Category Archives: History

Benefits to High Seas Piracy

While the study isn’t recent, I came across this news brief on a study on the relationship between piracy and the colonies,

Pirates mapped new territory, expanded trade routes, discovered good ports and opened doors with the native peoples, Acosta said. “They really helped European nations explore the Americas before Europeans could afford to explore them on their own,” he said.

By selling stolen silks, satins, spices and other merchandise in ports and spending their booty in the colonies, pirates created an economic boom, helping struggling settlements and making Port Royale in Jamaica and Charleston, S.C., huge mercantile centers, Acosta said. “They didn’t bury their treasure, they spent it, helping colonies survive that couldn’t get the money and supplies they needed from Europe,” he said.

Without the infusion of money into the New World from piracy, it is possible that Britain and France may not have been able to catch up with Spain, Acosta said.

When Charity Saved Rome

[ed. I originally wrote this essay in 2009.]

Roman civilization is remembered for a plethora of reasons: her expansive empire, her roads, Roman jurisprudence, and her aqueducts, amongst others. Perhaps one of the most well known “qualities” was the wars she fought. Indeed, Roman military history is so extensive that a historian could spend his or her entire career researching the topic. For many centuries, Rome was the premier military power in Europe and the Middle East. Like any military controlled by the State, the Roman army and navy were built via tax money. These riches were squandered on large-scale wars meant to protect the Empire from foreign invasion or to increase the size of the Empire proper. However, despite the fame and glory attributed to Roman military power, her legions and fleets were not invincible. Roman armies as large as eighty thousand men were lost in single battles: one can recall the battle of Cannae, where it is thought that Rome lost 70,000 men alone. But, for the majority of the Roman Republic and the first centuries of the Empire, the Roman government had the ability to rebuild its lost cohorts and continue to wage war. But, the Roman government did not always have the money to rebuild its forces.

One such rut the Roman government found itself in was during the First Punic War. This war, first in a series of three, was fought between 264 and 241 B.C.E. Its origins can be traced back to Roman and Carthaginian political and economic interests with the island of Sicily, which at the time divided both States from each other. Much of the campaigning was done on land, in Sicily proper. However, the Romans quickly realized that the only way of decisively occupying the entirety of the island was to use a navy to defeat the Carthaginian fleet, which at the time was considered the best in the Mediterranean, and to blockade the several port cities controlled by Punic armies. Also, naval units were necessary to protect Roman supply and transport vessels. Despite the paramount importance of naval units during this war, the Roman Republic did not dispose of a navy immediately upon declaration of war. Prior to the First Punic War the Republic had relied exclusively upon allied ships, and so it became necessary to fund a ship construction program at the onset of war with Carthage. In Roman tradition, the Roman government funded a huge project to build over one hundred warships (100 quinqueremes and 20 triremes, according to Adrian Goldsworthy).

According to Polybius, a contemporaneous historian, the Romans scavenged their shipbuilding technology from a Punic warship which had run aground near the city of Rhegium, on the southern part of the Italian peninsula. In any case, they immediately put their new fleet to use. A series of small scale naval battles were fought in the coming years, including several Roman setbacks. Finally, however, the Roman navy was able to meet the bulk of the Punic fleet in a large naval battle called Ecnomus. According to Polybius, the Romans had amassed an estimated 330 warships for the impending invasion of North Africa, while the Carthaginians had put together a naval force of some 350 war vessels. The battle ended in Roman victory, temporarily giving them command of the sea and allowing their army to land in North Africa. Ultimately, the North African land campaign ended in defeat, forcing the Romans to muster a large naval rescue force to bring back their North African forces to Italy. This led to a second large naval battle at Aspis, ending in a second Carthaginian defeat. With this newfound naval success, the Roman government ordered their fleet to tour the Carthaginian held Sicilian coast in an effort to “shock and awe” the local populations and persuade them to defect. As the fleet sailed close to the coast, it was caught in a massive July storm and the fleet was literally thrown against the cliffs. Their first fleet had been destroyed not by enemy action, but by Mother Nature.

Unaltered, the Republic set on to build a second great fleet in 254 B.C.E. 220 warships were constructed in three months and then were immediately deployed to war. They aided in the capture of the Sicilian coastal town of Panormus and then proceeded to raid the North African coastline. Upon their return to Italy the fleet was caught in another storm and destroyed, again. However, the Romans still maintained large fleets elsewhere, allowing them to continue naval operations around Sicily, although much less aggressively. Ship constructed continued, as well, although much less intensively. Emboldened by their prior victory during the siege of Panormus, the Romans decided to blockade the city of Lilybaeum. During the siege, the Roman navy launched a surprise attack on the Carthaginian fleet at Drepana, in 249 B.C.E. This would go down as a costly mistake. The ensuing battle claimed a large portion of the Roman navy, and the engagement would be followed by a series of other Roman naval disasters. For example, a convoy of 120 warships and 800 transports stopped near Syracuse to wait for stragglers. Half of the convoy was sent north, towards Italy, and was soon trailed by Carthaginian warships. Hugging the coastline, the Romans set themselves up for destruction. While the Punic naval expedition avoided the coastline, the Roman ships were destroyed by yet another storm. It is suspected that these losses were greater than earlier losses combined. Following the debacle, the Roman Senate abandoned any attempts to build a brand new fleet.

Unsurprisingly, the State was penniless. It could not afford a new fleet. The expense was not only in the cost of constructing the ships. The Senate had spent massive sums of money supplying replacement rowers for the fleets while they had been besieging multiple Carthaginian cities. Rowers and other sailors who had died to disease had to be replaced, and experienced rowers were expensive to train. To give an idea of the true magnitude of the loss the Roman censors registered a total of 241,712 citizens for 247-246. For 265-264 292,234 citizens were recorded and for 252-251 a total of 297,797. In other words, the Romans suffered a loss of 50,000 citizens between 251 and 247. This figure should be even larger when considering the fact that a large portion of the warships’ manpower came from allied cities. The loss in manpower symbolizes a gargantuan loss in investment. After a decade of war it is unsurprising that the Senate ran out of money. Nevertheless, the Republic continued to prosecute the war on land. It turned to private merchant ships to carry out the war on sea. As expected, this was not very successful and it became necessary to build yet another fleet. With no money to fund this new project the Senate must have found itself in despair.

In financial morass, the government turned to the private sector. A new fleet was built in 243 B.C.E., but this time funded voluntarily by some of the wealthy citizens of the Republic. Polybius (I.59) wrote:

Yet the effort sprang from sheer resolution rather than material resources. There were no funds in the treasury to finance the enterprise; but in spite of this, thanks to the patriotism and generosity of a number of leading citizens, the money was found. Single individuals or syndicates of two or three, according to their means, each undertook to build and fit out a quinquereme, which was fully equipped on the understanding that they would be repaid if the expedition was successful. In this way a fleet of 200 quinqueremes was quickly made ready…

The State was effectively lent the money to pay for a new fleet. Andrian Goldsworthy points out:

The money was a loan to be paidback after the victory when the State’s finances had recovered, but it appears to have been interest free and should be interpreted as a gesture of genuine patriotism.

Admittedly, it would be difficult to know whether or not there were political considerations behind the decision to donate the necessary money to the State (even if the State ultimately had to return the loan). However, it seems as if the main motives for the act were “patriotism” and “generosity”. It should also be noted that ultimate the money was given to the State so that it could continue to fight what could only be considered an unjust war, as the Romans were not fighting in self-defense. They were fighting the Carthaginians over the fate of another people altogether. But, it is also fair to say that the fact that a large naval fleet had been funded privately was unprecedented for the era. As aforementioned, the rational behind the loans were patriotism and generosity. This interpretation is extremely important, given that it highlights people’s willingness to donate to a common pool of funds to raise an army in times of need.

It would not be correct to assume that Rome would have lost the war had she not been able to raise a new fleet as early as she did, thanks to the assistance of her private sector. But, the fleet was crucial for ending the war as early as she did. In 242 B.C.E. this brand new fleet defeated the Carthaginian navy at the Aegetes Islands and finally wrestled away ownership of the Western Mediterranean. The Roman fleet could now conduct raiding operations around Sicily and North Africa with impunity, and the Carthaginian army in Sicily was doomed as it could not be supplied as easily or safely. The year following Carthage’s defeat at the Aegetes Islands she sued for peace. It was only thanks to the charity of the private sector that the Senate was able to raise a fleet fast enough to end the war two years after the fleet had been raised.

The exact reasons behind the donations are irrelevant. Polybius’ writings suggest that it was merely out of generosity and patriotism to the Roman State. On the other hand, it is also true that many wealthy Romans got even wealthier thanks to the grain market opened with the conquest of Sicily. But, where the State failed the private sector succeeded. It would be impossible to know whether this final fleet was in any way better prepared for the war than the last fleets. This is not an example of a military in a free market. Rather, it illustrates that in times of crisis individual citizens can band together to jointly pay for an effective defense. It shows that national security provided by the State is not more efficient, or in any way better, than the national security that can be provided by the private sector itself. Just as important, it also proves that private citizens can pay for a defense on the same scale as the State. The Roman Empire was not built with the State’s treasury; it was built by the wealth accumulated by its people.

Piketty on Becker

From the seventh footnote, in chapter 11,

Becker never explicitly states the idea that the rise of human capital should eclipse the importance of inherited wealth, but it is often implicit in his work. In particular, he notes frequently that society has become “more meritocratic” owing to the increasing importance of education (without further detail). Becker has also proposed theoretical models in which parents can bequeath wealth to less gifted children, less well endowed with human capital, thereby reducing inequality. Given the extreme vertical concentration of inherited wealth (the top decile always owns more than 60 percent of the wealth available for inheritance, while the bottom half of the population owns nothing), this potential horizontal redistribution effect within groups of wealthy siblings (which, moreover, is not evident in the data, of which Becker makes almost no use) is hardly likely to predominate.

— Thomas Piketty, Capital in the Twenty-First Century (Cambridge: Belknap Press, 2014), p. 616.

Gary Becker, and the Theory of Human Capital

Gary Becker, who Greg Mankiw rightly describes as “one of the greatest economists,” has passed away. I know Becker’s research indirectly, for the most part. If you haven’t had the opportunity to read any of his work, there is a list of great open-access papers at Marginal Revolution.

I was reading Gary Becker’s encyclopedia entry at EconLog. This paragraph caught my attention,

In the early 1960s Becker moved on to the fledgling area of human capital. One of the founders of the concept (the other being Theodore Schultz), Becker pointed out what again seems like common sense but was new at the time: education is an investment. Education adds to our human capital just as other investments add to physical capital. For more on this, see Becker’s article, “Human Capital,” in this encyclopedia.)

I wondered why it took so long for the concept of human capital to become an explicit component of the discussion. I remember recently having a conversation on the lack of recognition of “human capital” in Austrian literature, even as late as Mises’ Human Action. The idea wasn’t explicitly considered in length at the time. It didn’t strike many bright people, others brilliant, as relevant, or significant.  Like Becker’s encyclopedia entry says, “human capital” seems like commonsense. But, it was Becker and Schultz who made it commonsense, in the middle of the 20th century — roughly 160 years after The Wealth of Nations.

But, we have to remember that there was a time when education was seen as consumption, or at the very best an investment with an insignificant return,

The pre-modern aristocracy was a social elite defined by investments in hostage capital, and their education was another important case in point… [T]he emphasis was on knowledge that was not practical and had few alternative uses. The young gentlement was to learn ancient languages such as Greek and Latin in his study of classic literature and other liberal arts. Time was invested in learning music, dance, taste, and good manners. There was an outright avoidance of any type of training in the trades or skills, and a professional education was tolerated only for younger songs.

— Douglas Allen, The Institutional Revolution (Chicago: University of Chicago Press, 2012), pp. 68–69.

A “professional education” is what we know as an “education” today. The majority of people, a little over 100 years ago, did not receive one. If they had, it would have come at an intolerable opportunity cost. It simply did not pay to “go to school.” Think about what we learn in school. It would have been worthless to the median, or even average, person in the mid-19th century. Latin and Greek was practiced mainly amongst aristocrats, because belonging to that social class required that investment — it was a price; the cost of the risk of being banished, with useless knowledge outside of their old “job.”

True, many people did learn a trade, and all professions required varying levels of both general and specific knowledge. But, it was taken for granted. You are a blacksmith, because that is where your comparative advantage is. Nobody asked where that comparative advantage came from. Someone had to learn the trade, and that required an apprenticeship. But, on average, these educations weren’t as long, and broad, as the ones we’ve become accustomed to today. Maybe it took 160 years for “human capital” to become explicit because, empirically, its relevance was too subtle.

Gary Becker published his book, Human Capital, in the 1960s. I don’t think it’s a coincidence. Education was becoming increasingly important for the upper middle class before the world wars, but it was only after the Second World War that a “professional education” — from a very young age to late adolescence and, increasingly, early twenties — became truly enjoyed by a broad middle class. Household incomes were growing, and the G.I. Bill provided funding for U.S. soldiers during and after the Second World War. By the 1960s and 1970s, advanced educations were becoming increasingly common amongst discriminated social groups, especially women. This was the empirical fact that made relevant an explicit concept of human capital.

During the late 19th and throughout the 20th century, a broad, “professional” education gradually became more-and-more valuable. An advanced degree soon became useful for securing a person a relatively high-paying job. It signaled certain analytical skills, creativity, and the ability to read information, interpret it, and apply it. The concept of “human capital” was developed in the mid-20th century, because of this change in the value of an education. By that time, the transformation was too obvious for a brilliant economist like Gary Becker to miss.

The Good, the Very Good, and the Exceptional

I still think K > R. But, a good and fair point against any interpersonal comparison is that there is a division of labor within economics, and therefore all economists contribute on their own margins. I am sympathetic to the argument that interpersonal comparisons between economists are difficult, because the type of work being done is not the same. Still, I think that we can broadly distinguish between different caliber of economists. It’s not that there are bad economists and there are good economists. It’s that there are good economists, there are very good economists, and then there are exceptional economists.

Economists do many different things. First, not every economist goes into research or academia. Second, within academia, economists fulfill different roles. Some are pushing on the frontiers of the science, typically focusing on a relatively narrow field within the discipline. Others are great teachers. Others are able to critically dissect their peers’ work, apply it, and/or communicate it well. There is a division of labor, and every member is valuable, needed, and greatly contributes to the science.

Still, like with any division of labor, I think we have an objective, if rough, sense of which are the most prestigious and highly rewarded roles. The narrower the market, the easier interpersonal comparisons are — we can rank between doctors, for example. Further, it usually is the case that these upper-end roles are more difficult to earn, and that they typically go the best. Which employee, for instance, is most likely to be hired for a new managerial position? The most qualified. Within that organization, there will be some members who are so exceptional that they will eventually be chosen to fill the most prestigious positions.

Those who push on the frontiers and are able to gain acres of ground, rather than inches, are of a different kind. And I don’t mean coming up with vague, and often unpersuasive (even if they’re right), ideas. Nobel winners and those of similar caliber are able to make a vague idea explicit, really flesh it out, and defend interesting implications that draw the attention of their peers. The kind of ideas economists of this caliber are coming out with make you think about the world differently. It’s no surprise that many of these exceptional theories seem “clear” in retrospect, because of how well it was developed and communicated by the exceptional economist.

Mises’ theory of price formation and economic calculation really shook up the profession during the 1920s, because it forced a large chunk of academics to think about the possibility of socialism very differently. The same is true of Hayek’s work on the communication of decentralized knowledge. I’d mention his business cycle research, but his efforts there, as judged by his peers, were largely unsuccessful (although, I think undeservingly). Buchanan taught us to look at government as an economist would. Exceptional economists think in exceptional ways.

This brings me to make a related comment (see this Bob Murphy piece): what did I mean when I said that Mises and Krugman are comparable? I don’t mean they are equally good economists. I prefer Mises (I also prefer Hayek). Others prefer Krugman. We can have an endless debate, and I’m not interested in that. The point is, they are comparable in that they are both exceptional economists, regardless of how they rank between themselves. Suppose there’s a test that can give us an objective measure of the quality of a physicist, and it turns out that Einstein was a better physicist than Newton (for the sake of argument). It seems wrong to claim that their quality isn’t comparable in magnitude.

Some ask: how can we trust the profession to decide which ideas are of higher quality? There are people who are suspicious of the profession, because they think the general “mainstream,” or “neoclassical,” approach to economics is all wrong. I think the belief that the bulk of economists are missing obvious insights is nonsense. Similarly, it is completely unjust to accuse the majority of the profession of being poor economists, or of intellectual dishonesty. The type of people who become economists are strong analytical thinkers, they are interested in ideas, and are very intelligent. So, yes, the aggregate judgment of the profession is an important gauge of quality.

There are economists who even other economists will consider superior in their field. Krugman is one of them. Mises is another. No matter how they rank between each other, the fact is that they are both exceptional and comparable in that sense.

K > R

This post has nothing to do with Piketty; it’s all about Krugman > Rothbard. Or, why Paul Krugman is a better economist than Murray Rothbard was. My argument might be somewhat controversial to a handful of Austrians, but it really should not be. K > R does not imply that Rothbard was a poor economist, or even that he was not a good economist. The fact is, however, that Krugman is an exceptional economist, and Rothbard was just “above average.” I’ve received some flak for making this argument in passing, here — I also once compared Krugman to Milton Friedman (not in beliefs, of course) —, and it might be worth it to provide some evidence.

Truth is, the evidence screams. Krugman was the main player in a theoretical breakthrough made during the 1960s and 70s: economies of scale can explain trade, without having to make any of the assumptions of Ricardian comparative advantage. He also was in the vanguard with his work on exchange rates and crises. And, while Krugman is not known as a macroeconomist, much of his work in this area is widely cited. In short, Krugman’s academic career is characterized by a reasonable amount of high quality output. And, a fraction of his work is responsible for a major change in worldview (what earned him his Nobel Memorial prize).

The quality of Rothbard’s output (as an economist) is less obvious. Man, Economy, and State is Rothbard’s magnum opus, but it’s hard to think of a single idea original to Rothbard that has been seen as a major theoretical breakthrough. One could argue that Rothbard, as a “heterodox” economist, was at a disadvantage. Maybe, but it’s just as hard to think of a major single idea original to Rothbard that has been widely accepted even within his own school of thought (e.g. monopoly theory). His best book is, perhaps, a great textbook, but as a piece of economic research it’s not comparable to Krugman’s work — even if it’s more than what the average economist accomplishes in a lifetime. Other than MES, Rothbard does not have another important book on theoretical economics, and no academic paper really comes to mind as impressive (in the context discussed in this post).

Here’s the test: would economics be worse off if either Rothbard or Krugman never existed? In the case of the former, economics wouldn’t even notice. In Krugman’s case, on the other hand, we would be short a very simple, straightforward, and clear model of the role of increasing returns in trade, and therefore short of the implications Krugman was able to draw thanks to his model. We would be just as unable to explain part of real world trade patterns, because we would still be trapped within the “Ricardian box.” Think of a production possibilities frontier, where the curve shows the limits to current economic thought — Krugman produced outside the curve, Rothbard produced inside the curve.

I am not disparaging Rothbard. I am not saying that Rothbard’s work is useless. I, in fact, enjoy reading Rothbard. (I enjoy reading Rothbard even though I disagree with many of his ideas; you should be able to do the same with Krugman — as I often do.) He, no less, was crucial for the revival of the Austrian school. He is seen as a major intellectual forebearer to many modern Austrian economists. He was clearly an important guy. But, he is simply not comparable to Krugman as an economist.

Jon Finegold's books by Rothbard

My Rothbard credentials

Neither is it because Rothbard is an Austrian. I think Hayek and Mises are comparable to Krugman. Mises’ socialist calculation problem was a major theoretical breakthrough, and it was very influential for the profession. It changed the terms of the socialist calculation debate — a controversy that is difficult to value from a modern point of view, but that at the time was very important. Hayek was, maybe, less influential (although, I don’t entirely agree), but his work on business cycle theory has influenced a large fraction of economists, and at one point was seen as important work in the vanguard (between ~1931–37). Hayek’s institutional economics also influenced modern institutionalism; not just the likes of Ostrom, Williamson, and Coase, but also economists from different traditions, such as Douglass North. It’s no surprise Hayek also won the Nobel Memorial prize; Mises probably would have won it had it been awarded earlier.

Wrong economics versus correct economics offers Rothbard no help here, either. Rothbard could often be very wrong, as evidenced by his critique of fractional reserve banking. But, that’s an eternal debate, and it’s better to go down a separate route. Krugman’s academic work is usually right, and it’s never entirely wrong. If you don’t appreciate Krugman’s trade theory, you just don’t know it. If you can’t think of anything of value in Krugman’s work, you simply haven’t read it. (And this is all too often the case with some of Krugman’s biggest haters.) This seems like a strong claim, but it doesn’t appear so strong when you read some of the common “internet” criticisms:  (a) he assumes homogenous capital; (b) mathematics can’t tell us anything about economics; (c) perfect competition cannot exist in the real world (which somehow makes it useless as a tool, and it also, somehow, makes imperfect competition useless as a tool); et cetera. These are just throw away lines to dismiss a line of reasoning without having to really consider it or think about it. They are either very silly (i.e. the arguments v. math and monopolistic competition as tools), or they don’t change anything (i.e. you could, I suppose, explicitly include capital heterogeneity in your model — an infinite set of inputs? —, but one wonders what use that would be).

As an academic economist, Krugman’s major ideas are novel and visionary, he is relatively flexible in his argument (a relatively simple formal model, with generalized results), and usually right. Rothbard, on the other hand, was very often wrong, which is ironic given the status he ordained on “watertight” praxeology. Finally, ignoring right v. wrong, Rothbard did not produce a game-changing idea. His influence — on a very small number of economists — is constrained to popularizing theories that may have otherwise died, which has its value, but value which is incomparable to the value added by Krugman’s research.

Rhetoric of Capitalism

In November 1957, just a month after Russia’s Sputnik satellite blasted into space, causing Americans to fear that they were losing in the space rate, Lawrence gave an optimistic address about America’s strengths to students and faculty at Seton Hall University in South Orange, New Jersey. Lawrence told the assembly, “Spread of shareownership in America brings about a silent revolution, and this people’s capitalism is given impetus by the Stock Exchange.” He continued, “The most dramatic feature of this free-enterprise system has not erupted in newspaper headlines. Nor has it been squeezed into the small talk of ordinary parlor conversation. The phenomenon I’m talking about is the gradual emergence of what we have come to call a People’s Capitalism — the ownership by millions of people everywhere, through their stock investments, of our means of production.”

— Janice M. Traflet, A Nation of Smaller Shareholders: Marketing Wall Street after World War II (Baltimore: Johns Hopkins University Press, 2013), pp. 139–140.

The Capitalist Mentality

How have views towards the free market changed over time? How society views markets matter, because it may help explain important questions. If, for example, views determined the significant growth rates of the 18th and 19th centuries — after centuries of stagnation —, a change in views could have quite an impact on our future wealth. Indeed, the Great Depression was capitalism’s nadir and communism, socialism, and fascism were at their height between 1920–50. If 1991 shattered the false allure to communism, in 1930 it seemed as if capitalism had failed. Several economists warned of the dangers of anti-liberal and anti-market ideas, arguing that those ideas promote not only low growth, but authoritarianism as well. Some believe that this anti-capitalist mentality has continued into the 21st century. Since the late 1940s, however, the public’s opinion on capitalism has matured and strengthened, and good evidence of this is how the public responded to the 2007–09 crisis.

In certain ways, it seems as if the public’s attitude towards markets has deteriorated over time. The initial reaction to the stock market crash of October 1929 was to blame small investors for making non-expert investment decisions based on emotion. Big finance was not immediately blamed, although its image soon blackened as the world economy continued to plunge, banks began to fail in large numbers, and unemployment rates began climbing to new heights. The 1930s were an “absolute minimum” for free markets, and the experience of the Great Depression continues to inform the public’s opinion. Compare, for example, the initial reaction to the crash of 1929 to that of 2008. Bankers and traders took the brunt of the criticism in 2008; in 1929, they were, at first, given the benefit of the doubt. But, this interpretation leaves part of the story out.

It is true that capitalism’s image was in serious trouble between 1930–50. In A Nation of Small Shareholders, Janice Traflet tells the story of the New York Stock Exchange’s (NYSE) struggle to revive it brand in the face of hostility and mistrust. The initial crash did not immediately wound society’s amicable relationship with markets, but the banking crises, repeated scandals of fraud and theft by part of bankers and wealthy investors, and high unemployment had struck an almost fatal blow. Traflet explains how resistance to regulation and state involvement collapsed by the late 1930s, because, after several crises and scandals, the NYSE and others simply chose to cut their losses and work with regulators, rather than against them. But, by the mid-1950s the situation, for capitalists at least, began to improve. Traflet looks at the NYSE’s advertising program, but external factors were probably even more important for repairing capitalism’s perforated image.

One such external factor was the public’s view of socialism and communism. During the first two decades of the 20th century, many intellectuals held an endearing opinion on socialism. The success of war controls and planning during the First World War served as an important impetus for those looking for a better alternative to capitalism. The initial experience with the Soviet Union was somewhat of a disillusionment — war, famine, and oppression usually are —, but socialist sympathy was at a high point and the Soviet’s rapid industrialization between 1930–50 was inspiring. 1920–40 were the decades of the ongoing socialist calculation debate, where top economics journals became ideological battlegrounds — the possibility for central planning was taken very seriously. “Luckily,” the Cold War would soon change things. Communism, and by extension socialism, became the West’s rival, and between 1950–70 the Keynesian consensus — not quite socialist, but not capitalist enough, either — gave way to a free market revival.

One interesting facet of the revival is the language used to sell capitalism to the people. Financial organizations selling their products, such as mutual funds and monthly investment plans (MIPs), talked about marketplace democracy, shareholding (vs. stocks), and freedom. Capitalism, not communism or socialism, is what empowers the non-wealthy. This is almost a complete reversal from the Great Depression, during which it was the worst off who suffered the most. Capitalism had lost much of its image as a mode of production for owners of capital, at the expense of owners of labor, and gained one of harmony between all classes. This view was not only promoted by industry, but by conservative intellectuals, as well. And, in 1991–92, communism and socialism lost all of its allure as a result of the Soviet Union’s collapse.

While capitalism continued strong during the 1990s, an era of “neoliberalism,” the 2000s is a more ambiguous decade in the context of how the public views markets. The mid- and late 90s are known for a series of crises throughout the world, and the boom of the mid-2000s gave way to the most severe crisis since the Great Depression. Conservatives have interpreted this turn of events as working against free markets. Tom Woods, for instance, declared that we are “back on the road to serfdom.” Oftentimes, rather than looking at the resurgence of popular pro-market sentiment, people look at the growth of the state, concluding that the anti-capitalist mentality has strengthened, or at least gained currency. This interpretation of recent history is problematic, however.

Compare the response to the Great Depression to that of the Great Recession. The 1920s were a period of growing wealth, where all classes seemed to benefit from growth. If Traflet is right, and the initial stock market crash was blamed on the common person (the small investor) instead of on the titans of industry and bankers, pro-market sentiment was very strong prior to 1930. The Great Depression was almost a 180° turn, when markets seemed to benefit only the rich, and at the expense of the poor. That is, the period 1929–33 oversees a dramatic change in public opinion towards capitalism. The 1990s, and even the 2000s, were similar to the 1920s, in that a healthy economy promoted existing market institutions. But, the Great Recession has not had the same effect as the Great Depression, not only in the United States, but also in Western Europe. To be sure, capitalism has received much criticism, but the impetus to choose alternative institutions is weaker — there is much more focus on improving markets. One strong piece of evidence is the pressure to structurally reform markets, and skepticism toward demand-side interventionism.

Why did the Great Recession not cause mass disillusionment with capitalism? First, the extent of the damage has something to do with it. The anti-capitalist mentality is probably stronger in Spain and Greece than in the U.S. or U.K. The two former countries have been hit harder, and a combination of bad demand- and supply-side policy has caused high (20+ percent) unemployment. Still, the extreme right-wing has been benefited almost as much as the extreme left-wing by the depression in those countries. Second, the end of the Cold War. The fall of the Soviet Union, and the gradual “liberalization” of China, shattered whatever credibility non-capitalist institutions, or “modes of production” if you prefer, had. Third, between 1950–06, we had a strong, relatively stable period of growth, where the living standards of all members of society markedly improved. This relates to the role of the end of communism, because elsewhere living standards stagnated or fell as a result of command economies. Capitalism’s great success is more widely appreciated.

The average opinion goes something like this: there are no radical alternatives to capitalism; capitalism is the best we have, it’s just a question of how to achieve robust institutions that minimize the impact of the business cycle. This view stands in stark contrast to average opinion during the 1930s, which did not think very favorably of free markets at all. And that conservatives, and some libertarians, have interpreted the concept of “robust institutions” as evidence of an anti-capitalist mentality actually works in favor of my argument. The standards of the “radical” pro-market advocates have risen. The type of interventions considered “socialistic” or “anti-market” are incredibly tame compared to those of the 1930s — where parts of industry were nationalized, private enterprise was heavily regulated, and public investment stepped to the forefront. We are, on average, a much more market-oriented society today, and the range of allowable changes to these institutions has become much stricter, more narrow. To free market advocates, this is good, not bad, news.

For this reason, the message in books such as The Road to Serfdom no longer resonates with most people. The modern interpretation of this line of reasoning is that any interventionism will eventually lead to full blown socialism. This is not Hayek’s actual argument, who was writing during a period of time in which opinion, intellectual and average, was very hostile towards markets. (In fact, Hayek’s message was, at the time, most popular amongst those looking to synthesize capitalism with a modern liberal democracy.) But, the erroneous interpretation of Hayek is popular because that is the only way one could apply Hayek’s message to the modern context. Many conservatives and libertarians think we are on a road to serfdom, and that there is a strong anti-capitalist mentality that needs to be fought against, but this simply is not so. That The Road to Serfdom is seen, amongst progressive intellectuals, as being mostly wrong is strong evidence that they no longer hold the views Hayek was warning against.

The strengthening of positive opinion towards capitalism is the product of the institutionalization of free market views. Few people believe there is a superior alternative. Communism is seen as a failure. Socialism is taboo. The success of markets in raising the standard of living of all members of society is too obvious to miss. If people advocate intervention, it’s to strengthen markets, not replace them. We are in an era of the pro-capitalist mentality.

Question for WWII History Buffs

I used to be a World War II military history buff, but since becoming involved in economics I lost interest in it. Hopefully, I remember enough so that the argument I’m making here is sensible.

The modern context is Russia’s military occupation of the separatist regions of Georgia and its more recent occupation of the Crimea (and the threat that it will also pursue military occupation of eastern Ukraine). The international response, for the most part, has to declare sympathies with the Ukraine and to shun Russia diplomatically, but otherwise it has been quite muted (at least, it has probably been largely irrelevant). Most people, I think, consider this the only sensible response the developed world can make — other than a harsher diplomatic shut-out —, and few support protecting the Ukraine should military force. My question: should this lead us to revise our judgment of Neville Chamberlain’s policy of appeasement?

In the late 1930s, Germany was beginning to annex territories that it claimed were primarily ethnically German. In early March 1938, this was Austria. Later that year, he basically green-lit the German occupation of the Sudetenland — parts of Czechoslovakia with ethnically German populations —, and by early next year the Third Reich had occupied all of Czechoslovakia. In September 1939, Germany invaded Poland, and the rest is history.

The Anglo-French policy, prior to their declaration of war on Germany in September 1939, was to be known as the policy of appeasement. It has received criticism, because had the British and French been stricter, the Second World War may have never occurred. But, of course, this accusation is easy to make ex post. No government, at the time, expected a major world war. They wanted to avoid a war, by allowing Germany to make limited annexations.

Leave the Second World War aside for a minute, and appreciate Chamberlain’s diplomacy without knowing what it led to. Germany is to Russia as Chamberlain (and France) is to the Western developed world. The responses are very similar. And, much like during the late 1930s, we more-or-less agree that the West’s diplomatic response to Russia’s aggression is pretty much all we can do, because war is simply not an option — we want to avoid that at all costs. Instead, we shun Russia for its occupations, and we hope that they will end there. If we knew that Russia would lead us into a Third World War, I’m sure our opinion of current policy on Russia would change; but, we don’t know that, and, in fact, I think most people (including me) would think of that scenario as unrealistic. But, this was true of most of the West in the late 1930s, as well.

So, maybe Chamberlain’s policy wasn’t so bad, ex ante, after all. Or, maybe we should learn our lesson, and treat Russia much more aggressively.

Update: I’m not comparing Putin to Hitler. I’m not saying that Russia will start World War III. I tried to make that clear in the post, but maybe the last sentence was misleading. What I’m mostly interested in is revisiting how we judge Chamberlain’s policy of appeasement.

Nominal and Real Wages During the Great Depression

Paul Krugman, following Keynes, argues that downward wage adjustments are not conducive to recovery, because real wage rates don’t tend to adjust even when nominal wages are cut. The theory is that output prices will move in line with nominal wages. To justify this theory, Keynes assumes that the most significant determinant of marginal cost are wage costs (wages multiplied by labor, or wL). I want to look into this, but I just wanted to quickly put up some evidence that contradicts the Krugman–Keynes story.

Unfortunately, the data that is most accessible to me comes from Krugman’s “favorite” book on the Great Depression, Rothbard’s America’s Great Depression. Rothbard, in turn, gets his data from Sol Shaviro, specifically from his unpublished manuscript, “Wages and Payroll During the Depression.” Here is that data,

Nominal and Real Wages 1929-33

Keynes’ theory about the relationship between real wages and nominal wage cuts assume that nominal wage cuts will have no effect on real wages. The data from December 1931 to March 1933 shows that this simply isn’t true. Nominal wage cuts correlate with falls in real wages, even if these rates of change are not symmetrical.

I know there is a more complete set of data out there (I can find real wages for the same years in Robert A. Margo’s “Employment and Unemployment in the 1930s,” but he doesn’t list nominal wages [or the wholesale price index he uses those deflate nominal wages] — and I have been having some trouble finding that data online); maybe I’m not looking hard enough.

To me, in any case, the premise that nominal wage cuts will not lead to real wage decreases, because the price of output will adjust to their new marginal costs (which must be almost entirely determined by labor costs), seems to fly against both reality and what we predict in the opposite case. If nominal wages were to rise, say because of labor union involvement, what we predict is unemployment, because the real wage will rise above the market clearing wage. The assumption is that the price level will stay the same. But, what we would predict based on Keynes’ assumption is that nominal wage increases will raise the price level, because the price of output will rise to reflect increases in marginal cost. Admittedly, this is consistent with, say, a wage-push theory of inflation, but it’s not what (I thought) most economists would expect to happen (and I thought most economists, except some of those on the margins, believe that inflation is “always and everywhere a monetary phenomenon” — an increase in M or a fall in the demand for money).