experience lower productivity growth. Demographic change and a shift to services are features of high living standards, which suggests that the growth slowdown is a sign of success. Other factors played a very small or no role in the slowdown. A decline in the reallocation of firms and workers and a decline in geographic mobility played a minor roles in the slowdown, and these contributors are not really signs of success. Other explanations such as inequality, the rise of China and taxation and regulation had no apparent role, or an ambiguous role in the case of market power, in the slowdown, but may have had distributional consequences. Immigration is a means of slowing the slowdown, while other policies may pertain more to distribution than growth.

Longer summary

Fully Grown is a fantastic introduction to and explanation of the two-decade period of slow growth in the US economy.

Fully Grown starts with the recognition of a slowdown in per capita real GDP, which is a concern because it suggests living standards are growing less quickly than if growth had remained on its 1950-2000 path of 2.25% per person. Instead, real GDP per capita has grown at about 1% per year over the last two decades, a substantial slowdown, resulting in living standards being lower by 25% compared to the 1950-2000 path. The issue isn’t a fall in living standards, or falling behind other countries, but a lost opportunity. The book clinically examines the reasons for this slowdown.

Importantly, the author, Dietrich Vollrath, chooses to define the slowdown in terms of growth in living standards (real GDP per capita), instead of productivity per worker. He does this because ultimately we care more about the former than the latter. This choice is critical because it leads to different explanations of the slowdown.

In defining the slowdown as the reduction in real GDP per capita, or living standards, Vollrath is considering how production is spread across the population, not across workers. This allows demographics to play a major role in the explanation of the slowdown. By having slower growth in, or even less, human capital (less work hours and/or less skill) employed relative to the population, per capita production may grow more slowly or fall. Vollrath finds that a reduction in human capital contributes 1.11 percentage points (pp) of the 1.25 pp fall in growth in real GDP per capita in the period 2000-2016 – it explains almost all of the slowdown. The residual explains 0.25 pp, while physical capital actually contributes 0.1pp per year to growth.

The major driver of the reduction in human capital is the demographic change from changes in family size, which are the result of increased living standards and reproductive control – signs of success. Of the 1.11 pp that human capital contributed to the 1.25 pp fall in real GDP per capita growth, 0.4pp was from a fall in the growth rate of the educational level of the average worker, and 0.8pp from a reduction in the growth rate of workers per capita, as the baby boomers retired. The growth rate of the average experience level and number of hours worked per person actually rose slightly in the period 2000-2016 and therefore contributed positively to growth in real GDP per capita.

With human capital contributing much of the slowdown in economic growth per capita, it was a fall in fertility rates and therefore family size that explains this fall. The decline in fertility and family size is seen across all populations as living standards rise and is therefore a symptom of success. It has an economic rationale. Vollrath invokes Gary Becker’s work on the economics of the family. As family income rises, the opportunity cost of having kids rises. Families choose family size in a way that equates the marginal utility of a child with the marginal utility of income. The optimal family size is found where the marginal utilities are equal. As income increases, families have fewer children. Therefore, the decline in fertility is a function of economic growth and therefore a symptom of success.

Similarly, labour-saving devices raised the cost of having children because it facilitated the movement of women into the workforce. This also made it easier to remain single (as women become more financially independent), which reduces fertility. Women also gained greater control over their fertility through better contraception, which is associated with growth in human capital in women.

These changes and decisions change the demographics of the future. Human capital lead to a 1.11 pp reduction in economic growth, and Vollrath is willing to attribute, at minimum, 0.8 pp directly to population ageing and smaller families (he subtracts 0.31 pp because the changes in education and hours worked per person may not relate strictly to population ageing). Therefore, population ageing accounts for 0.8 pp of the 1.25 pp fall in growth in real GDP per capita, or about two-thirds.

Of the remainder of the fall in growth in real GDP per capita, the residual, or productivity, accounts for 0.25 pp, or about one-fifth. This is the bucket in which anything not related to human capital or physical capital accumulation, sits. Vollrath considers whether slower growth in the residual could be due to mismeasuring GDP, but he seems to lean against that argument. He considers whether innovation – a major cause of productivity growth – is getting harder, and while showing that it is, this doesn’t mean that less innovation is occurring, and indeed, there is evidence that innovation continues apace. He instead finds some contribution to the slowdown from the shift from consuming goods to consuming services, a sign of an advanced economy and therefore a sign of success. He finds some contribution from reallocating resources between uses, such as workers switching jobs, and capital being redeployed in new business ventures and old business ventures exiting the market. Geographic mobility is also a small factor. What does not contribute to the slowdown is inequality, competition from China, or increased taxation or regulation. Market power’s role is ambiguous. Market power has increased since the 1980s, and while it can lead to inefficiency, it can also see production shift to more efficient firms. And indeed, market power is required for innovation to occur. Housing restrictions can have an impact and slow the reallocation of resources to more productive cities. Vollrath labels the lack of mobility of resources as ‘failures’, while the shift to services is a success. The shift to services is also the largest contributor to the fall in residual growth, which adds to his thesis that most of the slowdown is a symptom of success.

Vollrath provides final numbers for the contributors to the slowdown:

Successes

-0.8pp — Effects of ageing and smaller family sizes

-0.2pp — The shift from goods to services

Failures

-0.15pp — The decline in reallocation of workers and firms

-0.1pp — The decline in geographic mobility

0 — Taxation and regulation, increased inequality, trade with China

When subtracted from the longer-run growth rate of 2.25% for real GDP per capita, the above numbers show a 1% growth rate for the period 2000-2016.

There were many interesting and useful technical and empirical points made about the components making up the residual. I’ve only mentioned their role briefly because they play such a small role in the overall explanation for the slowdown. However, these make up a substantial part of the book, and I may write about these at a later date.

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Economic Effects of the Spanish Flu (RBA 2020)

Paper summary: Economic Effects of the Spanish Flu – James Bishop, RBA, Bulletin, June 2020

Summary

There was an estimated 6% fall in real GDP per capita in 42 countries over the period 1918-21. In Australia, unemployment rose by 3 percentage points among union members, two-thirds of which was due to the illness, caring, etc, and one-third due to a lack of work. Australia’s GDP growth rose by 2.25% in 1918/19 and fell by 5.5% in 1919/20. The causes of these effects are difficult to discern given there were other factors at play, namely the removal of wartime stimulus and the influx of workers returning to the workforce after the war. Due to substantial differences in the Australian economy then and now, the relevance of comparisons between the effects of the two pandemics on the economy is questionable, despite similarity in public health measures used then and now.

Additional notes

  • The pandemic emerged in early 1918 and ended at the end of 1920. In Australia, it emerged in January 1919 and ended at the end of 1919.
  • Waves of the virus were dependent on social distancing measures/policies, which were similar to those used today
  • The pandemic most affected those aged 18-40. Typically, influenza viruses affect those aged 60+.
  • Economic effects of government social distancing policies could theoretically be positive or negative. Negative effects would be due to a reduction in economic activity, while positive effects could be due to coordination effects that reduce disruption.
  • The definition of unemployment for the purpose of official statistics was different then to now. Then, unemployment included those not looking for work, unavailable for work, or sick. Therefore, the unemployment rates reported in Australia during the Spanish Flu should be considered more of a reduction in the labour supply instead of a rise in unemployment. 
  • There are many differences between the economy then and now. Then there was:
    • A smaller share of workers in agriculture and manufacturing
    • Less globalisation
    • A pegged currency
    • More frequent IR disputes
    • Lower female labour force participation
    • Less work from home capacity
  • Due to these differences, considering the economic effects between then may not shed much light on the current pandemic.
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Theory and History by Ludwig von Mises (1957)

Contents:
Summaries
Take-aways
Extracts

One sentence summary

The fact that causality cannot be traced from the environment to human action renders many ideologies, philosophies and methodologies unsuitable for understanding human action.

One paragraph summary

The science of human action is comprised of history and praxeology. Both take ends as given and evaluate the means chosen by human actors to achieve their subjectively chosen goals. This is the appropriate method of science regarding human action because there is no established physical causality between physical phenomena and human action. There is also insufficient regularity in human action for predictive science. Only an approach that evaluates the suitability of means to achieving given ends is suitable for scientific and historical understanding. Other approaches do not respect these fundamental truths and are therefore unsuitable for understanding human action.

Detailed summary

Mises examines the fundamentals of different doctrines, ideologies and approaches to history and social science, and critiques them and compares them to his approaches to the sciences of human action: praxeology and history.

The fundamental argument of this book is that the various competing frameworks for understanding the world are ill-founded, by ignoring the fact that humans act. Human action involves consciously acting to achieve ends determined by values, which in turn are influenced by ideas, emotion and other people.The causal link between the environment, human thought and human action has not been established, while human action does not feature a sufficient degree of regularity to render it suitable to predictive methods. Due to these characteristics, human action cannot be viewed causally, but is instead teleological. Therefore, human action is fundamentally different from the subjects of the natural sciences, and must be interpreted with different epistemological and methodological approaches.

From this viewpoint, Mises criticises doctrines, ideologies and methodologies, including positivism, historicism, Marxism, determinism, behaviorism and materialism. All are found wanting compared to Mises’ proposed methods of the science of human action: praxeology and history. 

Positivism is invalid because it relies on regularity in human action that simply isn’t there. It relies on historical data and assumes they are valid inputs for prediction. Instead, Mises argues historical data is just that – historical; statistics is a representation of the history of human action at a particular time and place. 

Historicism, Mises argues, features contradictions and faulty foundations. Historicism has changed over time, but at various times has held that there is nothing generalisable from history and therefore nothing can be learned from it that is useful outside of that time. Historicism also developed theories of civilisational life cycles, a theory of regularity in social and political life. Mises, on the other hand, argues that each historical event is unique, and a universal theory of human action (praxeology) can be applied as a filter to aid in understanding historical human action.

The fundamental lack of understanding of how physical phenomena lead to changes in the mind and therefore in action forms the basis of Mises’ discussion of determinism. In discussing free-will, Mises notes the two extremes – complete free-will, or complete subjection to environmental forces – and falls somewhere in the middle in his emphasis on the role ideas play in influencing behaviour. People are influenced by ideas, which are influenced by environment and material factors. Ultimately, however, humans act, and we don’t know the causal link between the environment, thoughts and action, and so therefore have no foundational basis for determinism.

Materialism takes a substantial portion of Mises’ time, especially his dissection of Marxism. His main point with respect to materialism is his major underlying point: that we don’t yet know the mechanism between external factors and human action. We don’t know how to get from one to the other, rendering materialism invalid. Mises then spends much of the time pulling apart Marxism, which rests on the assumption that peoples’ beliefs are based on their material circumstances (their economic class). Life and society is a class struggle, with workers uniting to overthrow an exploitative capitalist system, the necessary forerunner of a socialist paradise. Mises takes this apart from many angles.

Mises’ main point – that humans engage in rational action whereas everything else doesn’t, rendering human action a distinct science – underlies his criticism of scientism, which is based on the idea of panphysicalism – the view that the method for physics is the only valid method for all branches of science (‘unified science’). Such a view leaves no room for consciousness, and leads ultimately to behaviorism, which holds that humans simply adjust to their environment. It can’t however explain why they adjust differently.

Mises argues against the idea of absolute values, which many ideologies or doctrines feature. These doctrines attempt to substitute absolute values for the subjective values of individuals. Mises views this as fundamentally wrong. It is not the role of science to discover a universal set of values, an ultimate good that we should be aiming for. All it can do is simply evaluate the means chosen to achieve individually-chosen, subjective ends, hence praxeology’s approach that treats ends as given and evaluates means chosen. Accordingly, the historian, engaging in the science of human action, should not use value judgments, but simply discover the ideas and intent of the human actors, and evaluate the means chosen to pursue their ends. Similarly, economists should not advocate for a policy, for example, even if it maximises output. He should simply state the effects on output/efficiency of a particular policy, as other considerations can be important, such as national security in the case of trade policy. The economist is not equipped to evaluate these other considerations; it is the role of the politician to make this trade-off. (This obviously applies to the Covid-19 crisis regarding the role of experts in advising government.)

Mises argues for rational utilitarianism over natural law. He argues that natural law is contested, similar to religious doctrine. Nature couldn’t be interpreted unequivocally, for nature is not clear in its ways.  Also, there is no natural tendency for these supposed natural laws to come about. Wars had to be fought and won, and bad laws had to be recognised as such, fought over and overturned. In the end, Mises argues, natural law ultimately fails because the idea of natural law simply substituted debate over interpretations of nature for debate over values. It didn’t solve the problem of disagreement or subjectivity. However, Mises noted the major accomplishment of natural law: the destruction of legal positivism – the idea that the only legitimate source of law is the government or ruler. In fact, every law could be subject to ‘critical examination by reason’. Mises concedes that there is a kernel of truth in natural law, and it aligns with Mises’ worldview. Mises argues that there is a ‘nature-given order of things…to which man must adjust his actions….’, acknowledging there is something to the idea of natural law. However, it seems that what Mises was referring to were the laws of economics (human action), and not, for example, some universal aspect of human nature beyond the idea of rational human action. From this recognition, Mises lays out his approach to assessing the world of human action: there is a ‘nature-given order of things’ (economics) that can be discovered by reason, according to their effects (utilitarianism). Natural law therefore leads to rational utilitarianism. Utilitarianism involves evaluating the means chosen, not the ends aimed at.

From this fundamental contention, Mises proposes that there are two main branches of the science of human action: praxeology and history. His method for history is explained in the following paragraph. According to Mises, praxeology is the theoretical science of human action, a deductive science based on axiomatic aspects of human life. It begins with the idea that humans act to improve their situation. Actions are based on values, which are subjective. People act by choosing means to achieve their desired ends. Thus, praxeology takes ends as given, and evaluates the means chosen. It evaluates human action with respect to chosen ends. It is non-judgmental of ends and values; it simply takes them as given. From this starting point, Mises establishes important, universal aspects of human action, such as cost and uncertainty. These then inform the doing of history. 

The second main field in the science of human action is history. Mises’ historical method involves combining knowledge from logic, mathematics, the natural sciences, the science of human action (praxeology), and thymology (psychology, or why people act the way they do) to form a specific understanding – an understanding of a specific historical event. Historical analysis uses the lens of praxeology as a filter to understanding the immutable laws of human action that apply in any historical setting, as well as the knowledge from the natural sciences, etc. and adds to that with specific, circumstantial data about the person, such as emotion, motivation, ideas, value judgments, etc. (thymology). It therefore attempts to understand the ends people were aiming at, and evaluate the means they chose to achieve them. Therefore, Mises’ history is always teleological – a history of purposeful actors, as opposed to a causal explanation of phenomena. The historian does not know the causal link between the environment and the action. However, he can evaluate the actions (means) taken by people in seeking their chosen ends.

Take-aways from the book

Given my lack of formal training in philosophy or methodology, there was a lot of low hanging fruit in reading Theory and History. Part of the value was simply from taking the time to unpack many of the ideas that underlie different perspectives that are still seen today (Theory and History was published in 1957).

With my recent attention on the limitations of science, I enjoyed Mises’ clearly correct point that humans are fundamentally different to the subjects of the natural sciences and therefore need to be examined and studied using different approaches. This is obviously contrary to the trend in economics, which is increasingly empirical, as economists seek guidance about the future from the past, and engage in forecasting. Economics uses historical data in predictive models, or finds relationships from the past and assumes they may be indicative of the world today. 

Mises doesn’t quite address an issue that arose for me, which is that while human action is not of sufficient regularity to enable accurate prediction, it has, as Mises acknowledges, a degree of regularity. Indeed, somewhere in either this book or Human Action, Mises concedes that history may have some use in speculation about the future. So, while positivism may fall south of the bar of ‘science’ in the realm of human action, of what use is it? Can Mises be correct and yet we be able to continue on with our methods, in some more modest form? If not, is Mises’ alternative up to the task? What is possible with Mises’ approach? Economists coming out of George Mason University, such as Peter Leeson and Christopher Coyne, apparently employ a Misesian approach, which is something to investigate further. Dani Rodrik’s book Economics Rules is a further text to examine this issue, as it assesses economic methodology in recent times and suggests a way forward.

If we are to persist with positivism, training in the limitations of positivism, of which Mises’ critique could form a part, would be most useful. I received no training in the limitations of economics, to the detriment of my education. Theory and History was of such value to me precisely because of the lack of awareness I had of these issues from my education. But Theory and History is by no means an introductory text. It took perhaps 5-6 years of on- and off-again thinking and reading on this topic, with more focused recent attention, to be ready to read and understand this book. It is dense, erudite, and focused – whether to its detriment or not – on a single idea: the fact that humans act and are thus different to other natural phenomena in that there is no causal relationship between external phenomena and human action. What is beyond dispute in my mind is the incredible degree of knowledge Mises brings to the topic. 

Mises’ discussion of universal values was incredibly stimulating, as I’ve considered this question in recent years. Mises’ contention that all values are subjective and that there are no universal values, goes against religion, collectivism, even Marxism. Marxists and collectivists have values they wish to force on the population – the true values that others have been blinded by ideology to see. As Mises argues, historically, those that have argued for true, higher values have not lived up to them themselves, and there has been perpetual disagreement over such values. Instead, what is needed is a society where the subjectivity and diversity of values is allowed, allowing everyone to pursue their own subjectively defined values. Social cooperation is the ultimate means for enabling that. Therefore, maintaining social cooperation is just. This aligns nicely with Hayek’s advocation of general rules for the maintenance of an extended order society. Hayek refers to these general rules as morals.

Mises’ contention that values are subjective may ultimately be true, but I wonder if it may be only partly true, and a truth that is not widely observed. While there is clear disagreement between people over values, there is a large degree of commonality across cultures and religions. So while Mises rightly argues that there is conflict over values, he seems to underappreciate the cross-cultural agreement and therefore the possibility of some shared values that may be considered ‘objectively true’. Further, as Henry Hazlitt later noted, people see value as all important; ‘it is the very standard by which we judge importance’. It is therefore a rudder and a tool for assessment, and will naturally form a major part of philosophy. Is Mises throwing the baby out with the bathwater by focusing purely on means and not on ends or values? In fairness to Mises, he saw his role as that of a scientist, evaluating means, not ends, but philosophy, as Roger Scruton argued, is a field for areas of inquiry where science cannot shed light.

Mises was utterly convinced of his worldview. He argued against the tide, unwilling to compromise in his academic work (he was willing to compromise in his political work, though that, he maintained, was appropriate, for politics is about compromise). Mises was a very concrete and opinionated thinker. There was little room for equivocation. This is what makes him so compelling, but may also be a weakness. It’s all or nothing for Mises.

There were so many interesting tidbits that I enjoyed in this book. It was interesting to note that it was the ‘antisecularists’, as Mises referred to them as, that viewed capitalism as an unjust system. It seems that that has switched around in the present, with much of the modern radical left being, seemingly, secular. (However, many have pointed out the ‘religious’ aspects of their behaviour – the outing of ‘heretics’, the quest for moral purity, etc. This seems to align with ideas put forward by, for example, Joseph Bottum in An Anxious Age.) Mises’ discussion of the Irish who want to take back their language at the time of Mises’ writing was interesting. His discussions of interactions with other cultures also grabbed my attention. 

There were many others, but I won’t go on. However, below I’ve posted some interesting passages from the book.

Overall, Theory and History  was an incredibly stimulating and challenging read. I appreciate his major point about the uniqueness of human action, his discussion of values, his incredible breadth of knowledge, and I’ll remember his critiques of different doctrines, ideologies and philosophies as I evaluate different arguments put forward in discussion today.

Extracts

On value

“It is one of the tasks of the specific understanding of the historical sciences to establish what content the value judgments of the acting individuals had. It is a task of history, for example, to trace back the origin of India’s caste system to the values which prompted the conduct of the generations who developed, perfected, and preserved it. It is its further task to discover what the consequences of this system were and how these effects influenced the value judgments of later generations. But it is not the business of the historian to pass judgments of value on the system as such, to praise or to condemn it. He has to deal with its relevance for the course of affairs, he has to compare it with the designs and intentions of its authors and supporters and to depict its effects and consequences. He has to ask whether or not the means employed were fit to attain the ends the acting individuals sought. It is a fact that hardly any historian has fully avoided passing judgments of value. But such judgments are always merely incidental to the genuine tasks of history. In uttering them the author speaks as an individual judging from the point of view of his personal valuations, not as a historian.”

“All judgments of value are personal and subjective. There are no judgments of value other than those asserting I prefer, I like better, I wish. It cannot be denied by anybody that various individuals disagree widely with regard to their feelings, tastes, and preferences and that even the same individuals at various instants of their lives value the same things in a different way. In view of this fact it is useless to talk about absolute and eternal values. This does not mean that every individual draws his valuations from his own mind. The immense majority of people take their valuations from the social environment into which they were born, in which they grew up, that moulded their personality and educated them. Few men have the power to deviate from the traditional set of values and to establish their own scale of what appears to be better and what appears to be worse. What the theorem of the subjectivity of valuation means is that there is no standard available which would enable us to reject any ultimate judgment of value as wrong, false, or erroneous in the way we can reject an existential proposition as manifestly false. It is vain to argue about ultimate judgments of value as we argue about the truth or falsity of an existential proposition. As soon as we start to refute by arguments an ultimate judgment of value, we look upon it as a means to attain definite ends. But then we merely shift the discussion to another plane. We no longer view the principle concerned as an ultimate value but as a means to attain an ultimate value, and we are again faced with the same problem.” 

“Value is not intrinsic. It is not in things and conditions but in the valuing subject.”

“Contrary to popular conceptions, it [the theory of comparative advantage] does not say that free trade is good and protection bad. It merely demonstrates that protection is not a means to increase the supply of goods produced. Thus it says nothing about protection’s suitability or unsuitability to attain other ends, for instance to improve a nation’s chance of defending its independence in war.”

“From the bewildering diversity of doctrines presented under the rubric of natural law there finally emerged a set of theorems which no caviling can ever invalidate. There is first the idea that a nature-given order of things exists to which man must adjust his actions if he wants to succeed. Second: the only means available to man for the cognizance of this order is thinking and reasoning, and no existing social institution is exempt from being examined and appraised by discursive reasoning. Third: there is no standard available for appraising any mode of acting either of individuals or of groups of individuals but that of the effects produced by such action. Carried to its ultimate logical consequences, the idea of natural law led eventually to rationalism and utilitarianism.”

“The chief accomplishment of the natural law idea was its rejection of the doctrine (sometimes called legal positivism) according to which the ultimate source of statute law is to be seen in the superior military power of the legislator who is in a position to beat into submission all those defying his ordinances. Natural law taught that statutory laws can be bad laws, and it contrasted with the bad laws the good laws to which it ascribed divine or natural origin. But it was an illusion to deny that the best system of laws cannot be put into practice unless supported and enforced by military supremacy.”

“Marxism is a revolutionary doctrine. It expressly declares that the design of the prime mover will be accomplished by civil war. It implies that ultimately in the battles of these campaigns the just cause, that is, the cause of progress, must conquer. Then all conflicts concerning judgments of value will disappear. The liquidation of all dissenters will establish the undisputed supremacy of the absolute eternal values.”

[On those who seek justice…in social institutions.] “Social institutions…must be just. It is base to judge them merely according to their fitness to attain definite ends, however desirable these ends may be from any other point of view. What matters first is justice. The extreme formulation of this idea is to be found in the famous phrase: fiat justitia, pereat mundus . Let justice be done, even if it destroys the world.”

“Although some intolerance, bigotry, and lust for persecution is still left in religious matters, it is unlikely that religious passion will kindle wars in the near future. The aggressive spirit of our age stems from another source, from endeavors to make the state totalitarian and to deprive the individual of autonomy.”

On statistics

“In the field of human action statistics is a method of historical research. It is a description in numerical terms of historical events that happened in a definite period of time with definite groups of people in a definite geographical area. Its meaning consists precisely in the fact that it describes changes, not something unchanging. In the field of nature statistics is a method of inductive research. Its epistemological justification and its meaning lie in the firm belief that there are regularity and perfect determinism in nature. The laws of nature are considered perennial. They are fully operative in each instance. What happens in one case must also happen in all other like cases. Therefore the information conveyed by statistical material has general validity with regard to the classes of phenomena to which it refers; it does not concern only definite periods of history and definite geographical sites.”

On dialectical materialism

“Marx obfuscated the problem by confusing the notions of caste and class. Where status and caste differences prevail, all members of every caste but the most privileged have one interest in common, viz., to wipe out the legal disabilities of their own caste. All slaves, for instance, are united in having a stake in the abolition of slavery. But no such conflicts are present in a society in which all citizens are equal before the law. No logical objection can be advanced against distinguishing various classes among the members of such a society. Any classification is logically permissible, however arbitrarily the mark of distinction may be chosen. But it is nonsensical to classify the members of a capitalistic society according to their position in the framework of the social division of labor and then to identify these classes with the castes of a status society.” “This socialist or communist doctrine fails entirely to take into account the essential difference between the conditions of a status or caste society and those of a capitalistic society.”

“If a man expresses opinions at variance with the ideology of a definite class, that is because he does not belong to the class concerned. There is no need to refute his ideas by discursive reasoning. It is enough to unmask his background and class affiliation. This settles the matter. But if a man whose proletarian background and membership in the workers’ class cannot be contested diverges from the correct Marxian creed, he is a traitor. It is impossible to assume that he could be sincere in his rejection of Marxism. As a proletarian he must necessarily think like a proletarian. An inner voice tells him in an unmistakable way what the correct proletarian ideology is. He is dishonest in overriding this voice and publicly professing unorthodox opinions. He is a rogue, a Judas, a snake in the grass. In fighting such a betrayer all means are permissible.”

On the philosophy of history

“Simplified accounts of history, adapted to the capacity of people slow of comprehension, have presented history as a product of the feats of great men…. No serious historian ever shared in such nonsense. It has never been contested that the part played even by the greatest figures of history was much more moderate. Every man, whether great or small, lives and acts within the frame of his age’s historical circumstances. These circumstances are determined by all the ideas and events of the preceding ages as well as by those of his own age. The Titan may outweigh each of his contemporaries; he is no match for the united forces of the dwarfs. A statesman can succeed only insofar as his plans are adjusted to the climate of opinion of his time, that is to the ideas that have got hold of his fellows’ minds. He can become a leader only if he is prepared to guide people along the paths they want to walk and toward the goal they want to attain. A statesman who antagonizes public opinion is doomed to failure. No matter whether he is an autocrat or an officer of a democracy, the politician must give the people what they wish to get, very much as a businessman must supply the customers with the things they wish to acquire.”

On historicism

“History is a sequence of changes. Every historical situation has its individuality, its own characteristics that distinguish it from any other situation. The stream of history never returns to a previously occupied point. History is not repetitious.”

“There is no harm in comparing different historical events and different events that occurred in the history of various civilizations. But there is no justification whatever for the assertion that every civilization must pass through a sequence of inevitable stages.”

“Those who want to set the clock of history back ought to tell people what their policy would cost.”

On religion as a substitute for science

“Where people did not know how to seek the relation of cause and effect, they looked for a teleological interpretation. They invented deities and devils to whose purposeful action certain phenomena were ascribed. A god emitted lightning and thunder. Another god, angry about some acts of men, killed the offenders by shooting arrows. A witch’s evil eye made women barren and cows dry. Such beliefs generated definite methods of action. Conduct pleasing to the deity, offering of sacrifices and prayer were considered suitable means to appease the deity’s anger and to avert its revenge; magic rites were employed to neutralize witchcraft. Slowly people came to learn that meteorological events, disease, and the spread of plagues are natural phenomena and that lightning rods and antiseptic agents provide effective protection while magic rites are useless. It was only in the modern era that the natural sciences in all their fields substituted causal research for finalism.”

On phsychology

“What characterizes the neurotic as such is not the fact that he resorts to unsuitable means but that he fails to come to grips with the conflicts that confront civilized man. Life in society requires that the individual suppress instinctive urges present in every animal. We may leave it undecided whether the impulse of aggression is one of these innate urges. There is no doubt that life in society is incompatible with indulgence in the animal habits of satisfying sexual appetites. Perhaps there are better methods of regulating sexual intercourse than those resorted to in actual society. However that may be, it is a fact that the adopted methods put too much strain upon the minds of some individuals. These men and women are at a loss to solve problems which luckier people get over. Their dilemma and embarrassment make them neurotic.”

On fiction

“Fiction is free to depict events that never occurred. The writer creates, as people say, an imaginary story. He is free to deviate from reality. The tests of truth that apply to the work of the historian do not apply to his work. Yet his freedom is limited. He is not free to defy the teachings of thymological [psychological] experience. It is not a requirement of novels and plays that the things related should really have happened. It is not even necessary that they could happen at all; they may introduce heathen idols, fairies, animals acting in human manner, ghosts and other phantoms. But all the characters of a novel or a play must act in a thymologically [psychologically] intelligible way. The concepts of truth and falsehood as applied to epic and dramatic works refer to thymological [psychological] plausibility. The author is free to create fictitious persons and plots but he must not try to invent a thymology—psychology—different from that derived from the observation of human conduct.”