Free Markets and Policy

[The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years ♦ by Lawrence H. White ♦ Cambridge University Press, 2012]

[ed.: This review is available as a PDF.]

Lawrence White’s The Clash of Economic Ideas is not your usual history of economic thought; neither is it a comprehensive review of all the important developments in economic theory nor does it focus exclusively on any specific period.  Instead, White’s focus is on the “great policy debates” of the 20th century: from the socialist calculation debate of ~1920–40 to the austerity/stimulus that characterize the period following the 2007–09 industrial contraction.  Very early on, the purpose of the work is established: its “focus [is] on the policy-relevant parts of economics,” contrasting “with the encyclopedic histories of economic thought.”1

One theme transcends the entire period discussed: market freedom versus interventionism.  As such, in the course of narrating the history of the modern world’s great intellectual discussions White not-so-subtlety works in a policy recommendation of his own.  Indeed, someone already wary of the laissez-faire message would find little to reinforce this position.  Each debate — whether on socialism, business cycle (and response) theory, the New Deal, post-war development theory and monetary order, and the role of government in providing goods and services —  is set up so that the interventionist position is explained and then refuted by the pro-market logic that follows.  Given the hidden agenda of the book, someone already knowledgeable of these topics may not find anything new, since it is not a profound or far-reaching exploration of the contemporaneous academic work that provided the substance to the debates.  Rather, it is a relatively superficial — and this is not meant to belittle its merits — treatment, meant to set the stage for a final policy prescription: liberate the market.

The “thin” treatment of the whole body of the intellectual tradition behind any given theory sometimes leads to a few errors — for example, the author’s interpretation of Mises’ response to the market socialism of the 1930s and Keynes’ business cycle theory —, which are often enough counter-balanced by savvy insights — including a subtle suggestion towards Adam Smith’s true intellectual position towards laissez-faire (pro-consumer rather than pro-business) —, but makes for a far more enjoyable read.  The 412 page chronicle reads quickly and lucidly; the prose in engaging.  The various positions are explained well, and White’s excellent footnotes allow one to quickly jump into further research.  This book is extremely well-suited for those who have relatively little background in the history of economic thought.  It, for instance, is especially well-suited for an undergraduate class and the general public.

The bulk of this review focuses on a few quibbles that, for anybody who has read The Clash of Economic Ideas, prove to be relatively very minor.  The disagreements on interpretation expressed here should not be understood as a major criticism of White’s book.  They are just points that some may find value in further understanding, since they serve to better clarify what exactly some of the characters in White’s narrative argued.  On the whole, as already suggested, White’s effort is commendable and the book is most likely the best in its class.  Apart from providing greater detail — at the expense of the audience — the only major difference perceivable in rival literature is replacing the pro-market glaze with a pro-interventionism one (or shades of in-between); but, one can just take our book and shed it of ideology — that is, take the best of it — and garner greater results.

Minor Quibbles: Mises and Keynes

After setting up the context of the great policy debates to follow by explaining the move away from a laissez-faire consensus during the late-20th century, White dives into the socialist calculation debate led by the Austrians, and a few Neoclassical economists (such as Frank H. Knight), on one side and market socialists (especially Oskar Lange and Abba Lerner) on the other.  The opening salvo is Ludwig von Mises’, who in 1920 and 1922 published two tracts against socialism, explaining that socialism — defined by the collective ownership of the means of production — is unviable given that it lacks of a method by which the means of production can be efficiently distributed throughout the structure of production; this is because socialism dispenses with the market’s process of accomplishing this: the price system.  In the 1930s, Lange fired back with a theory of market socialism, where State planners can find prices through an equilibrating trial-and-error process.  Mises, and his disciple Friedrich Hayek, rejoined the debate right away.  But, the focus of White’s treatment of both of these economists’ arguments leads the reader away from the most important insights of their responses.

Lange’s theory of socialistic price determination is summed up as follows.  Price can be computed if three things are available: a preference scale, the opportunity cost of alternative uses, and the supply of a resource.  With the first and second sets of information given and a least-cost production function, price and opportunity cost can be mathematically found.  As aforementioned, using imperfect information a central planning board can find the market clearing price through trial-and-error.  White’s description of Hayek’s response focuses on the fact that Lange had simply assumed a “given” least cost production function, waving away one of the functions of market competition, and also had presumed all relevant information to be readily available.  In the case of Mises, he rebutted Lange’s argument by positing that central planning committees cannot replicate the profit and loss phenomena of the market, and that without profit there would be no incentive for efficient market activity.2  If true, this would be a major step back for Mises, since in the early 1920s he dismissed the incentive problems of socialism as non-fundamental.3  While both Hayek and Mises provided multifaceted cases against socialism, the insights White draws from are possibly not the most important.  Rather, Mises and Hayek sought to reformulate the Austrian theory of price determination, in light of the now suddenly very apparent shortcomings of the traditional Neoclassical approach.4

Both men took Mengerian/Böhm-Bawerkian price theory for granted.5  The Austrian theory of price formation is not an equilibrium-dominated one, and neither is it one where price is considered an ex-post or a given phenomenon.  Rather, price formation of the Austrian tradition traces the causal processes originating from participating individuals and the derivation of prices based on subjective value.  In light of this, Lange’s case for socialist price formation was absurd.  Lange wrote, “The administrator of a socialist economy will have exactly the same knowledge, or lack of knowledge, of the production function as the capitalist entrepreneur have.”6  Within the Austrian framework, this statement is both true and suggestive of theoretical conclusions lying at the opposite side of those of Lange.  Price is not just set by a single entrepreneur, but by many competing for profits and losses, in turn related to consumer preferences.

Hayek’s work on equilibrium theory highlights the fragmentation of relevant knowledge.  As White writes, Hayek sought to prove to market socialists that none of the “givens” Lange assumed to exist actually do.  This is the origin of Hayek’s well-known “knowledge problem.”  It is not just a lack of knowledge of consumer preferences, but also insufficient knowledge of the various data required to arithmetically compute the various least cost production functions that decide allocative efficiency.7  Thus, the nature of the diffusion of information is better solved through a decentralized market, given that competing entrepreneurs can much more quickly accumulate relevant knowledge and use it towards production.  This is especially important in the dynamic and changing market, where change provides a time constraint on the accumulation and interpretation of information.8  While Hayek’s analysis may not have been perfectly symmetrical with that of Mises, it is clear that the former saw the “price mechanism” as a corrective feature of the market, forcing entrepreneurs to revise their plans in light of new knowledge suggesting that prior plans had inadequately interpreted available information.9

While White, in The Clash of Economic Ideas, seemingly attributes Mises’ rebuttal against Lange’s attack as secondary to Hayek’s (evident in the very superficial treatment of Mises’ contributions to the debate in Human Action), it was perhaps more important than his student’s.  As established in Mises’ 1920 publication, the lack of private property in a socialist economy is just as condemning as the lack of knowledge.  Without private property in the means of production — even while assuming the right to property amongst consumers’ goods — there is no means by which prices can be arrived at, since it disallows entrepreneurs from participating in the continuous process of appraisement.10  This much is contained in Hayek’s rebuttal to Lange, “[W]e much show how a solution is produced by the interactions of people each of whom possesses only partial knowledge.”11  Whereas Hayek went only a little farther than Mises’ original volley, Mises’ 1949 contribution went as far as to provide a consistent, integrated, and comprehensive account of the market’s pricing process.12  In short, it was proof that Lange had by and large missed the mark in his alleged “solution” to the calculation problem.

Another error, important within its own context, is White’s rendition of John M. Keynes’ business cycle theory.  The author borrows the common interpretation of Keynes’ argument that there is a disconnect of a connection between savings and investment.13  At fault, according to White, is the disappearance of the role of the loanable funds market, which in Classical economic theory is the main artery that distributes savings to entrepreneurs.14  Strangely, White offers little on Keynes’ theory of interest, which recognizes that savings can be held in various forms.15  Most surprisingly, considering Keynes’ theory of interest, White does not recognize that this is not the principal cause — at least, on its own — for deficient effective demand.  It much less surprising, therefore, that White misses the mark in his analysis of Keynes’ statement that “[the Classical economists] are fallaciously supposing that there is a nexus which units decisions to abstain from present consumption with decisions to provide for future consumption; whereas the motives which determine the latter are not linked in any simple way with the motives which determine the former.”16

Very early in The General Theory, Keynes establishes the fact that entrepreneurial actions are guided by expectations (his aggregate supply function).17  The above-quoted passage ought to be interpreted within this context; entrepreneurial expectations are endogenous to themselves, and not only reliant on the decision to save by those who they presumably can borrow from.  The disconnect between savings and production, therefore, is a product of divergent expectations, where entrepreneurs no longer feel that they can profit from a use of saved resources.  The rate of interest of loanable funds no longer serves to coordinate only because the rate of interest is higher than the marginal efficiency of capital, or, more broadly, the expectations of income.  It is no less unsurprising that The Clash of Economic Ideas’s index lacks an entry for “expectations.”

Related, White argues that Keynes holds that any act of savings is detrimental to the economy during periods of idle employment, because it decreases effective demand.18  Presumably, this is related to Keynes’ alleged ignorance of the “Austrian” theory of multi-stage production.19  Samuelson’s work is used as an affirmation of this interpretation, but if this understanding of Samuelson is correct then Samuelson too misinterpreted Keynes.  While it may be the case that Keynes did not recognize Hayek’s “Ricardo effect,”20 which stated that increased consumption during periods of less than full employment will lead to even greater unemployment, White’s assertion is not true insofar that Keynes also accepted the “socialization of investment” and artificially decreased rates of interest as alternative, possibly superior, solutions.  While it was still far from perfect, the rendition of Keynes’ theory made in The Clash of Economic Ideas make it seem as if they are elementary and devoid of basic economic knowledge.  In other words, The General Theory is a more advanced treatise than many non-Keynesians acknowledge.  By characterizing Keynes’ work in a way that makes him seem almost like an ignoramus, White does his audience a disservice.

Hopefully, elucidating upon these two errors does not send the message that White’s book is replete with others.  Again, these errors should be seen as individual and unique (although, admittedly, quite major within the context of their respective specific debates); they are a product of attempting to package decades of intellectual evolution within the space of a single chapter of a space-constrained book.  At some points, actually, White does a great job at making subtle remarks that seemingly favor the policies which he opposes.21

Adam Smith’s Distrust of Business

While The Clash of Economic Ideas does not put too great of stress on it, White does go to some length to make sure the reader walks away knowing that Smith placed value on laissez-faire only because he saw it as a restraint on the evils of the businessman.22  To some, this seems difficult to fit in with the idea that Smith stands for, essentially, an unbridled market, the classical conception of freedom and liberty, and the pursuit of self-interest.  One explanation might be the “bleeding heart” one, showing the compatibility between capitalism and the welfare of society’s poorest members.  Certainly, this was one of Smith’s interests when defending the market economy in The Wealth of Nations.  But, his general support of the market follows a much more fundamental insight.

Smith saw mercantilism as a process of collusion between the State and merchants, allowing the latter to take advantage of the former’s monopoly on force for their own benefit and against the well-being of the average consumer.  He did not recognize the State as an effective tool to restrain the potential damages that self-interest could wreak in a completely unrestrained environment.  Rather, Smith saw the market as the mechanism of restraint; it is the market which increases competition between merchants, figuratively enslaving them to the wants of the consumer.  This “macroeconomic” interpretation may stem from his views on the division of labor, which he also saw as a restraint on the actions of men.  Indeed, the division of labor makes all dependent on others, meaning that one needs to produce to the benefit of others in order to earn the income to consume for one’s own wellbeing.  Inter-dependency and competition jointly restrain the producer in favor of the welfare of society as a whole.

While Smith may be rightfully invoked against some of the modern arguments in favor of intervention, as does White,23 one must be wary of overuse.  Our author notes at least one exception to Smith’s support for capitalism: public goods.24  In cases where the market cannot guarantee the existence of competition — as disputed as these are — Smith may have readily supported interventionism.  During his time, he may not have recognized a great many examples (although, Smith did argue in favor of various forms of interventionism25), but the modern rise of welfare economics26 may be seen as just as Smithian as any modern free-market theory.

Clash of Economic Ideas as a Contribution to the Literature

The bulk of this review is not a review as such, but a look at two errors and one insightful accuracy.  As such, it also unfortunately detracts from the overarching contributions the book does make.  Some of these have been listed in the opening paragraphs of the present essay: White’s book is engaging, easy to read, and it introduces the reader to the important debates that characterize economics-related public policy of the 20th and 21st centuries.  Another is that, while White attempts to distinguish between the academic and policy debates, the book shows that these two are not entirely separable.  Indeed, the latter can only be informed by the former.  This is exemplified by the great many references White makes to the support, academic, literature.  In this way, Clash of Economic Ideas spurs the reader to look forward to further research into the academic texts which gave rise to the substance of the popular debates.  The book also suggests that with regards to many of the debates, further academic research is needed to be able to make conclusive statements with regards to policy (or whether there should be no public policy at all!).

As aforementioned, in the course of reviewing the history of these debates, White makes an undeniable policy statement of his own: liberate markets.  This is, for example, almost very nearly explicit in his use of two chapters, illustrating the case of post-war Germany and India, to prove via empirical evidence the merits of the free market and the demerits of interventionism (influenced directly and indirectly, according to White, by English Fabian socialism and German Historicism27).  India, of course, was a failed case, until the relative liberalization of its markets during the 1990s; Germany, on the other hand, was a great post-war success, led by German “ordoliberalism.”  Whatever interventionist tendencies “ordoliberalists” had, these are framed as inconsistencies and wrinkles.  In the book, interventionist policies in Germany are not presented as possible factors behind this country’s post-war growth.28  This is not to say that one ought to disagree with White’s implicit policy recommendations, rather only to show that behind a thin and transparent veneer of academic neutrality is a clear favoring of the free-market.

One should not interpret the above, a priori, as error.  Surely, those convinced of the merits of socialism or extreme interventionism are not likely to gain anything by reading White’s book.  But, for the rest, the examples and literature used convincingly suggest that at the very least one should adopt a Smithian stance.  Markets ought to remain free, and divergence in the opposite direction should not be taken for granted.  Rather, arguments in favor of interventionism suffer the burden of proof and should be approached with delicacy.  While, of course, White, et. al., may disagree in the details with economists such as Bradfrod Delong and Paul Krugman, the last two accept in principle the before-defined “Smithian stance” (they just believe, whether rightly or wrongly, that the necessary proof has been provided).  Once it is admitted that pro-market economics allows for a very broad range of opinion, and in theory admits the possibility of beneficial interventionism, then White’s policy conclusions — when broadly considered — are not so disputable.

While, again, one is likely to disagree with some of the details presented in The Clash of Economic Ideas, all except extreme left-wing ideologues (and, believe it or not, I do not mean to use this term is a necessarily derogatory manner) should find the book an extremely interesting read.


1. White (2012), p. 2.

2. “Completely taxing profits away would completely suppress entrepreneurial activity;” ibid., p. 52; White cites Mises, Human Action, 3rd rev. ed. (Chicago: Henry Regnery, 1966), p. 709.

3. White (2012), p. 46.

4. This is apparent in Hayek’s critique of Schumpeter’s Capitalism, Socialism, and Democracy.  Schumpeter had claimed that the law of price imputation makes the derivation of input prices easy to determine, since the prices of outputs reveals the preferences of the consumers.  Hayek’s response illustrates the essence of the Mises/Hayek rebuttal to Lange: the market is complex and dynamic, and thus the price of one producers’ good cannot be inputed from an output since there are a range of alternative possible outputs.  The purpose of market competition is to “discover” the least cost use of a particular producers’ good, and this is done with uncertain expectations; ibid., p. 57.

5. Carl Menger, Principles of Economics (Auburn, Alabama: Mises Institute, 2007), pp. 171–225; Eugene von Böhm-Bawerk, Capital and Interest, Volume II: The Positive Theory of Capital (New York City: G.E. Stechert and Co., 1930), pp. 166–234.  Literature differentiating between Mengerian price theory and that of Walras and Jevons, the two other originators of the subjective doctrine, is extensive; see, for example, A.M. Endres, “Carl Menger’s Theory of Price Formation Reconsidered,” History of Political Economy 27, 2 (1995), pp. 261–287.  Also, see Joseph Salerno, “Varieties of Austrian Price Theory: Rothbard Reviews Kirzner,” Libertarian Papers 3, 25 (2011).  For an attempted de-homogenization of the Misesian and Hayekian approaches to price formation and the market process see Salerno, “Mises and Hayek De-Homogenized,” The Review of Austrian Economics 6, 2 (1993), pp. 113–146; also, Leland B. Yeager, “Mises and Hayek on Calculation and Knowledge,” Review of Austrian Economics 7, 2 (1994), pp. 93–109.

6. White (2012), p. 49; Oskar Lange, “On the Economic Theory of Socialism: Part I,” The Review of Economic Studies 4, 1 (1936), p. 55.

7. White (2012), p. 53–54.

8. See especially Friedrich A. Hayek, “The Use of Knowledge in Society,” The American Economic Review 35, 4 (1945), pp. 522–526.

9. “It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement;” Hayek (1945), p. 527.

10. Jörg Guido Hülsmann, “Knowledge, Judgment, and the Use of Property,” Review of Austrian Economics 10, 1 (1997), pp. 23–24; Salerno, “Postcript: Why a Socialist Economy is ‘Impossible’,” in Mises, Economic Calculation in the Soviet Commonwealth, pp. 35–37.

11. Hayek (1945), p. 530.

12. Joseph Salerno, “The Place of Mises’s Human Action in the Development of Modern Economic Thought,” The Quarterly Journal of Austrian Economics 2, 1 (1999), pp. 57–58.

13. This line of reasoning, for instance, is explicit in Roger Garrison, Time and Money (New York City: Routledge, 2001).

14. White (2012), p.135.

15. The Selgin/White theory of free banking holds that even money saved in the form of holding it is manifested in the interest rate of the loanable funds market, because it allows relevant banks to expand the quantity of fiduciary media (maintaining the quantity of currency in circulation stable).  But, in Keynes’ theory of interest holding money under a mattress or brick is not the only alternative method of saving.  One, for instance, could easily imagine the purpose of the bond and stock markets.  This is what is contained in the passage White quotes of Keynes’ book dealing with his theory of interest (Ibid., pp. 136–137).

16. Ibid., p. 147.

17. John M. Keynes, The General Theory of Employment, Interest, and Money (BN Publishing, 2008), pp. 23–26.

18. White (2012), pp. 135–136.  Regarding Keynes’ view of the role of savings, consider the following passage, “[E]mployers would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption” (Keynes [2008], p. 27).

19. Ibid., p. 133.  Keynes actually uses a two-stage structure of production, meaning that the second (or earlier) stage directly derives profits from other entrepreneurs and indirectly from consumers (i.e. the imputation of price).  It is implicit, also very early on, in his discussion of long-term expectations and income (Keynes [2008], pp. 46–47, 52).

20. See Friedrich A. Hayek, Profits, Interest, and Investment and Other Essays on the Theory of Industrial Fluctuations (Clifton, United Kingdom: Augustus M. Kelley, 1975 [1939]), pp. 3–71; Hayek, “The Ricardo Effect,” Economica 9, 34 (1942), pp. 127–152.

21. For the nitpicker and Cantillon-advocate, one additional error may be the fact that White does not cite Richard Cantillon as one of Adam Smith’s intellectual predecessors and major influences.  The economics of Cantillon ought to be recognized as one of the earliest, if not the earliest, complete bodies of economic (and anti-mercantilist) theory; Cantillon’s Essai is one of the few works cited by Smith in The Wealth of Nations.  See Jonathan M. Finegold Catalán, “Richard Cantillon: Founder of Political Economy.”  Of course, and in all seriousness, White’s book is not meant as a textbook introduction to the history of economic thought.  But, White does write on Smith’s influences between pages 219–221, even mentioning French economist François Quesnay.

22. White (2012), pp. 194, 219; “Businessmen are ‘an order of men, whose interest to deceive and even to oppress the publick, and who accordingly have an interest to deceive and even to oppress the publick, and who accordingly have, upon many occasions, both deceived and oppressed it.’”

23. Take, for example, White’s use of Smith against the “infant industry” argument for protectionism (pp. 372–373).

24. Ibid., pp. 216–217.

25. Murray N. Rothbard, An Austrian Perspective on the History of Economic Thought, Volume 1: Economic Thought Before Adam Smith (Auburn, Alabama: Mises Institute, 2006), pp. 465–469.

26. Discussion of welfare economics, including the argument in favor of the existence of public goods, is made on pp. 332–355 of White (2012).

27. White’s discussion of American Institutionalism, and its influence on modern American economics, should prove extremely interesting to the Austrian reader; see Ibid., pp. 18–25, 99–125.  While White does not elucidate more in this direction, it is evident from some of the discussion that Institutionalism had a profound impact on the development of American economics.  While its branches may be less visible in modern American macroeconomics, one wonders whether some of today’s prevalent methodologies — for instance, econometrics and “Friedmanite” positivism — would have existed otherwise.  American Institutionalism is relevant in this case, because it originated in German Historicism; it is, in fact, the American arm of historicism, and it was very popular in American economics.  German Historicism, of course, composed the opposite side of Menger’s methodenstreit, where Menger famously made the case for pure theory.

28. See, for one example, discussion on “competition policy;” Ibid., pp. 243–244.

3 thoughts on “Free Markets and Policy

  1. Blue Aurora

    Regarding Adam Smith’s “interventionism”…

    Are you aware that Adam Smith actually supported the creation of an organisation like the Bank of England? IIRC, there is a passage in The Wealth of Nations that seem to indicate that he supported the establishment of a central bank to regulate banks.

    1. Jonathan Finegold Catalán Post author

      I do know that Adam Smith, influenced on his observations of the Scottish banking industry, favored competitive note issue. The relevant parts of The Wealth of Nations is interpreted as an early defense of free banking. I don’t have my copy of The Wealth of Nations with me in Spain and I don’t have time at this moment to look through the internet, but a superficial search brought me to this (which I haven’t read yet): Hugh Rockoff, Parellel Journeys: Adam Smith and Milton Friedman on the Regulation of Banking.

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