27 December 2005

Economics and the Public Purpose

Review of Economics and the Public Purpose by John Kenneth Galbraith

I realize that the title seems to suggest that reading the U.S. tax code would be more interesting, but Economics and the Public Purpose is actually a great book. The writing is wonderfully crisp and engaging, and the ideas are something that everyone needs to become familiar with, even if they sometimes overreach a bit.

Galbraith is a famous liberal economist, born in Canada in 1908 and somehow still alive. He wrote this book as part of a series which also includes The New Industrial State and The Affluent Society. I haven't read anything else by him, but if I do, I'll blog about it, and perhaps one of you can tell me about his other writings? Economics and the Public Purpose was written in 1970, and arguably the corporate climate has changed since then in ways that invalidate some of the book's arguments; however, I think most are still applicable.

As the title implies, the book is framed as a critique of economics (or as he calls it, "neoclassical economics") for not serving the public purpose. In particular, neoclassical economics assumes various things about markets that (a) are false and (b) obscure and thereby naturalize and strengthen existing power structures. These assumptions survive because of (b) and also because of their conceptual simplicity. Here are a few:

ideas from neoclassical economics
  1. Firms always try to maximize profits. (It might seem paradoxical that profits are zero in perfectly competitive markets, but this isn't a big problem either in theory or practice.)
  2. Sovereignty rests with consumers, whose tastes/needs dictate demand curves, and nature, which dictates supply curves. In particular, firms have no sovereignty, since if they try to do anything other than maximize profits they'll be replaced. (Even a firm in a monopoly position will be forced by its shareholders to maximize profits. Its shareholders have to, because they're mutual fund managers who will be fired if they don't. Or because if not, some aggressive new manager could borrow a few billion dollars, perform a hostile takeover and make higher profits. You get the idea...)
  3. Similarly for government. All government ultimately responds to voter will. Or maybe voter plus lobbyist will, and maybe voters are dumb, but still government officials have no meaningful agency of their own to exercise.
I've of course phrased these in ways where it should be obvious what's wrong with them.
problems with neoclassical economics
  1. Agency problems mean that corporations/governments are run in practice by managers (which Galbraith calls the 'technostructure') that are distinct from owners/voters. Monitoring is imperfect and costly.

    This idea has been enormously productive in economics, political economy and elsewhere. For example, perfect credit markets make persistent poverty hard to explain, since the higher marginal product of capital in India (or wherever) should cause American investors to prefer it to loser GM stock. This would mean that a country's starting amount of cash should dictate only its level of consumption, while production moves to wherever it's most efficient (assuming free trade). The problem is that prospective borrowers don't have collateral, and it's too hard to keep them from disappearing with the money they've borrowed. As a result, everyone invests (inefficiently) in rich countries and poor countries stay undeveloped. Microcredit seems like a good, if limited, answer to this problem.

    There are actually a lot of other interesting stories of agency problems, but I'll save them for another post, so I can focus on what Galbraith is talking about.

  2. Firms no longer try to maximize profits. Instead their first goal is growth, as long as profits are high enough to avoid bankruptcy or a takeover. This is because profits (mostly) go to owners, but the technostructure mostly benefits from growth, through promotions, increased market power and better job security. (Arguably corporate shakeups in the last few decades have weakened this argument, though much of it still rings true.) The only time profits become an issue are when there's the possibility of takeover, shareholder revolt, or some other kind of external threat, which is not too often if things are going decently.

    Some people have a hard time believing this point. If so, here's a useful thought experiment. Would you rather run a small dry cleaning business that gets 20% returns on capital, or be the CEO of GM in a year where the company loses 1% of its value?

  3. Firms no longer react passively to consumer demand, government regulation and market prices. Instead they can shape these with advertising, lobbying/regulatory capture and by using their market muscle to dictate prices. Advertising and lobbying are obvious. Regulatory capture is when the corporate technostructure links up with the government technostructure and helps shape government action; the most famous example is the military-industrial complex, but the same principle applies to the FCC, EPA, FDA, etc...: Congress can pass laws, but the implementation has to be left to bureaucrats who can never be perfectly monitored and held accountable. Finally, having a large market share (the result of a focus on growth) means that large corporations have a good deal of freedom to negotiate their own prices. However, while a neoclassical monopoly or oligopoly should charge higher prices (and have lower sales, but higher profits), we actually see lower prices (and higher sales) since firms use their market power to promote growth rather than profits.
So (neoclassical) economics gets it all wrong. So what? What's so bad about implicit rule by the technostructure? (I should point out that Galbraith often reads like Chomsky. He has the same sweeping and blistering critiques of ideology and orthodoxy, and is refreshing in many of the same ways. Both are good remedies to Thomas Friedman, for example. Of course, he's frustrating in some of the same ways too; sometimes he treats the reader as though we've never read anything other than the standard party line, c.f. Goldstein's book. One of their main differences is that Galbraith is a liberal and Chomsky is a radical, so that Galbraith proposes solutions that, though counter-cultural, are more technical than revolutionary.)
Why rule by technostructure is bad
  1. Inefficiency: Like in USSR-style state capitalism, prices and levels of production are set arbitrarily, and therefore inefficiently. If we presuppose that a free market will maximize total welfare (first law of welfare economics), then this is in general suboptimal. However, Galbraith gives more specific and interesting problems.
  2. Underdevelopment of the market sector: First I should explain that Galbraith refers to large corporations as the "planning sector," meaning that they can exert control over prices, consumer demand, gov. regulation, etc., as opposed to the "market sector," which consists of small firms that don't have this power. Many economic activities naturally fall within the market sector and resist organization into large corporations: personal services, local businesses, artists that can't deliver standardized products, etc..

    Since the planning sector is stronger than the market sector, they get to treat the market sector like a poor stepchild, for example passing price increases on to it as they see fit. Also, the market sector is vulnerable to inflation and interest rate fluctuations in ways that the planning sector is not, as large corporations are often able to finance expansion using profits rather than debt.

    So we have less art, medicine and child care than we should, though these arguments always seem a little dicey to me. More compelling is...

  3. Overdevelopment of the planning sector: We overconsume things produced by the planning sector, like cars and Coke.

    It seems like this can't totally explain problems like suburban sprawl, though. Is it the planning sector's fault that we have too many cars and too few trains? Well, sort of, in that one part of the planning sector (car manufacturers) muscled out another part (trolley manufacturers, or whatever). But it's not like some general tilt of the playing field away from the planning sector and towards the market sector would help this.

    More interesting is that we overconsume period. Or rather, we overconsume products and underconsume services and leisure (i.e. work too hard). This is relevant to the planning/market distinction because many services naturally fit into the market sector (because small/local businesses are involved), while manufactured products tend to come from the planning sector. Advertising is one mechanism that makes this possible. Advertising has many different effects: encouraging consumption of a particular brand (Saab), encouraging consumption of that class of products (cars) and encouraging consumption in general as a solution to problems (angst, need to express personality but not knowing how). (Or I could mention the rush credo for pre-frosh weekend: "rush MIT, then rush Greek, then rush AEPi," with "rush college" left implicit.) A car company without much market share can only take advantage of building brand awareness, while a large company also benefits from new drivers entering the market, since they'll get a decent fraction of them. Thus, we expect the planning sector to advertise more heavily than the market sector. Not only is this part of their advantage over the market sector, it also encourages consumption of products in general as a road to happiness.

    However, advertising is only the crudest way that the planning sector shapes public thought. Beyond telling us what to consume, it also tells us what to think.

  4. Shaping ideology: This last point is tricky, because large corporations of course don't have Thought Police (for the most part) and outside of their marketing departments, don't usually try too hard to shape public thought. However, ideology follows power, and so it's inevitable that our values will be shaped by the planning sector: the difference between serious/frivolous, respectable/eccentric, etc...

    One example is the different way that we view science/technology and art. Advanced technology is naturally suited to the planning sector, because it relies on standardization, mass production, specialized labor, and so on, while art is not, since it's usually better if it's individually produced. Before the Industrial Revolution, art and science were considered comparably valuable, and as science and engineering became more useful to people in power, social values changed accordingly. On the other hand, maybe people just respect money, and that's why executives have higher status than performance artists. But that can't fully explain why we think some jobs should be higher paid than others; it's considered natural for artists to be poor, and in fact there's often the suggestion that their art is better if they don't expect to be paid for it (i.e. they don't "sell out"). No one would ever suggest doing the same for scientists, even if most scientists are similarly motivated more by interesting work than by money.

The way that the planning sector shapes ideology is worth dwelling on, since it's the first obstacle to reform. Galbraith uses the term convenient social virtue to describe values of the planning sector that have been internalized by mainstream culture in ways that make things cheaper, easier or more profitable (hence convenient) for the planning sector. For example, the military needs to convince millions of people to enlist and get salaries much smaller than civilian contractors doing similar jobs. This can be done on the cheap by promoting the virtues of patriotism and serving one's country; equivalently, one might say that soldiers are compensated partly by their salary, partly by their social role, which lets them be proud of themselves and gives them respect from the rest of society. For example, Vietnam vets complain that they were cheated out of the post-war respect that they considered their due. And compare the reactions of soldiers and of corporate lawyers when the work they do is criticized: soldiers need the cultural compensation in a way that people with higher pay and better working conditions never would.

Patriotism also has the side benefit of helping the government convince the population to go along with its policies, especially wars. Iraq is a good example, but in general, the political system in the U.S. finds wars almost irresistible. Dwelling on this point turns the idea of government responding to voter preference (e.g. the median voter theorem) on its head, in the same way that Galbraith critiques consumer sovereignty. It's far from a new idea (recall the Goering quote: "Of course the people don't want war. But after all, it's the leaders of the country who determine the policy,..."), but it's interesting how Galbraith unifies his critiques of modern capitalism and of modern democracy. Similarly, the Nazi political theorist Carl Schmitt famously said that "Sovereign is he who decides on the exception"” (e.g. who declares a state of emergency).

There are many other examples of the convenient social virtue, and how it enables the system to be run more cheaply. Teachers, for example, could be underpaid initially because other jobs were closed to educated women, and later by representing teaching as a form of national service, as in Teach for America. Similarly for social work. (To see this, observe that if these jobs had competitive salaries, we wouldn't need to think of performing them as "service.")

Another of Galbraith's examples is the idea of the hard-working small business owner. He says that while those with comfortable jobs in the planning sector wouldn't accept unpredictable unpaid overtime, this is a natural part of the life of a small business owner. They put up with it because of the status afforded to entrepreneurs, rather than for the financial benefit. This one seems kind of dubious to me, mostly because I've forgotten his argument as to why it should help the planning sector, but also because even highly-paid people in the planning sector (like consultants) often work long hours, and because there are natural reasons for small businesses to be more flexible than large ones in many things, including demands on their workers.

Finally, he describes patriarchal consumerist family life ("the American way of life") as a convenient social virtue that's key to most of the others. The idea is that maintaining a high level of consumption requires women to stay at home to organize it all (an assertion which I don't think has aged well), but also that suburban family life encourages consumption through competitive pressure. It's seen as virtuous for women to take care of kids and do housework (w/o much pay) and for men to work hard to support their families. (An alternative choice might be for both parents to work part-time, reduce their consumption of goods and raise their consumption of services, including outsourcing housework. Or the traditional family might be rejected altogether.) Neoclassical economics overlooks all of these issues by making the "household" the unit of analysis rather than the individual.

The problem with this whole "convenient social virtue" discussion is that agency often gets confused, and it oversimplifies to say that the planning sector both benefits from and creates these convenient social virtues. The examples Galbraith gives are good starting points, but a Foucault-style critique is probably more appropriate. For example, The Wages of Whiteness is one long examination of how White supremacy became dominant in 19th century America; White pride is mainly considered a convenient social virtue for lower-class White workers (i.e. they receive social/psychological "wages" from their Whiteness), but the book goes on to say some nonobvious things about the origins of this racism. If/when I blog about it, I'll explain in more detail.

This post is getting long, so I'll skip to the punchline.

how to make things better
He starts with a section called "The Emancipation of Belief," which says that we need to actively resist advertising and propaganda that supports the values that come from the planning sector, instead of imagining that we're protected by cynicism about the more outrageous claims of advertising. Of course, this isn't really a personal project, and he's a little vague about how to pursue it with most of civil society in the hands of the planning sector, but it's a good start. And he also says that universities are a good place to organize around, since the economic necessity of critical thinking in universities will preclude any 1984-style repression.

The next step is to use the state (specifically the legislature) to restore economic parity between the planning and market sectors. This means easy credit from the central bank (since the planning sector finances expansion with cash and only the market sector needs credit), precisely targeted price and wage controls (since the planning sector is already controlling prices and wages), a universal living wage (he responds to the claim that it'll encourage unemployment by saying that unemployment is preferable to degrading low-wage work once you've rejected the convenient social virtue which says otherwise), and various other liberal reforms. In an era of New Democrats, New Labour (with new New Deals), etc., it's refreshing to hear such an unapologetic and compelling defense of big-government liberalism, even if it's not all completely convincing.

Most of his arguments are still relevant in one form of another, and the writing is infinitely better and more enjoyable than the brief summary I've given above. Read it!


Saheli said...

Whoa. That's quite a post. I actually feel inspired to go find the book when I get back to the US. (Out of print!!! I wonder if I could find a cheap edition in India, where JKG is quite beloved) Any chance you could be persuaded to TeX it up as an actual document, or somesuch? It actually seems like printing out your review and using it as a bookmark might be useful.

Would you rather run a small dry cleaning business that gets 20% returns on capital, or be the CEO of GM in a year where the company loses 1% of its value? Nice. Yours or JKG's?

The potential disconnect between shareholders, management, and liability of the modern corporation is truly mindboggling to really contemplate.

Or rather, we overconsume products and underconsume services and leisure (i.e. work too hard).

An excellent way to put an important point. Particularly excellent because a lot of "desirable" jobs (as in find-your-bliss jobs) are essentially service jobs, and so there's a kind of enjoying-your-work utility that's not being maximized over society.

(he responds to the claim that it'll encourage unemployment by saying that unemployment is preferable to degrading low-wage work once you've rejected the convenient social virtue which says otherwise)

Now that's a dangerous idea I might be able to get behind.

aram harrow said...

Hi Saheli,
I tried posting this earlier, but apparently the Internet ate it.

Anyway, you can get the book used on amazon for basically the cost of shipping. As for TeX'ing, well, don't hold your breath, but an html file is also "an actual document," no? In any case, here is a permalink.
The example is mine (and is from recent events...), but the style of thinking is entirely JKG's.

The question of "enjoying-your-work" utility is to me an interesting one. In particular, why are many low-wage service jobs (e.g. working at McDonald's) also seemingly needlessly degrading and low-status. By needless, I mean that the employer could presumably put the employees in a more comfortable/respected position in a way that benefits the employees as much as a wage increase that would cost much more.

Possibilities are (a) I'm wrong, and treating McDonald's workers better really would cost a lot, (b) customers demand subservient employees (kind of a variant of a), (c) keeping employees in a shitty position improves the bargaining power of management in general (as Ehrenreich argued in Nickel and Dimed), (d) workers won't trade better working conditions for even slightly lower wages, either b/c they're harder to observe than wages, or they're already at minimum wage, or their preferences include their family's welfare (which is affected by their wages more than their working conditions), or b/c they think of the jobs as temporary.

Ideas? Maybe this should be a blog post of its own...

aram harrow said...

Oops, of course forgot the Galbraith-style (e), which is that it's not in the best interests of McDonald's, but managers can get away with it because the central corporate office can't control everything on the ground. Also, managers get personal benefit from their workers' lousy conditions (like relative job satisfaction? or maybe somehow more pay? I'm not really sure...) that gives them an incentive to exploit them that is stronger than any disincentive McD central can give.