Anti-Communism and 20th-century Economics

This was the focal point

As the twentieth century recedes into history, I think it is important for students to understand what motivated the great economists of that time. I will argue that the core issue for them was capitalism vs. communism. Since the fall of the Berlin Wall (“the end of history”), that issue has lost its salience.

Consider two propositions:

(1) Under actually-existing Communism, people suffer from a dehumanizing lack of freedom.

(2) Under capitalism, people suffer from economic pain, meaning very low income or sudden loss of income.

If both propositions are true, then there is a trade-off: the less you rely on markets, the more you deprive people of freedom. The more you allow free markets, the more people will suffer from economic pain.

I think that 20th-century economics can be understood as an attempt to assess and deal with such a trade-off. All of the great 20th-century economists were anti-Communists. But they differed on how best to adapt the capitalist alternative.

For John Maynard Keynes, the most painful economic calamity was mass unemployment. His project was to prevent Depressions, which otherwise make free markets intolerable.

For Friedrich Hayek, central planning under Communism was both dehumanizing and a source of economic calamities. His “Uses of Knowledge” paper, which Tyler Cowen calls the greatest economics paper of all time, demonstrated that central planning is antithetical to prosperity, making free markets necessary. Hayek warned that the attempt to eliminate all economic pain would undermine human freedom, leading to the Road to Serfdom. But he was not against government attempts to alleviate some economic pain. Keynes was very much in alignment with Hayek on these points.

Where Keynes and Hayek differed is that Hayek had a model of the business cycle in which government management was the problem, not the solution. Although Hayek’s business cycle theories are what were cited by the Nobel Committee in awarding him the prize, they were rejected by all of the leading mainstream economists.

Milton Friedman Is known for his advocacy of free markets. But he worried about the pain of low income. That is why he advocated the Negative Income Tax, which works out to be the same as what we would now call a Universal Basic Income.¹

But his main project was to deny the trade-off between human freedom and widespread prosperity. He insisted instead that Capitalism and Freedom depend on one another. Along the way, he sought to demonstrate all of the ways that free markets actually reduce economic pain and government interventions exacerbate it. And he countered Keynes by arguing that monetary policy alone could stabilize or destabilize overall economic performance, without deficit spending.

I am not an expert on Joseph Schumpeter. But I see him as arguing that capitalist progress does cause economic pain, because the necessary “creative destruction” necessarily entails the latter. And he foresaw voters coming to demand protection in the form of socialism, even though he preferred the progress of capitalism.

Communists argued that under capitalism, workers suffer pain because they are exploited by the owners of factories and machines. Paul Samuelson and Robert Solow argued instead that everyone receives a due reward. For this purpose, they pushed the Neoclassical Production Function. In this model, under perfect competition, workers are paid their marginal product. And with constant returns to scale, marginal product and average product are equal, so that wages rise with productivity. The division between wages and profits is likely to be fair to workers, not exploitative.

British economists who were to the left of Samuelson argued that the marginal product of capital was not single-valued. You would not believe how much ink was spilled in post-World War II economics journals over this “re-switching controversy.” Somehow, the re-switching possibility was supposed to show that workers were exploited, or at least exploitable. The importance of this controversy was greatly exaggerated, especially by the British leftists.

Samuelson, Solow, and their many followers instead justified left-of-center economic policies by focusing on ways in which markets can deviate from perfect competition. They argued that the pain that these market failures might cause should be treated with government intervention. This is where Friedman and his followers disagreed, emphasizing the ways that markets could go right and government could go wrong.

Further to the left was John K. Galbraith. He argued that the differences between capitalism and central planning were exaggerated. He saw the American economy as dominated by entrenched large enterprises. Management of industrial giants, in America as well as the Soviet Union, required what Galbraith called the “technostructure,” a set of skilled bureaucrats. In America, they operated within corporations. But he suggested that they could just as easily operate within government, and we could continue to enjoy human freedom and obtain the benefits of more rational planning.

In Galbraith’s view, only large enterprises matter in a modern economy. The small entrepreneur was a myth used by big business to ward off government control. But entrepreneurship turned out not to be a myth, as we have seen with the personal computer revolution, the Internet, biotech, and so on.

Over on the right, James Buchanan and others developed Public Choice theory. While Samuelson and company treated government policy as if it were designed and executed by an altruistic, technocratic optimizer of social welfare, Public Choice treats policy as the outcome of self-interested agents.

My shorthand version of public choice theory is that government will subsidize demand and restrict supply. That is because the interests of producers are more concentrated and politically effective than the interests of consumers. The technocratic optimizer would recommend either one or the other—subsidies to get more of something or taxes/regulations to get less of it. But my statement of public choice theory instead predicts that government will not influence the quantity of something, and instead will only act to boost its price.

Conclusion

I have described 20th-century economics as revolving around the trade-off between the freedom-destroying nature of Communism and the economic pain some people suffer under capitalism. But since 1990, leading intellectuals are not obsessed with this issue. Instead, the big concerns of the 21st century seem to be climate change, terrorism, and various cultural issues.

Economics is not as central as it was to these issues. Economists have retreated to playing “small ball,” finding datasets to exploit to look at relatively minor questions. I call this the Road to Sociology, because there is considerable overlap these days between economics and sociology, both in terms of topics (see Freakonomics) and, increasingly, in left-wing ideology.

1. Suppose that your government-provided income under a UBI is X, and your earned income is Y. Your after-tax equals (X+Y)(1-t), where t is a single income tax rate. For example, if the income tax rate is 10 percent, then t=.1. If X= $10K and Y=$20K, your after-tax income is $27K. If your earned income is $90K, then your after-tax income is also $90K, the same as your earned income. Note that in this case the net UBI (after taxes) is only $9K.

Under an equivalent negative income tax, you would receive 10 percent of any shortfall in earned income below $90K. So if you earned $20K, you would receive 10 percent of $70K, or $7K. Your total income is $27K, exactly the same as your after-tax income in the UBI case. In fact, your income with a negative income tax is the exact same formula: (X+Y)(1-t), where X works out to be $10K in order to get equivalence with a $10K UBI.