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Money and Markets: Essays in Honor of Leland B. Yeager

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<strong>Money</strong> <strong>and</strong> <strong>Markets</strong>In recent decades, it has <strong>of</strong>ten seemed that economists have been more <strong>in</strong>terested <strong>in</strong>mathematical technique than anyth<strong>in</strong>g else. In a career spann<strong>in</strong>g more than 50years, Lel<strong>and</strong> B. <strong>Yeager</strong> has stood aga<strong>in</strong>st this trend. An em<strong>in</strong>ent team <strong>of</strong> scholarsexplore the array <strong>of</strong> topics on which Lel<strong>and</strong> <strong>Yeager</strong> has written, <strong>in</strong>clud<strong>in</strong>g monetarytheory <strong>and</strong> history, public choice, the history, philosophy, <strong>and</strong> methodology <strong>of</strong>economic thought, macroeconomics, <strong>and</strong> bus<strong>in</strong>ess cycles.Contributions <strong>in</strong>clude Nobel laureate James Buchanan on the orig<strong>in</strong>s <strong>of</strong> publicchoice, constitutional economics, <strong>and</strong> the Virg<strong>in</strong>ia School <strong>of</strong> Political Economy,Gordon Tullock on <strong>Yeager</strong>’s contributions to public choice, James C. Miller on theproblem <strong>of</strong> monopoly politics <strong>in</strong> America, Maria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnik onstopp<strong>in</strong>g <strong>in</strong>flation <strong>in</strong> Slovenia, Harry L<strong>and</strong>reth <strong>and</strong> David Col<strong>and</strong>er on pluralism<strong>and</strong> formalism <strong>in</strong> American economics, Jürgen Backhaus on the ordo-liberal school<strong>of</strong> economic thought, Roger Garrison on capital theory <strong>and</strong> reswitch<strong>in</strong>g, <strong>and</strong>R<strong>and</strong>all Holcombe evaluat<strong>in</strong>g <strong>Yeager</strong>’s utilitarian approach to policy espousal.Many readers will be surprised to learn <strong>of</strong> <strong>Yeager</strong>’s contributions to the creation<strong>of</strong> public choice theory as related <strong>in</strong> the separate contributions <strong>of</strong> Buchanan <strong>and</strong>Tullock. Steven Horwitz <strong>and</strong> Garrison po<strong>in</strong>t to important Wicksellian themes<strong>in</strong> both <strong>Yeager</strong>’s work <strong>and</strong> Austrian economics. They highlight an <strong>in</strong>terest<strong>in</strong>g“post-Wicksellian macroeconomics” that <strong>in</strong>tegrates Austrian themes with <strong>Yeager</strong>’smonetary-disequilibrium theory <strong>of</strong> macroeconomic dynamics. William Breit,Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willett provide a portrait <strong>of</strong> <strong>Yeager</strong>, the man,which is not to be missed for its sheer joy <strong>and</strong> delight <strong>in</strong> represent<strong>in</strong>g vividly theunique m<strong>in</strong>d <strong>and</strong> personality <strong>of</strong> the volume’s honoree.Roger Koppl is a Pr<strong>of</strong>essor <strong>of</strong> Economics <strong>and</strong> F<strong>in</strong>ance <strong>in</strong> the Silberman College<strong>of</strong> Bus<strong>in</strong>ess at Fairleigh Dick<strong>in</strong>son University, USA.


Foundations <strong>of</strong> the market economyEdited by Mario J. Rizzo, New York University <strong>and</strong>Lawrence H. White, University <strong>of</strong> Missouri at St. LouisA central theme <strong>in</strong> this series is the importance <strong>of</strong> underst<strong>and</strong><strong>in</strong>g <strong>and</strong> assess<strong>in</strong>g the marketeconomy from a perspective broader than the static economics <strong>of</strong> perfect competition <strong>and</strong>Pareto optimality. Such a perspective sees markets as causal processes generated by thepreferences, expectations <strong>and</strong> beliefs <strong>of</strong> economic agents. The creative acts <strong>of</strong> entre preneurshipthat uncover new <strong>in</strong>formation about preferences, prices <strong>and</strong> technology are centralto these processes with respect to their ability to promote the discovery <strong>and</strong> use <strong>of</strong> knowledge<strong>in</strong> society.The market economy consists <strong>of</strong> a set <strong>of</strong> <strong>in</strong>stitutions that facilitate voluntary cooperation<strong>and</strong> exchange among <strong>in</strong>dividuals. These <strong>in</strong>stitutions <strong>in</strong>clude the legal <strong>and</strong> ethical frameworkas well as more narrowly “economic” patterns <strong>of</strong> social <strong>in</strong>teraction. Thus the law, legal<strong>in</strong>stitutions <strong>and</strong> cultural <strong>and</strong> ethical norms, as well as ord<strong>in</strong>ary bus<strong>in</strong>ess practices <strong>and</strong>monetary phenomena, fall with<strong>in</strong> the analytical doma<strong>in</strong> <strong>of</strong> the economist.Other titles <strong>in</strong> the seriesThe Mean<strong>in</strong>g <strong>of</strong> Market Process<strong>Essays</strong> <strong>in</strong> the development <strong>of</strong> modernAustrian economicsIsrael M. KirznerPrices <strong>and</strong> KnowledgeA market-process perspectiveEsteban F. ThomasKeynes’ General Theory <strong>of</strong> InterestA reconsiderationFiona C. MaclachlanLaissez-faire Bank<strong>in</strong>gKev<strong>in</strong> DowdExpectations <strong>and</strong> the Mean<strong>in</strong>g <strong>of</strong>Institutions<strong>Essays</strong> <strong>in</strong> economics by LudwigLachmannEdited by Don LavoiePerfect Competition <strong>and</strong> theTransformation <strong>of</strong> EconomicsFrank M. MachovecEntrepreneurship <strong>and</strong> theMarket ProcessAn enquiry <strong>in</strong>to the growth <strong>of</strong>knowledgeDavid HarperEconomics <strong>of</strong> Time <strong>and</strong> IgnoranceGerald O’Driscoll <strong>and</strong> Mario J. RizzoDynamics <strong>of</strong> the Mixed EconomyToward a theory <strong>of</strong> <strong>in</strong>terventionismSanford IkedaNeoclassical MicroeconomicTheoryThe found<strong>in</strong>g <strong>of</strong> Austrian visionA. M. Endres


The Cultural Foundations <strong>of</strong>Economic DevelopmentUrban female entrepreneurship <strong>in</strong> GhanaEmily Chamlee-WrightRisk <strong>and</strong> Bus<strong>in</strong>ess CyclesNew <strong>and</strong> old Austrian perspectivesTyler CowenCapital <strong>in</strong> DisequilibriumThe role <strong>of</strong> capital <strong>in</strong> a chang<strong>in</strong>g worldPeter Lew<strong>in</strong>The Driv<strong>in</strong>g Force <strong>of</strong> the Market<strong>Essays</strong> <strong>in</strong> Austrian economicsIsrael KirznerAn Entrepreneurial Theory <strong>of</strong> theFirmFrédéric SautetTime <strong>and</strong> <strong>Money</strong>The macroeconomics <strong>of</strong> capital structureRoger GarrisonMicr<strong>of</strong>oundations <strong>and</strong>MacroeconomicsAn Austrian perspectiveSteven Horwitz<strong>Money</strong> <strong>and</strong> the Market<strong>Essays</strong> on free bank<strong>in</strong>gKev<strong>in</strong> DowdCalculation <strong>and</strong> Coord<strong>in</strong>ation<strong>Essays</strong> on socialism <strong>and</strong> transitionalpolitical economyPeter BoettkeKeynes <strong>and</strong> HayekThe money economyG. R. SteeleThe Constitution <strong>of</strong> <strong>Markets</strong><strong>Essays</strong> <strong>in</strong> political economyViktor J. VanbergFoundations <strong>of</strong> Entrepreneurship<strong>and</strong> Economic DevelopmentDavid A. Harper<strong>Markets</strong>, Information <strong>and</strong>CommunicationAustrian perspectives on the <strong>in</strong>terneteconomyEdited by Jack Birner <strong>and</strong> Pierre GarrousteThe Constitution <strong>of</strong> Liberty <strong>in</strong> theOpen EconomyLüder GerkenLiberalism aga<strong>in</strong>st LiberalismJavier Aranzadi<strong>Money</strong> <strong>and</strong> <strong>Markets</strong><strong>Essays</strong> <strong>in</strong> honor <strong>of</strong> Lel<strong>and</strong> B. <strong>Yeager</strong>Edited by Roger Koppl


<strong>Money</strong> <strong>and</strong> <strong>Markets</strong><strong>Essays</strong> <strong>in</strong> honor <strong>of</strong> Lel<strong>and</strong> B. <strong>Yeager</strong>Edited by Roger Koppl


First published 2006by Routledge2 Park Square, Milton Park, Ab<strong>in</strong>gdon, Oxon OX14 4RNSimultaneously published <strong>in</strong> the USA <strong>and</strong> Canadaby Routledge270 Madison Ave, New York, NY 10016Routledge is an impr<strong>in</strong>t <strong>of</strong> the Taylor & Francis Group, an <strong>in</strong>forma bus<strong>in</strong>ess© 2006 editorial matter <strong>and</strong> selection, Roger Koppl; <strong>in</strong>dividual chapters,the contributorsThis edition published <strong>in</strong> the Taylor & Francis e-Library, 2006.“To purchase your own copy <strong>of</strong> this or any <strong>of</strong> Taylor & Francis or Routledge’scollection <strong>of</strong> thous<strong>and</strong>s <strong>of</strong> eBooks please go to www.eBookstore.t<strong>and</strong>f.co.uk.”All rights reserved. No part <strong>of</strong> this book may be repr<strong>in</strong>ted or reproducedor utilised <strong>in</strong> any form or by any electronic, mechanical, or other means,now known or hereafter <strong>in</strong>vented, <strong>in</strong>clud<strong>in</strong>g photocopy<strong>in</strong>g <strong>and</strong> record<strong>in</strong>g,or <strong>in</strong> any <strong>in</strong>formation storage or retrieval system, without permission <strong>in</strong>writ<strong>in</strong>g from the publishers.British Library Catalogu<strong>in</strong>g <strong>in</strong> Publication DataA catalogue record for this book is available from the British LibraryLibrary <strong>of</strong> Congress Catalog<strong>in</strong>g <strong>in</strong> Publication Data<strong>Money</strong> <strong>and</strong> markets: essays <strong>in</strong> honor <strong>of</strong> Lel<strong>and</strong> B. <strong>Yeager</strong>/editedby Roger Koppl.p. cm.Includes bibliographical references <strong>and</strong> <strong>in</strong>dex.1. <strong>Money</strong>. 2. Free enterprise. 3. Economics. 4. <strong>Yeager</strong>, Lel<strong>and</strong> B. I. Koppl,Roger, 1957– II. <strong>Yeager</strong>, Lel<strong>and</strong> B.HG220.A2M582 2006332.4–dc22 2005025298ISBN10: 0–415–70162–7 (Pr<strong>in</strong>t Edition)ISBN13: 978–0–415–70162–4


ContentsList <strong>of</strong> figuresList <strong>of</strong> contributorsPreface <strong>and</strong> acknowledgmentsixxixiii1 A zeal for truth 1ROGER KOPPL2 The <strong>Yeager</strong> mystique: a pr<strong>of</strong>ile <strong>of</strong> the scholar as teacher <strong>and</strong>colleague 21WILLIAM BREIT, KENNETH ELZINGA, AND THOMAS D. WILLETT3 The Virg<strong>in</strong>ia renaissance <strong>in</strong> political economy: the 1960srevisited 34JAMES M. BUCHANAN4 Lel<strong>and</strong>: a personal appreciation 45GORDON TULLOCK5 Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 48JAMES C. MILLER III6 Good ideas <strong>and</strong> bad regressions: the sad state <strong>of</strong> empirical work<strong>in</strong> public choice 66STEVEN B. CAUDILL7 Pluralism, formalism, <strong>and</strong> American economics 83HARRY LANDRETH AND DAVID C. COLANDER8 Lel<strong>and</strong>’s favorite economists 99JÜRGEN G. BACKHAUS


viiiContents9 The genesis <strong>of</strong> an idea: Classical economics <strong>and</strong> the birth <strong>of</strong>monetary disequilibrium theory 126MICHAEL R. MONTGOMERY10 The macroeconomics <strong>of</strong> money, sav<strong>in</strong>g, <strong>and</strong> <strong>in</strong>vestment 143ROBERT L. GREENFIELD11 No-name money 151MARIA MINNITI AND LIDIJA POLUTNIK12 Monetary disequilibrium theory <strong>and</strong> Austrian macroeconomics:further thoughts on a synthesis 166STEVEN HORWITZ13 Reflections on reswitch<strong>in</strong>g <strong>and</strong> roundaboutness 186ROGER W. GARRISON14 Lel<strong>and</strong> <strong>Yeager</strong>’s utilitarianism as a guide to public policy 207RANDALL G. HOLCOMBE15 Ethnic conflict <strong>and</strong> the economics <strong>of</strong> social cooperation:reflections on a difficult problem 221LAURENCE S. MOSS16 The legacy <strong>of</strong> Bismarck 242GORDON TULLOCKIndex 251


Figures8.1 The “Genealogical Table” 1018.2 Eucken’s Wheel 1048.3 Lel<strong>and</strong>’s Diagram 12112.1 Intertemporal discoord<strong>in</strong>ation due to credit expansion 17712.2 Intertemporal discoord<strong>in</strong>ation due to excess dem<strong>and</strong> for money 17813.1 A three-period project 19213.2 Present value (0%–14%) 19313.3 Present value (0%–1000%) 19313.4 Cost advantage (C B /C A ) 195


ContributorsJürgen G. Backhaus is the Krupp-Foundation Chair <strong>in</strong> Public F<strong>in</strong>ance <strong>and</strong>Fiscal Sociology at the University <strong>of</strong> Erfurt <strong>in</strong> Germany.William Breit is Pr<strong>of</strong>essor Emeritus at Tr<strong>in</strong>ity University <strong>in</strong> Texas. He was theE.M. Stevens Dist<strong>in</strong>guished Pr<strong>of</strong>essor <strong>of</strong> Economics at Tr<strong>in</strong>ity from 1983 to1999 <strong>and</strong> the Vernon F. Taylor Dist<strong>in</strong>guished Pr<strong>of</strong>essor <strong>of</strong> Economics from1999 until his retirement <strong>in</strong> May 2002.James M. Buchanan is Advisory General Director <strong>of</strong> the James BuchananCenter for Political Economy <strong>and</strong> Holbert L. Harris University Pr<strong>of</strong>essor atGeorge Mason University. He received the Nobel Memorial Prize for Economics<strong>in</strong> 1986.Steven B. Caudill is Regions Bank Pr<strong>of</strong>essor <strong>of</strong> Economics at AuburnUniversity.David C. Col<strong>and</strong>er is Christian A. Johnson Dist<strong>in</strong>guished Pr<strong>of</strong>essor <strong>of</strong> Economicsat Middlebury College.Kenneth Elz<strong>in</strong>ga is Robert C. Taylor Pr<strong>of</strong>essor <strong>of</strong> Economics at the University <strong>of</strong>Virg<strong>in</strong>ia.Roger W. Garrison is Pr<strong>of</strong>essor <strong>of</strong> Economics at Auburn University.Robert L. Greenfield is Pr<strong>of</strong>essor <strong>of</strong> Economics <strong>and</strong> F<strong>in</strong>ance at FairleighDick<strong>in</strong>son University.R<strong>and</strong>all G. Holcombe is DeVoe Moore Pr<strong>of</strong>essor <strong>of</strong> Economics at Florida StateUniversity.Steven Horwitz is Pr<strong>of</strong>essor <strong>of</strong> Economics at St. Lawrence University.Roger Koppl is Pr<strong>of</strong>essor <strong>of</strong> Economics <strong>and</strong> F<strong>in</strong>ance at Fairleigh Dick<strong>in</strong>sonUniversity.Harry L<strong>and</strong>reth is Ew<strong>in</strong>g T. Boles Pr<strong>of</strong>essor Emeritus at Centre College.James C. Miller III is Chairman <strong>of</strong> The CapAnalysis Group, an affiliate <strong>of</strong> the<strong>in</strong>ternational law firm, Howrey Simon Arnold & White, Dist<strong>in</strong>guished Fellow at


Contributorsthe Center for Study <strong>of</strong> Public Choice at George Mason University as well as theuniversity’s Mercatus Center, <strong>and</strong> Senior Fellow (by courtesy) <strong>of</strong> the HooverInstitution.Maria M<strong>in</strong>niti is Associate Pr<strong>of</strong>essor <strong>of</strong> Economics, Associate Pr<strong>of</strong>essor <strong>of</strong> Entrepreneurship,<strong>and</strong> holder <strong>of</strong> the Ann Higdon Term Chair at Babson College.Michael R. Montgomery is Associate Pr<strong>of</strong>essor <strong>of</strong> Economics at the University<strong>of</strong> Ma<strong>in</strong>e.Laurence S. Moss is Pr<strong>of</strong>essor <strong>of</strong> Economics at Babson College <strong>in</strong> Massachusetts<strong>and</strong> now serves as the editor-<strong>in</strong>-chief <strong>of</strong> The American Journal <strong>of</strong> Economics <strong>and</strong>Sociology. His specialty fields <strong>in</strong>clude the History <strong>of</strong> Economic Thought, AustrianEconomics, <strong>and</strong> Law <strong>and</strong> Economics.Lidija Polutnik is Associate Pr<strong>of</strong>essor <strong>of</strong> Economics at Babson College.Gordon Tullock is University Pr<strong>of</strong>essor <strong>of</strong> Law <strong>and</strong> Economics at George MasonUniversity. He has been the Karl Eller Pr<strong>of</strong>essor <strong>of</strong> Economics <strong>and</strong> PoliticalScience at the University <strong>of</strong> Arizona, Holbert R. Harris University Pr<strong>of</strong>essor atGeorge Mason University, <strong>and</strong> University Dist<strong>in</strong>guished Pr<strong>of</strong>essor at Virg<strong>in</strong>iaPolytechnic Institute <strong>and</strong> State University.Thomas D. Willett is Horton Pr<strong>of</strong>essor <strong>of</strong> Economics at the Claremont GraduateSchool <strong>and</strong> Claremont McKenna College.xii


Preface <strong>and</strong> acknowledgmentsLel<strong>and</strong> B. <strong>Yeager</strong> is Paul Goodloe McIntire Pr<strong>of</strong>essor Emeritus at the University <strong>of</strong>Virg<strong>in</strong>ia <strong>and</strong> Ludwig von Mises Dist<strong>in</strong>guished Pr<strong>of</strong>essor <strong>of</strong> Economics Emeritus atAuburn University. He was born <strong>in</strong> Oak Park, Ill<strong>in</strong>ois on 4 October 1924. Hereceived his AB <strong>in</strong> Economics from Oberl<strong>in</strong> College <strong>in</strong> 1948; his MA <strong>in</strong> Economicsfrom Columbia University <strong>in</strong> 1949. <strong>Yeager</strong> wrote his doctoral dissertation, “AnEvalu ation <strong>of</strong> Freely-Fluctuat<strong>in</strong>g Exchange Rates,” under the jo<strong>in</strong>t supervision <strong>of</strong>the monetary economist James W. Angell <strong>and</strong> Ragnar Nurkse, the famed specialist<strong>in</strong> International Economics <strong>and</strong> Economic Development. <strong>Yeager</strong> received his PhD<strong>in</strong> Economics from Columbia University <strong>in</strong> 1952. In the same year, <strong>Yeager</strong> wasappo<strong>in</strong>ted an Instructor at the University <strong>of</strong> Maryl<strong>and</strong>. He was promoted toAssistant Pr<strong>of</strong>essor <strong>in</strong> 1955. In 1957 he was elected Assistant Pr<strong>of</strong>essor at the University<strong>of</strong> Virg<strong>in</strong>ia, where he was promoted to Associate Pr<strong>of</strong>essor <strong>in</strong> 1959 <strong>and</strong> toPr<strong>of</strong>essor <strong>in</strong> 1963. In 1969, <strong>Yeager</strong> was named Paul Goodloe McIntire Pr<strong>of</strong>essor atthe University <strong>of</strong> Virg<strong>in</strong>ia, a position he retired from <strong>in</strong> 1986. In the same year<strong>Yeager</strong> was named Ludwig von Mises Dist<strong>in</strong>guished Pr<strong>of</strong>essor <strong>of</strong> Economics atAuburn University, where he stayed until his retirement <strong>in</strong> 1995. <strong>Yeager</strong> hasbeen a Visit<strong>in</strong>g Pr<strong>of</strong>essor at Auburn University, Southern Methodist University,University <strong>of</strong> California, Los Angeles, New York University, <strong>and</strong> George MasonUniversity. <strong>Yeager</strong> was President <strong>of</strong> the Southern Economic Association <strong>in</strong> 1974–75 <strong>and</strong> <strong>of</strong> the Atlantic Economic Society <strong>in</strong> 1994–95; he has been an AdjunctScholar with the American Enterprise Institute <strong>and</strong> the Cato Institute; a Fellowwith the American Association for the Advancement <strong>of</strong> Science; a member <strong>of</strong> theMont Peler<strong>in</strong> Society; <strong>and</strong> Director <strong>and</strong> President <strong>of</strong> Interl<strong>in</strong>gua Institute <strong>and</strong> <strong>of</strong>Union Mundial pro Interl<strong>in</strong>gua. Today he lives <strong>in</strong> Auburn, Alabama.This Festschrift was prepared to honor Lel<strong>and</strong> B. <strong>Yeager</strong> on the occasion <strong>of</strong> his80th birthday. Many <strong>of</strong> the contributions <strong>in</strong> this volume were delivered <strong>in</strong> twosessions <strong>of</strong> the 2004 meet<strong>in</strong>g <strong>of</strong> the Southern Economic Association. The participantswere Jürgen G. Backhaus, William Breit, Edgar Brown<strong>in</strong>g, Luis Dopico,Kenneth Elz<strong>in</strong>ga, Roger Garrison, R<strong>and</strong>all Holcombe, Michael Montgomery,Laurence Moss, George Selg<strong>in</strong>, Gordon Tullock, <strong>and</strong> Lel<strong>and</strong> <strong>Yeager</strong>. I thank themfor their participation. The same annual meet<strong>in</strong>g saw a reception <strong>in</strong> <strong>Yeager</strong>’shonor, at which time a manuscript version <strong>of</strong> this book was presented to him. Ithank William Johnson, then president <strong>of</strong> the Southern Economics Association, for


Preface <strong>and</strong> acknowledgmentssponsor<strong>in</strong>g the two sessions honor<strong>in</strong>g <strong>Yeager</strong>. I thank Steve Caudill <strong>and</strong> RogerGarrison for abundant <strong>and</strong> energetic help <strong>in</strong> arrang<strong>in</strong>g them <strong>and</strong> plann<strong>in</strong>g theeven<strong>in</strong>g reception. The even<strong>in</strong>g reception was entirely the product <strong>of</strong> their efforts.Steve Caudill arranged for Auburn University, the University <strong>of</strong> Virg<strong>in</strong>ia, <strong>and</strong>the Ludwig von Mises Institute to fund the even<strong>in</strong>g reception for <strong>Yeager</strong>. RogerGarrison edited <strong>and</strong> pr<strong>in</strong>ted the manuscript version <strong>of</strong> this book presented to<strong>Yeager</strong> on that occasion. This job <strong>in</strong>cluded the burdensome transformation <strong>of</strong>the Word files I sent him <strong>in</strong>to elegantly formatted pdf files. Roger Garrison alsoprovided the photograph <strong>of</strong> the frontispiece, which he arranged to have takenspecifically for use <strong>in</strong> this book. Figure 12.1 is reproduced from Roger’s book Time<strong>and</strong> <strong>Money</strong>: The Macroeconomics <strong>of</strong> Capital Structure (2001, Routledge).I thank the Eastern Economic Association for permission to repr<strong>in</strong>t Chapter 2,which, apart from some m<strong>in</strong>or changes, orig<strong>in</strong>ally appeared as Breit, William,Kenneth G. Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willett, “The <strong>Yeager</strong> Mystique: The Polymathas Teacher, Scholar <strong>and</strong> Colleague,” Eastern Economic Journal, Spr<strong>in</strong>g 1996,22(2): 215–29.I thank all the contributors to this volume for comments on my <strong>in</strong>troductoryessay <strong>and</strong> for their prompt <strong>and</strong> pr<strong>of</strong>essional delivery <strong>of</strong> papers that, <strong>in</strong> my op<strong>in</strong>ion,are <strong>of</strong> uniformly high quality. F<strong>in</strong>ally, I owe further thanks to Roger Garrison forprovid<strong>in</strong>g encouragement, lots <strong>of</strong> good advice, <strong>and</strong> close supervision <strong>of</strong> my efforts.xiv


1 A zeal for truthRoger KopplIf there is one Great Fact from which all <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong>’s special qualities derive,it is his zeal for truth. He must seek the truth, learn the truth, know the truth, writethe truth, <strong>and</strong> speak the truth. An honest scholar is constra<strong>in</strong>ed by truth. He mayerr, <strong>of</strong> course, but he must be truthful. Lel<strong>and</strong> B. <strong>Yeager</strong> is much more than anhonest scholar; he has a fervent devotion to truth, a zeal for truth. The contributorsto this volume have all experienced this zeal <strong>and</strong> been <strong>in</strong>spired by it. The notoriety<strong>of</strong> the scholars contribut<strong>in</strong>g to this volume is a testament to the respect, admiration,<strong>and</strong> love that Lel<strong>and</strong> <strong>Yeager</strong> <strong>in</strong>spires <strong>in</strong> all his colleagues <strong>and</strong> students. They haveall experienced the special qualities that make Lel<strong>and</strong> <strong>Yeager</strong> an exceptionalscholar <strong>and</strong> an exceptional friend. These exceptional qualities are reflected <strong>in</strong> theessay by Breit, Elz<strong>in</strong>ga, <strong>and</strong> Willett, “The <strong>Yeager</strong> Mystique: A Pr<strong>of</strong>ile <strong>of</strong> the Scholaras Teacher <strong>and</strong> Colleague.” Their paean to <strong>Yeager</strong> does not exaggerate. He is anextraord<strong>in</strong>ary teacher, an extraord<strong>in</strong>ary scholar, <strong>and</strong> an extraord<strong>in</strong>ary personality.Breit, Elz<strong>in</strong>ga, <strong>and</strong> Willett (Chapter 2) comment on <strong>Yeager</strong>’s teach<strong>in</strong>g “duende,”which is “that mysterious quality that endears great teachers to pupils <strong>in</strong> the sameway that it endears great performers to their audience.” I remember <strong>Yeager</strong> <strong>of</strong>tensay<strong>in</strong>g (credit<strong>in</strong>g Wilhelm Roepke) that you cannot learn any economics until youhave learned all <strong>of</strong> economics. And he seemed to squeeze all <strong>of</strong> economics <strong>in</strong>toevery class.The tribute <strong>of</strong> Breit, Elz<strong>in</strong>ga, <strong>and</strong> Willett covers his scholarly publications as wellas his teach<strong>in</strong>g. They beg<strong>in</strong> <strong>in</strong> 1954, the year <strong>of</strong> <strong>Yeager</strong>’s first scholarly publicationsas an economist. In that year <strong>Yeager</strong> published two journal articles, a monographon free trade, <strong>and</strong> a reply to a critic. These four publications by a University <strong>of</strong>Maryl<strong>and</strong> <strong>in</strong>structor display <strong>in</strong> fully developed form many, perhaps all, <strong>of</strong> thesalient characteristics <strong>of</strong> <strong>Yeager</strong>’s scholarship. Free Trade: America’s Opportunity(<strong>Yeager</strong> 1954a) was an 88 page monograph argu<strong>in</strong>g, <strong>of</strong> course, for free trade.“Some Questions About Growth Economics” (<strong>Yeager</strong> 1954b) is a critique <strong>of</strong>Harrod-Domar growth models. “Some Questions About Growth Economics:A Reply” (<strong>Yeager</strong> 1954c) responds to G.M. Meier’s criticism. F<strong>in</strong>ally, “TheMethodology <strong>of</strong> Henry George <strong>and</strong> Carl Menger” (<strong>Yeager</strong> 1954d) is a classicarticle published <strong>in</strong> the American Journal <strong>of</strong> Economics <strong>and</strong> Sociology.All these works display what Breit et al. rightly describe as <strong>Yeager</strong>’s “passionfor gett<strong>in</strong>g the analysis straight.” They display many other characteristic traits,


2 Roger Kopplhowever, <strong>in</strong>clud<strong>in</strong>g <strong>Yeager</strong>’s fearlessness <strong>in</strong> <strong>in</strong>tellectual exchange, his concernwith practical policy advice <strong>and</strong> the role <strong>of</strong> values <strong>in</strong> policy prescription, his deep,but unadorned erudition <strong>in</strong> economic method, <strong>in</strong>clud<strong>in</strong>g methodological <strong>in</strong>dividualism,his deep immersion <strong>in</strong> the history <strong>of</strong> economic thought, his freedomfrom the idolatry <strong>of</strong> methods <strong>and</strong> the fetishism <strong>of</strong> jargon, <strong>and</strong> his constant attentionto the central role <strong>of</strong> money <strong>in</strong> creat<strong>in</strong>g or frustrat<strong>in</strong>g economic coord<strong>in</strong>ation.<strong>Yeager</strong>’s free trade pamphlet, Free Trade: America’s Opportunity, uses the samedevice he would later exhibit <strong>in</strong> his books co-authored with David Tuerck (1966,1976), namely, us<strong>in</strong>g testimony at Congressional hear<strong>in</strong>gs as a foil aga<strong>in</strong>st which toset the analysis straight. The style is dis<strong>in</strong>terested, but impassioned; non-technical,but <strong>in</strong>tellectually rigorous; scientific, but richly <strong>in</strong>formed by the values <strong>of</strong> peace,cooperation, <strong>and</strong> <strong>in</strong>dividual autonomy. He says, for example, “Free Trade wouldcontribute not only to the health <strong>of</strong> democratic government but also to worldpeace” (p. 26). He even considers the prospects <strong>of</strong> promot<strong>in</strong>g peace through aworld government <strong>and</strong> asks us to consider whether legal rules defend<strong>in</strong>g liberty“might be enforced by a limited world government with no other powers” (p. 27).Free Trade: America’s Opportunity was published by the Robert SchalkenbachFoundation. This foundation, accord<strong>in</strong>g to its webpage, “was organized <strong>in</strong> 1925 topromote public awareness <strong>of</strong> the social philosophy <strong>and</strong> economic reforms advocatedby Henry George (1839–97), <strong>in</strong>clud<strong>in</strong>g the ‘s<strong>in</strong>gle tax on l<strong>and</strong> values.’”<strong>Yeager</strong>’s pamphlet shows the strong <strong>in</strong>fluence <strong>of</strong> Henry George’s writ<strong>in</strong>gs onthe topic, but it sticks to the subject <strong>and</strong> is not an overall Georgist tract. (I thankthe Schalkenbach Foundation for graciously provid<strong>in</strong>g me a copy <strong>of</strong> <strong>Yeager</strong>’spamphlet.)<strong>Yeager</strong> has expla<strong>in</strong>ed to me his relationship to Henry George. When <strong>Yeager</strong> was<strong>in</strong> high school, his history teacher, Miss Conner, suggested that he take the HenryGeorge School’s correspondence course <strong>in</strong> Progress <strong>and</strong> Poverty. After f<strong>in</strong>ish<strong>in</strong>g thatcourse, he took the course <strong>in</strong> Protection or Free Trade? Through this course <strong>of</strong> study,<strong>Yeager</strong> became a conv<strong>in</strong>ced, even passionate, Georgist; <strong>and</strong>, conv<strong>in</strong>ced that healready knew the essentials <strong>of</strong> economics, he majored <strong>in</strong> economics at Oberl<strong>in</strong>College <strong>in</strong> Ohio. There, <strong>and</strong> especially <strong>in</strong> graduate school at Columbia, he learnedthat there was much more to economics that fasc<strong>in</strong>ated him. “I still greatly admireHenry George,” he has <strong>in</strong>formed me, “although I am no longer a s<strong>in</strong>gle-taxer.”While I share <strong>Yeager</strong>’s view that the Georgist idea is “economically <strong>in</strong>expedient,” itmay be worth po<strong>in</strong>t<strong>in</strong>g out that similar ideas have been expressed by economists asprom<strong>in</strong>ent as François Quesnay <strong>and</strong> Leon Walras.<strong>Yeager</strong>’s free-trade pamphlet conta<strong>in</strong>s an <strong>in</strong>terest<strong>in</strong>g passage (pp. 24–5) brieflytouch<strong>in</strong>g on themes such as rent seek<strong>in</strong>g that later characterized Virg<strong>in</strong>ia PoliticalEconomy. This Virg<strong>in</strong>ia discussion leads <strong>in</strong>to a defense <strong>of</strong> “Free Trade” on thebasis <strong>of</strong> democracy.Government should not have to manufacture agreement on matter whose verynature makes a genu<strong>in</strong>e consensus unlikely. Government should conf<strong>in</strong>e itself,as far as possible, to policies that the citizens can discuss <strong>in</strong>telligently. Now, thefree market decentralizes <strong>and</strong> keeps out <strong>of</strong> politics a far-reach<strong>in</strong>g <strong>and</strong> important


A zeal for truth 3k<strong>in</strong>d <strong>of</strong> decision-mak<strong>in</strong>g. It is a shame, <strong>in</strong> my op<strong>in</strong>ion, to sabotage by Protectionistmeasures such a great bulwark <strong>of</strong> democratic government <strong>and</strong> human freedomas the free market.(<strong>Yeager</strong> 1954a: 26)Free Trade: America’s Opportunity displays fully <strong>Yeager</strong>’s passion for gett<strong>in</strong>g theanalysis straight. In a section entitled “The Importance <strong>of</strong> Not Weasel<strong>in</strong>g,” he says,“Free Traders should speak out bluntly. They should argue not for lower tariffs, notfor reciprocal trade agreements, not for freer trade, but for Free Trade – thecomplete end to government <strong>in</strong>terference with imports <strong>and</strong> exports” (p. 86). Thenotion that halfway measures are more “practical, reasonable, realistic” is firmlyrejected. “Practicality, reasonableness, realism take the place <strong>of</strong> thought. True FreeTraders should not care about a cheap reputation for practicality, reasonableness,realism” (p. 87). He quotes Dennis Robertson’s admonition “not to m<strong>in</strong>d whetheror not the ‘temper <strong>of</strong> the age’ makes some policy ‘politically impossible’: ‘Let us getthe analysis right . . .’” (p. 87).<strong>Yeager</strong>’s “passion for gett<strong>in</strong>g the analysis straight” is also reflected <strong>in</strong> a st<strong>in</strong>g<strong>in</strong>gremark from “Some Questions” cited by Breit et al.:One can juggle concepts <strong>and</strong> symbols def<strong>in</strong>ed <strong>in</strong> a question begg<strong>in</strong>g or mean<strong>in</strong>glessway for quite a while with no danger <strong>of</strong> say<strong>in</strong>g anyth<strong>in</strong>g contradictable byobservable facts <strong>of</strong> technology or <strong>of</strong> human behavior. Metaphorical languagelets the theorist even th<strong>in</strong>k he is say<strong>in</strong>g someth<strong>in</strong>g.(<strong>Yeager</strong> 1954b: 62)This comes after a careful demonstration that then-st<strong>and</strong>ard growth models hidmonetary factors beh<strong>in</strong>d non-monetary variables <strong>and</strong>, <strong>in</strong> so do<strong>in</strong>g, obscured therelation between the supposed results <strong>of</strong> the model <strong>and</strong> “actual human behavior”(p. 61). In his first major statement <strong>of</strong> monetary disequilibrium theory, “A Cash-Balance Interpretation <strong>of</strong> Depression,” <strong>Yeager</strong> is explicit about l<strong>in</strong>k<strong>in</strong>g microeconomics<strong>and</strong> macroeconomics. The “cash-balance approach achieves” itstheoretical “unity” <strong>in</strong> part “by ty<strong>in</strong>g macro- <strong>and</strong> micro-economics together”(<strong>Yeager</strong> 1956: 438). Fifty years on, we could use more <strong>of</strong> this k<strong>in</strong>d <strong>of</strong> micr<strong>of</strong>oundationfor macroeconomics.<strong>Yeager</strong>’s paper on growth stimulated a response from G.M. Meier. <strong>Yeager</strong>’sreply demonstrates the same fierce pursuit <strong>of</strong> the pla<strong>in</strong> truth as the earlier article.Deftly dispos<strong>in</strong>g <strong>of</strong> Meier’s mistakes <strong>and</strong> mis<strong>in</strong>terpretations, <strong>Yeager</strong> closes bychalleng<strong>in</strong>g Meier to address the issues at h<strong>and</strong>. “If he had felt able to refute myargument that the nightmares <strong>of</strong> the growth theorists presuppose monetary<strong>in</strong>stability . . . Meier might well have taken up the challenge” (1954c: 937). Thisremark is pure <strong>Yeager</strong>: Let’s get to the real issues <strong>and</strong> not be sidetracked bymethodological postur<strong>in</strong>g, uncharitable <strong>in</strong>terpretations, or any other distractionfrom the real po<strong>in</strong>ts at issue.<strong>Yeager</strong>’s seem<strong>in</strong>g impatience with methodology is really impatience with badmethodology, which <strong>in</strong>cludes any “preachments” that would, <strong>in</strong> Fritz Machlup’s


4 Roger Kopplwords, “proscribe any technique <strong>of</strong> <strong>in</strong>quiry deemed useful by an honest <strong>and</strong> experiencedscholar” (Machlup 1956 as quoted <strong>in</strong> <strong>Yeager</strong> 1995: 28). In class <strong>Yeager</strong>would <strong>of</strong>ten quote Percy Bridgman’s remark that “the most vital feature <strong>of</strong> thescientist’s procedure has been merely to do his utmost with his m<strong>in</strong>d, no holdsbarred” (Bridgman 1955 as quoted <strong>in</strong> <strong>Yeager</strong> 1995: 27). The trouble with thisadvice is that it strips you <strong>of</strong> all methodological props <strong>and</strong> ornaments. It throws younaked <strong>in</strong>to the problem at h<strong>and</strong>. <strong>Yeager</strong> taught us by example to go thus naked <strong>in</strong>toeconomic theory.I suspect that <strong>Yeager</strong>’s impatience with bad methodology has been build<strong>in</strong>gsteadily for the past half century. His earliest explicit foray <strong>in</strong>to the topic was <strong>in</strong> thesignal year <strong>of</strong> 1954. There, <strong>in</strong> his classic “The Methodology <strong>of</strong> Henry George <strong>and</strong>Carl Menger,” <strong>Yeager</strong> outl<strong>in</strong>es a very sophisticated view from which, I believe, henever departed. Here we have a straightforward exposition <strong>of</strong> the good practices <strong>of</strong>two giants <strong>of</strong> the discipl<strong>in</strong>e, Henry George <strong>and</strong> Carl Menger. Today, when the“Hayek <strong>in</strong>dustry” has exploded <strong>and</strong> “Austrian economics” has been <strong>in</strong> “revival”for a generation, we are familiar with much <strong>of</strong> what <strong>Yeager</strong> said <strong>in</strong> 1954. But whenwe put his argument <strong>in</strong> the context <strong>of</strong> the times, it is startl<strong>in</strong>gly orig<strong>in</strong>al <strong>and</strong>penetrat<strong>in</strong>g. And even today, many will be surprised by its demonstration thatHenry George was “a pr<strong>of</strong>ound <strong>and</strong> orig<strong>in</strong>al economist” (1954d: 233). In six scantpages, <strong>Yeager</strong> outl<strong>in</strong>es Menger’s compositive method, which George arrived at<strong>in</strong>dependently, methodological <strong>in</strong>dividualism, a Misesian emphasis on humanaction, a defense <strong>of</strong> “<strong>in</strong>trospection” <strong>and</strong> “armchair theoriz<strong>in</strong>g,” the role <strong>of</strong> “mentalor imag<strong>in</strong>ative experiment,” a recognition <strong>of</strong> “some limitations <strong>of</strong> statistics <strong>and</strong>other methods <strong>of</strong> historical research <strong>in</strong> establish<strong>in</strong>g or test<strong>in</strong>g laws <strong>of</strong> economics,”an exposition <strong>of</strong> the “‘organic’ conception <strong>of</strong> society,” a discussion <strong>of</strong> dispersedknowledge l<strong>in</strong>ked to a criticism <strong>of</strong> socialism, <strong>and</strong> a recognition <strong>of</strong> money <strong>and</strong> “newcommunities” as evolutionary phenomena.<strong>Yeager</strong> po<strong>in</strong>ts out an important argument for the practice <strong>of</strong> methodological<strong>in</strong>dividualism. “The methodological <strong>in</strong>dividualism <strong>of</strong> George <strong>and</strong> Menger stemsfrom a realization that economists’ ‘<strong>in</strong>side’ knowledge <strong>of</strong> human motives <strong>and</strong>decision-mak<strong>in</strong>g is a lead<strong>in</strong>g source <strong>of</strong> basic empirical generalizations” (p. 238).Methodological <strong>in</strong>dividualism is not a first pr<strong>in</strong>ciple arbitrarily imposed or somesort <strong>of</strong> ontological idea. The po<strong>in</strong>t, rather, is that we cut ourselves <strong>of</strong>f from useful<strong>in</strong>formation if we do not make use <strong>of</strong> our “<strong>in</strong>side knowledge <strong>of</strong> human motives.”In class, <strong>Yeager</strong> would expla<strong>in</strong> methodological <strong>in</strong>dividualism as a k<strong>in</strong>d <strong>of</strong> check.Let’s see what your argument, theory, or model says about “who does what.” If itimputes to real actors actions that are unreasonable or improbable, the argument,theory, or model has probably gone wrong somewhere. If the implied actions <strong>of</strong><strong>in</strong>dividuals are reasonable, the argument, theory, or model has passed an importanttest <strong>and</strong> might be true.In 1954 <strong>Yeager</strong> restricted himself to similarities <strong>in</strong> the methodologies <strong>of</strong> George<strong>and</strong> Menger. Later, <strong>in</strong> “Henry George <strong>and</strong> Austrian Economics,” he turned hisattention to other similarities. George “<strong>in</strong>dependently arrived at several <strong>of</strong> the mostcharacteristic <strong>in</strong>sights <strong>of</strong> the ‘Austrian’ School” (2001a: 3). <strong>Yeager</strong>’s list <strong>of</strong> similarities<strong>and</strong> aff<strong>in</strong>ities is quite long. He f<strong>in</strong>ds po<strong>in</strong>ts <strong>of</strong> contact <strong>in</strong> their value theories


A zeal for truth 5<strong>and</strong> attributes to George some underst<strong>and</strong><strong>in</strong>g <strong>of</strong> the Austrian idea <strong>of</strong> imputation.He notes that George <strong>and</strong> the Austrians both had <strong>in</strong>visible-h<strong>and</strong> explanations <strong>of</strong>money’s evolution <strong>and</strong> both compared money <strong>and</strong> language. The “major po<strong>in</strong>ts <strong>of</strong>agreement” concern political philosophy, methodology, “knowledge, coord<strong>in</strong>ation,<strong>and</strong> unplanned order” (p. 11), <strong>and</strong> their criticisms <strong>of</strong> socialism. I willcomment on the last two po<strong>in</strong>ts.Chapter 6 <strong>of</strong> George’s (1898) The Science <strong>of</strong> Political Economy, “Of Knowledge <strong>and</strong>the Growth <strong>of</strong> Knowledge,” conta<strong>in</strong>s many strik<strong>in</strong>g similarities to Austrian treatments<strong>of</strong> the same theme. Much as Menger had done <strong>in</strong> his Pr<strong>in</strong>ciples <strong>of</strong> Economics(1871), George attributes the progress <strong>of</strong> civilization to the growth <strong>of</strong> knowledge.His discussion <strong>in</strong>cludes a relatively long treatment <strong>of</strong> “skill” <strong>and</strong> how skill emergesfrom practice <strong>in</strong>formed by explicit knowledge. He uses as his lead<strong>in</strong>g example theskill <strong>of</strong> rid<strong>in</strong>g a bicycle, which is the st<strong>and</strong>ard example <strong>in</strong> discussions <strong>of</strong> tacit knowledge.In much the way Michael Polanyi discussed the subsidiary <strong>and</strong> focalawareness, George notes that the person learn<strong>in</strong>g the skill <strong>of</strong> rid<strong>in</strong>g a bicycle “canlook neither to right nor to left, nor notice what he passes” (p. 35). But once the“knowledge required” has passed <strong>in</strong>to “subconscious memory,” the learner “mayride easily, <strong>in</strong>dulg<strong>in</strong>g <strong>in</strong> other tra<strong>in</strong>s <strong>of</strong> thought <strong>and</strong> notic<strong>in</strong>g persons <strong>and</strong> scenery”(p. 35). Skill “cannot be communicated from one to another, or so communicatedonly <strong>in</strong> very small degree” (p. 36). George’s “skill” is tacit knowledge <strong>in</strong> all butname. <strong>Yeager</strong> remarks that George “<strong>and</strong> the Austrians agree that a central task<strong>of</strong> economics is to expla<strong>in</strong> how specialized human activities may be coord<strong>in</strong>atedwithout deliberate direction” (p. 12). George deploys “<strong>in</strong>sights later also achievedby F. A. Hayek,” <strong>Yeager</strong> says, when discuss<strong>in</strong>g “the mobilization <strong>of</strong> knowledge thatis <strong>in</strong>evitably dispersed <strong>and</strong> that simply could not be centralized <strong>and</strong> put to use by as<strong>in</strong>gle m<strong>in</strong>d or a s<strong>in</strong>gle organization” (p. 13).George’s critique <strong>of</strong> socialism bears close similarity to Austrian arguments on thetopic. Build<strong>in</strong>g on his dist<strong>in</strong>ction between “directed or conscious co-operation” <strong>and</strong>“spontaneous or unconscious co-operation,” George argues for the “Impossibility<strong>of</strong> socialism” (p. 301). George <strong>in</strong>vites us to ignore the “<strong>in</strong>evitable tendency totyranny <strong>and</strong> oppression” created by power. Imag<strong>in</strong>e economic control is h<strong>and</strong>edover to “the very wisest <strong>and</strong> best <strong>of</strong> men.” Considerthe task that would be put upon them <strong>in</strong> the order<strong>in</strong>g <strong>of</strong> the when, where, how<strong>and</strong> by whom that would be <strong>in</strong>volved <strong>in</strong> the <strong>in</strong>telligent direction <strong>and</strong> supervision<strong>of</strong> the almost <strong>in</strong>f<strong>in</strong>itely complex <strong>and</strong> constantly chang<strong>in</strong>g relations <strong>and</strong> adjustments<strong>in</strong>volved <strong>in</strong> such division <strong>of</strong> labour as goes on <strong>in</strong> a civilized community.The task transcends the power <strong>of</strong> human <strong>in</strong>telligence at its very highest.(George 1898: 311–12)Some parts <strong>of</strong> George’s critique <strong>of</strong> socialism, <strong>Yeager</strong> says, “rem<strong>in</strong>d us <strong>of</strong> theemphasis <strong>of</strong> present-day Austrians on the creative role <strong>of</strong> entrepreneurship” (p. 15).<strong>Yeager</strong> th<strong>in</strong>ks George’s critique <strong>of</strong> socialism is better <strong>in</strong> The Science <strong>of</strong> Political Economy(1898) than the “earlier <strong>and</strong> less <strong>in</strong>sightful” (p. 22) comments <strong>in</strong> Protection or FreeTrade? (1886).


6 Roger KopplL<strong>and</strong>reth <strong>and</strong> Col<strong>and</strong>er (Chapter 7) identify the word to describe <strong>Yeager</strong>’s laissezfaire attitude on method: pluralism. They argue from <strong>Yeager</strong>’s pluralism to apessimistic conclusion on his methodology <strong>and</strong> economics. <strong>Yeager</strong>’s “commitmentto pluralism has played an important role <strong>in</strong> reduc<strong>in</strong>g his work’s <strong>in</strong>fluence.” Theirpessimism, however, is not complete. The pendulum, they th<strong>in</strong>k, is sw<strong>in</strong>g<strong>in</strong>g <strong>in</strong> asomewhat <strong>Yeager</strong>ian direction. L<strong>and</strong>reth <strong>and</strong> Col<strong>and</strong>er’s metaphorical pendulumrepresents the fashion <strong>in</strong> economic method. It sw<strong>in</strong>gs between formalism <strong>and</strong> antiformalism.Pluralism takes hold only when neither side has preponderate strength.Thus, <strong>Yeager</strong>’s methodological pluralism is fated to be a pass<strong>in</strong>g fancy at best. Buthis rather <strong>in</strong>ductive <strong>and</strong> non-formal style <strong>of</strong> theoriz<strong>in</strong>g is mak<strong>in</strong>g a comeback forgood <strong>in</strong>stitutional reasons. In the past, the formalism had an <strong>in</strong>stitutional advantageover its rival. The formalist had lots <strong>of</strong> tidy little projects to give his or her graduatestudents <strong>and</strong> these students could get tenure <strong>of</strong>f the project thus endowed.Formalism <strong>of</strong> the post-war type “created large numbers <strong>of</strong> small jobs, enough tokeep an academic neoclassical army <strong>of</strong> students busy.” Today, however, we havethe personal computer. “Today, <strong>in</strong>stead <strong>of</strong> writ<strong>in</strong>g a general solution to an abstractproblem, it is easier to provide a solution for a specific problem.” We can programcomputers to solve problems with heterogeneous agents <strong>and</strong> <strong>in</strong>stitutional details.Thus, “solid <strong>in</strong>ductive analysis comb<strong>in</strong>ed with a sharp <strong>in</strong>tuition <strong>and</strong> a rigor <strong>of</strong> thesort that characterized Lel<strong>and</strong> <strong>Yeager</strong>’s work will be mak<strong>in</strong>g a comeback, albeit <strong>in</strong>a quite different form.” Students <strong>and</strong> admirers <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong> should welcomethis change. They should also, however, recall the defense <strong>of</strong> “armchair theoriz<strong>in</strong>g”that he made <strong>in</strong> 1954. Let us not cut ourselves <strong>of</strong>f from our “<strong>in</strong>side” knowledge <strong>of</strong>human action.<strong>Yeager</strong>’s now classic essay compar<strong>in</strong>g George <strong>and</strong> Menger exemplifies <strong>Yeager</strong>’sability to construct a close methodological argument without slipp<strong>in</strong>g <strong>in</strong>to needlessjargon or the worship <strong>of</strong> either method or the study there<strong>of</strong>, methodology. Anothergood example <strong>of</strong> the same phenomenon is <strong>Yeager</strong>’s classic “Methodenstreit overDem<strong>and</strong> Curves” (<strong>Yeager</strong> 1960). Address<strong>in</strong>g a literature on the mean<strong>in</strong>g <strong>of</strong>dem<strong>and</strong>, <strong>Yeager</strong> takes aim at the “methodological precepts set forth <strong>in</strong> this literature:its <strong>in</strong>sistence on a particular conception <strong>of</strong> empirical falsifiability <strong>and</strong> concreteapplicability <strong>of</strong> theories <strong>and</strong> its <strong>in</strong>sistence that the theories deal only with actually orconceptually atta<strong>in</strong>able positions <strong>of</strong> equilibrium” (p. 53). “Methodenstreit” ends witha plea for methodological tolerance. He says, “there is no warrant for exclusive <strong>in</strong>sistenceon particular methods” (p. 60). Klappholz <strong>and</strong> Agassi were right, <strong>Yeager</strong>cont<strong>in</strong>ues, to say that methodological rules more specific than the general admonitionto be critical <strong>and</strong> exposed to criticism are “likely to be futile <strong>and</strong> possiblyharmful” (Klappholz <strong>and</strong> Agassi 1959: 74, as cited <strong>in</strong> <strong>Yeager</strong> 1960: 60). Here, as <strong>in</strong>most <strong>of</strong> <strong>Yeager</strong>’s methodological writ<strong>in</strong>gs, we sense a careful scholar disgruntled athav<strong>in</strong>g been driven <strong>in</strong>to the tedious muck <strong>of</strong> methodology <strong>in</strong> order to clear a pathfor our real bus<strong>in</strong>ess, namely, economics. This attitude reaches one <strong>of</strong> its highestexpressions <strong>in</strong> <strong>Yeager</strong>’s 1995 article “Tacit Preachments Are the Worst K<strong>in</strong>d.”In his contribution to his volume, Steven Caudill (Chapter 6) reveals himself tobe a <strong>Yeager</strong>ian methodologist. Caudill’s ire, his wither<strong>in</strong>g irony, <strong>and</strong> his straightshoot<strong>in</strong>gargument might be attributed to the co<strong>in</strong>cidence that he was born


A zeal for truth 7“30 years to the day after Lel<strong>and</strong> B. <strong>Yeager</strong>,” or to the <strong>in</strong>fluence <strong>of</strong> <strong>Yeager</strong> as acolleague, or, most likely, to a zeal for truth equal to that <strong>of</strong> his friend <strong>and</strong> colleague,Lel<strong>and</strong> <strong>Yeager</strong>. Caudill condemns “bad regressions” <strong>in</strong> economics, especiallypublic choice. We see research “characterized by the follow<strong>in</strong>g: 1) no structuralmodel is presented <strong>and</strong> may not exist, 2) many, if not all, <strong>of</strong> the variables are proxyvariables, 3) the estimation results may be the result <strong>of</strong> a proxy variable search, <strong>and</strong>4) more efficient statistical approaches have not been applied.” Caudill <strong>of</strong>fersseveral solutions, <strong>in</strong>clud<strong>in</strong>g that we should take our role as educators more seriously<strong>and</strong> impress upon econometrics students the importance <strong>of</strong> do<strong>in</strong>g good, carefulwork. In characteristically <strong>Yeager</strong>ian tones, Caudill says, “The most importantsuggestion is that we, as a pr<strong>of</strong>ession, stop publish<strong>in</strong>g papers conta<strong>in</strong><strong>in</strong>g badregressions.”It is only fitt<strong>in</strong>g that Caudill’s objections relat<strong>in</strong>g to public choice should be<strong>in</strong>cluded <strong>in</strong> a volume celebrat<strong>in</strong>g Lel<strong>and</strong> <strong>Yeager</strong>. Caudill’s objections are highly<strong>Yeager</strong>ian <strong>and</strong> they concern an <strong>in</strong>tellectual tradition, public choice, <strong>Yeager</strong> helpedto create. Buchanan’s contribution (Chapter 3) <strong>and</strong> the shorter contribution <strong>of</strong>Gordon Tullock (Chapter 4) reveal <strong>Yeager</strong>’s importance <strong>in</strong> the creation <strong>of</strong> thePublic Choice. Buchanan takes credit for hir<strong>in</strong>g <strong>Yeager</strong> away from the University<strong>of</strong> Maryl<strong>and</strong>, credit<strong>in</strong>g Warren Nutter for nabb<strong>in</strong>g future Nobel laureate RonaldCoase. Buchanan mentions someth<strong>in</strong>g noted with gratitude <strong>in</strong> Tullock’s essay aswell. <strong>Yeager</strong> played an important role <strong>in</strong> br<strong>in</strong>g<strong>in</strong>g Tullock to the University <strong>of</strong>Virg<strong>in</strong>ia. Buchanan speaks <strong>of</strong> <strong>Yeager</strong>’s “strong support for appo<strong>in</strong>t<strong>in</strong>g Tullock.”Tullock says <strong>of</strong> <strong>Yeager</strong>, “I rema<strong>in</strong> grateful to him for, <strong>in</strong> a way, gett<strong>in</strong>g me started <strong>in</strong>economics.” He attributes to <strong>Yeager</strong> a “major role <strong>in</strong> gett<strong>in</strong>g public choice started”<strong>and</strong> <strong>in</strong>sists that his contact with <strong>Yeager</strong> <strong>in</strong> Virg<strong>in</strong>ia contributed importantly tohis “<strong>in</strong>tellectual development” <strong>in</strong> the University <strong>of</strong> Virg<strong>in</strong>ia years. Buchanan’scontribution relates further particulars on <strong>Yeager</strong>’s <strong>in</strong>tellectual <strong>and</strong> adm<strong>in</strong>istrativecontributions to Virg<strong>in</strong>ia Political Economy, <strong>in</strong>clud<strong>in</strong>g the contribution <strong>of</strong> <strong>Yeager</strong>’sedited volume, In Search <strong>of</strong> a Monetary Constitution (1962), to constitutional politicaleconomy.When <strong>Yeager</strong>’s role <strong>in</strong> the creation <strong>of</strong> public choice theory is recognized, wehave less cause to feel surprise that James C. Miller (Chapter 5) would describe hisanalysis <strong>of</strong> monopoly politics as, <strong>in</strong> part, “an application <strong>of</strong> some <strong>of</strong> the basicpr<strong>in</strong>ciples <strong>of</strong> price theory Mr. <strong>Yeager</strong> taught” him. That description also makessense <strong>in</strong> light <strong>of</strong> <strong>Yeager</strong>’s dictum: You cannot learn any economics until you havelearned all <strong>of</strong> economics. Miller’s account is built on Virg<strong>in</strong>ia Political Economy<strong>and</strong> personal experience. The upshot is that under representative democracy,political <strong>in</strong>cumbents <strong>and</strong> <strong>in</strong>siders have a tendency to erect barriers to entry todemocratic political markets. Elaborate restrictions thwart outsiders from seek<strong>in</strong>gthe suffrages <strong>of</strong> their fellow citizens. Campaign f<strong>in</strong>ance “reform” is a salientexample. Incumbents have an <strong>in</strong>centive to restrict campaign spend<strong>in</strong>g because“they do not like their odds aga<strong>in</strong>st well-funded challengers <strong>and</strong> seek to limit theirability to raise such resources <strong>and</strong> to spend them effectively.” Besides, with suchrestrictions <strong>in</strong> place, <strong>in</strong>cumbents have the advantage that “they make news, <strong>and</strong> thushave more access to the media.”


8 Roger KopplBuchanan mentions <strong>Yeager</strong>’s 1954 growth paper. “I had scarcely put the articledown,” he reports, “before I commenced to search out <strong>Yeager</strong>’s possible <strong>in</strong>terest <strong>in</strong>a position on our faculty.” As I <strong>in</strong>dicated above, <strong>Yeager</strong>’s article drew out thehidden monetary elements <strong>in</strong> then-popular growth models. This was to be the first<strong>in</strong> a very long list <strong>of</strong> contributions to monetary theory, <strong>in</strong>clud<strong>in</strong>g “A Rehabilitation<strong>of</strong> Purchas<strong>in</strong>g-Power Parity” (1958b), International Monetary Relations: Theory, History<strong>and</strong> Policy (1966), “The Essential Properties <strong>of</strong> the Medium <strong>of</strong> Exchange” (1968),Experiences with Stopp<strong>in</strong>g Inflation (1981), <strong>and</strong> “A Laissez Faire Approach to MonetaryStability” (Greenfield <strong>and</strong> <strong>Yeager</strong> 1983). Readers <strong>in</strong>terested <strong>in</strong> <strong>Yeager</strong>’s monetarytheory should consult <strong>Yeager</strong> (1997) <strong>and</strong> the <strong>in</strong>troduction by its editor, GeorgeSelg<strong>in</strong>. <strong>Yeager</strong>’s achievements <strong>in</strong> monetary theory are reflected <strong>in</strong> several contributionsto this volume.Rob Greenfield (Chapter 10) uses metaphors characteristically his own, to giveus a k<strong>in</strong>d <strong>of</strong> primer on <strong>Yeager</strong>ian monetary disequilibrium theory <strong>and</strong> <strong>in</strong>directconvertibility. A primer on <strong>in</strong>direct convertibility seems especially desirable to me.I have long felt that the monetary proposal <strong>of</strong> Greenfield <strong>and</strong> <strong>Yeager</strong>, the “BFHsystem” as they unhappily dubbed it, has been underappreciated <strong>and</strong> misunderstood.(Their odd name derives from an attempt to honor some <strong>of</strong> their sources:Black, Fama, <strong>and</strong> Hall.) Their proposal is simpler <strong>and</strong> <strong>in</strong>f<strong>in</strong>itely more practical thanit is sometimes made out to be. Perhaps it would be helpful to some readers if Iexpla<strong>in</strong>ed a simplified version <strong>of</strong> BFH.Imag<strong>in</strong>e we have a monetary system with one bank. Bank notes, <strong>and</strong> only banknotes, circulate as h<strong>and</strong>-to-h<strong>and</strong> currency. To keep th<strong>in</strong>gs really simple, imag<strong>in</strong>ethat there are no checkable deposits <strong>in</strong> this system. We will call the unit for banknotes the “dollar.” Notes are denom<strong>in</strong>ated <strong>in</strong> silver, with each dollar <strong>in</strong> notes be<strong>in</strong>gworth, say, 0.8 ounces <strong>of</strong> silver. Thus, the “dollar” is a unit for count<strong>in</strong>g bank notes,but a dollar should also be worth 0.8 ounces <strong>of</strong> silver. The notes, after all, aredenom<strong>in</strong>ated <strong>in</strong> silver. But does the silver value <strong>of</strong> a dollar have operationalmean<strong>in</strong>g? If I cannot redeem bank notes, the stated silver value may be a fiction. Inour imag<strong>in</strong>ary system, bank notes can be redeemed, but <strong>in</strong> gold rather than silver.Each dollar can be redeemed for as much gold as happens to equal <strong>in</strong> value 0.8ounces <strong>of</strong> silver. This ratio values silver at $1.25 per ounce. Bank notes cannot bedirectly converted <strong>in</strong>to a fixed quantity <strong>of</strong> silver. They can, however, be converted<strong>in</strong>to a variable amount <strong>of</strong> gold, the amount depend<strong>in</strong>g on the price <strong>of</strong> gold <strong>in</strong> terms<strong>of</strong> silver. Such a system has “<strong>in</strong>direct convertibility.” Let us imag<strong>in</strong>e that the price<strong>of</strong> silver is $1.25 per ounce <strong>and</strong> the price <strong>of</strong> gold is $20 per ounce. If I have a $10bank note, I can go to the issuer <strong>and</strong> dem<strong>and</strong> my gold. For each dollar, he must giveme as much gold as is worth 0.8 ounces <strong>of</strong> silver. He must redeem my note for $10-worth <strong>of</strong> gold. Given the assumed prices, a $10 note can be redeemed for half anounce <strong>of</strong> gold.Let’s say the price <strong>of</strong> silver somehow rises to $1.50 per ounce. Perhaps, the bankhas over-issued. With that 20 percent <strong>in</strong>crease <strong>in</strong> the price <strong>of</strong> silver, we mightimag<strong>in</strong>e that we also have a 20 percent <strong>in</strong>crease <strong>in</strong> the price <strong>of</strong> gold, br<strong>in</strong>g<strong>in</strong>g it to$25 per ounce. This possibility turns out not to matter, however, for the operation<strong>of</strong> the system. Thus, we will cont<strong>in</strong>ue to imag<strong>in</strong>e gold is priced at $20 per ounce. If


A zeal for truth 9I have a $10 bank note, I can go to the issuer <strong>and</strong> dem<strong>and</strong> my gold. For each dollar,he must give me as much gold as is worth 0.8 ounces <strong>of</strong> silver. S<strong>in</strong>ce silver sells at$1.50 per ounce, each dollar <strong>in</strong> bank notes gets me $1.2-worth <strong>of</strong> gold. My $10 notegets me $12-worth <strong>of</strong> gold. When I redeem my $10 note, the issu<strong>in</strong>g bank gives me0.6 ounces <strong>of</strong> gold. I can now sell this gold for $12 <strong>in</strong> bank notes. If the price <strong>of</strong>silver cont<strong>in</strong>ues at $1.50 per ounce I will repeat the process, mak<strong>in</strong>g $2 pr<strong>of</strong>it foreach $10 I redeem. As long as silver is priced above $1.25 per ounce, banks willexperience a relatively high rate <strong>of</strong> redemption <strong>and</strong> notes will be retired from thesystem, putt<strong>in</strong>g downward pressure on the price <strong>of</strong> silver (<strong>and</strong> everyth<strong>in</strong>g else).Conversely, if the price <strong>of</strong> silver fell to $1 per ounce, a bank could issue a $10 note,buy $8-worth <strong>of</strong> silver to cover the note fully <strong>and</strong> have $2 left over. More generally,if the price <strong>of</strong> silver should fall below $1.25 per ounce, banks would exp<strong>and</strong> issue<strong>and</strong> put upward pressure on the price <strong>of</strong> silver (<strong>and</strong> everyth<strong>in</strong>g else). Thus, thesystem will automatically move to an equilibrium <strong>in</strong> which silver sells at $1.25 perounce.The system just described is a simplified version <strong>of</strong> Greenfield <strong>and</strong> <strong>Yeager</strong>’s“BFH” system. In the full BFH system, the “medium <strong>of</strong> account” is not silver, however,but a broad-based bundle <strong>of</strong> goods. The “medium <strong>of</strong> redemption” is not gold,but whatever the issu<strong>in</strong>g bank might choose, probably f<strong>in</strong>ancial assets. Checkabledeposits would, <strong>of</strong> course, exist <strong>and</strong> form part <strong>of</strong> the money supply. F<strong>in</strong>ally, the fullBFH system is a proposal for laissez faire monetary reform: private banks wouldengage <strong>in</strong> competitive issue <strong>of</strong> notes <strong>and</strong> deposits. The po<strong>in</strong>t <strong>of</strong> <strong>in</strong>direct convertibilityis to allow the medium <strong>of</strong> account to be def<strong>in</strong>ed so broadly that the system willautomatically produce price stability. The po<strong>in</strong>t <strong>of</strong> competition <strong>in</strong> bank<strong>in</strong>g <strong>and</strong> theissue <strong>of</strong> notes <strong>and</strong> deposits is to get government out <strong>of</strong> the bus<strong>in</strong>ess <strong>of</strong> regulat<strong>in</strong>g themoney supply.Writers such as Schnadt <strong>and</strong> Whittaker (1993) have worried about circularity <strong>in</strong>the system. To get at the problem <strong>and</strong> its solution, I will revert to our simplifiedsystem <strong>in</strong> which silver is the medium <strong>of</strong> account. It seems to Schnadt <strong>and</strong> Whittakerthat any event rais<strong>in</strong>g the price <strong>of</strong> silver would trigger a downward spiral <strong>in</strong> goldprices, so that eventually “the bank would be forced to suspend convertibility”(p. 217). We have seen that if silver’s price rises to $1.50 per ounce, then redeem<strong>in</strong>g$10 <strong>in</strong> bank notes gets you $12-worth <strong>of</strong> gold. When silver trades above par, thecheap way to get gold is through note redemption. But <strong>in</strong> this case no one wouldbuy gold at the relatively high market price; they would <strong>in</strong>stead redeem bank notes.Thus, the dem<strong>and</strong> for gold becomes perfectly elastic at the bank’s redemptionratio. But as long as the price <strong>of</strong> silver stays the same, the bank must <strong>of</strong>fer $12-worth<strong>of</strong> gold for every $10 <strong>in</strong> notes redeemed, which implies an even lower bankredemption ratio, lead<strong>in</strong>g to an even lower market price <strong>of</strong> gold, lead<strong>in</strong>g to a stilllower redemption ratio, <strong>and</strong> so on (Schnadt <strong>and</strong> Whittaker 1993: 215–17).The idea <strong>of</strong> such a downward spiral depends on the assumption that the dem<strong>and</strong>for gold is perfectly elastic (at the bank’s redemption ratio) when silver is pricedabove par. But, as Greenfield et al. (1995) po<strong>in</strong>t out (though <strong>in</strong> somewhat differentlanguage), there is one player with a relatively <strong>in</strong>elastic dem<strong>and</strong> for gold – the verybank whose notes are trad<strong>in</strong>g below par. As their gold reserves dw<strong>in</strong>dle, the bank


10 Roger Kopplwill buy gold to replenish its reserves. Unlike other dem<strong>and</strong>ers, it is will<strong>in</strong>g to pay aprice for gold that exceeds the redemption ratio. Other considerations might bemarshaled to bolster the po<strong>in</strong>t. The price <strong>of</strong> silver is not likely to be so sticky. Noteredemption entails transaction costs which, for some, will be high enough to <strong>in</strong>ducethem to buy gold on the open market even at prices above the redemption ratio.The deviations from par that we have imag<strong>in</strong>ed were set at unreasonably highvalues only to aid exposition; real deviations would be vanish<strong>in</strong>gly small <strong>and</strong>quickly closed. Like Greenfield et al., I conclude that there is no problem <strong>of</strong> circularity<strong>in</strong> the BFH system.Even if we imag<strong>in</strong>e that the circularity problem is real, there are easy fixes. AsBennett McCallum has said, “this difficulty, even if genu<strong>in</strong>e, can be overcome”(2004: 88). He notes that we can lag by one period the market price the bank uses tocalculate its redemption ratio. This period may be an hour, a day, a month, or ayear. Further safeguards, not mentioned by McCallum, could be applied. Forexample, the bank could reta<strong>in</strong> the option <strong>of</strong> suspend<strong>in</strong>g redemption for, say, tenbus<strong>in</strong>ess days. These <strong>and</strong> similar measures would prevent the sort <strong>of</strong> downwardspiral imag<strong>in</strong>ed by Schnadt <strong>and</strong> Whittaker, if such a problem could be shown toexist <strong>in</strong> the first place.The BFH system was conceived largely as an anti-<strong>in</strong>flation measure. <strong>Yeager</strong>’sconcern with <strong>in</strong>flation is reflected <strong>in</strong> many <strong>of</strong> his writ<strong>in</strong>gs <strong>in</strong>clud<strong>in</strong>g Experiences withStopp<strong>in</strong>g Inflation. Typical <strong>of</strong> his scholarly style, <strong>Yeager</strong> looked beyond theories <strong>and</strong>models to consider <strong>in</strong> detail several historical episodes <strong>in</strong> which <strong>in</strong>flation was put toa stop. M<strong>in</strong>niti <strong>and</strong> Polutnik (Chapter 11) use the framework <strong>of</strong> Stopp<strong>in</strong>g Inflation toexam<strong>in</strong>e an <strong>in</strong>terest<strong>in</strong>g recent case, that <strong>of</strong> Slovenia. They f<strong>in</strong>d that <strong>Yeager</strong>’sanalysis applies fully to the Slovenian case as well. They show that “the Slovenianmonetary reform was successful because it addressed all three aspects <strong>of</strong> the<strong>in</strong>flationary momentum” identified by <strong>Yeager</strong>, which they list as “1. The credibilitycomponent. 2. The catch up component. 3. The expectations component.” M<strong>in</strong>niti<strong>and</strong> Polutnik say, “<strong>in</strong> particular, that the newly appo<strong>in</strong>ted Slovenian monetaryauthorities were able to leverage popular expectations <strong>in</strong> favor <strong>of</strong> stabilization.”The foresight <strong>and</strong> cunn<strong>in</strong>g exhibited by the Slovenian authorities <strong>in</strong> stopp<strong>in</strong>gd<strong>in</strong>ar <strong>in</strong>flation was almost a match for that shown <strong>in</strong> their brief ten-day war <strong>of</strong><strong>in</strong>dependence. One government <strong>of</strong>ficial has told me how arms were smuggled <strong>in</strong>toSlovenia shortly before their war <strong>of</strong> <strong>in</strong>dependence. Slovenian political leaderssecretly engaged the leaders <strong>of</strong> the garbage-workers union to call a strike. Thegarbage piled up. These same Slovenian political leaders then pretended to breakthe strike by call<strong>in</strong>g <strong>in</strong> foreign garbage collectors from neighbor<strong>in</strong>g Austria. Theenter<strong>in</strong>g garbage trucks passed easily through checkpo<strong>in</strong>ts manned by Yugoslavsoldiers who were, one may guess, happy for the prospect <strong>of</strong> see<strong>in</strong>g rott<strong>in</strong>g garbageremoved from Slovenian street corners <strong>and</strong> alleyways. If the soldiers had looked<strong>in</strong>side the trucks, however, they would have discovered great caches <strong>of</strong> arms, whichwere later distributed to Slovenian soldiers. The fledgl<strong>in</strong>g Slovenian army was nowready to fight.The story M<strong>in</strong>niti <strong>and</strong> Polutnik tell is not quite as gripp<strong>in</strong>g, but it may be one<strong>of</strong> the more excit<strong>in</strong>g episodes <strong>in</strong> recent monetary history. In class <strong>and</strong> private


A zeal for truth 11conversation, <strong>Yeager</strong> <strong>of</strong>ten cited the l<strong>in</strong>e from Oscar Wilde’s “The Importance <strong>of</strong>Be<strong>in</strong>g Ernest,” <strong>in</strong> which the exceed<strong>in</strong>gly correct Miss Prism protects her charge, theyoung Cecily, from the overexcitement <strong>of</strong> certa<strong>in</strong> lurid episodes <strong>of</strong> monetaryhistory: “Cecily, you will read your Political Economy <strong>in</strong> my absence. The chapteron the Fall <strong>of</strong> the Rupee you may omit. It is somewhat too sensational. Even thesemetallic problems have their melodramatic side.” I would caution persons <strong>of</strong>delicate sensibility, therefore, to skip the more sensational passages <strong>of</strong> M<strong>in</strong>niti <strong>and</strong>Polutnik.The fledgl<strong>in</strong>g Slovenian monetary authority was able to “leverage popularexpectations” even though “there were no legal or regulatory barriers” aga<strong>in</strong>st thenew tolar simply cont<strong>in</strong>u<strong>in</strong>g the <strong>in</strong>flationary pattern <strong>of</strong> the replaced d<strong>in</strong>ar. “Andyet, because the Slovenian authorities had restored the credibility <strong>of</strong> the government,the <strong>in</strong>flationary momentum was <strong>in</strong>terrupted.” The Slovenes had secretlypr<strong>in</strong>ted up currency tokens, M<strong>in</strong>niti <strong>and</strong> Polutnik relate, <strong>in</strong> case the Yugoslavauthorities should cut <strong>of</strong>f the flow <strong>of</strong> d<strong>in</strong>ars. These no-name tokens were used tolaunch the currency, however, <strong>in</strong> response to an <strong>in</strong>flationary expansion <strong>of</strong> d<strong>in</strong>arnotes.M<strong>in</strong>niti <strong>and</strong> Polutnik relate an episode <strong>in</strong> monetary history. <strong>Yeager</strong>’s Experienceswith Stopp<strong>in</strong>g Inflation engages several such episodes. <strong>Yeager</strong> has made other contributionsto monetary history <strong>in</strong>clud<strong>in</strong>g <strong>Yeager</strong> (1958a), (1966), (1969), <strong>and</strong> (1984).<strong>Yeager</strong> is widely recognized as a monetary theorist <strong>of</strong> the highest order. As far as Ican tell, however, <strong>Yeager</strong>’s equal talents as a monetary historian are not widelyappreciated.Koppl <strong>and</strong> <strong>Yeager</strong> (1996) reveal an important episode <strong>in</strong> monetary history. Thehistorical (<strong>and</strong> by far best) bit <strong>of</strong> this paper is, <strong>of</strong> course, entirely <strong>Yeager</strong>’s achievement.<strong>Yeager</strong>’s sources were written <strong>in</strong> English, French, German, <strong>and</strong> Russian.Our data set, daily exchange rates for the ruble aga<strong>in</strong>st the German mark from1883 to 1892, was carefully compiled by <strong>Yeager</strong> from daily reports <strong>in</strong> Der Aktionär<strong>and</strong> Frankfurter Zeitung, contemporary German newspapers. <strong>Yeager</strong>’s full priceseries was considerably longer than the 2700 days we used <strong>in</strong> our study. <strong>Yeager</strong>recorded prices from two papers, not just one, as a control aga<strong>in</strong>st errors <strong>in</strong> report<strong>in</strong>g.This sort <strong>of</strong> care <strong>in</strong> construct<strong>in</strong>g a data series is unusual <strong>and</strong> highly meritorious.At one po<strong>in</strong>t dur<strong>in</strong>g the early discussions <strong>of</strong> the paper, which took place <strong>in</strong> hishome, <strong>Yeager</strong> went to a closet <strong>and</strong> pulled out a set <strong>of</strong> thick books conta<strong>in</strong><strong>in</strong>g noteson monetary history <strong>in</strong> Russia <strong>and</strong> Central <strong>and</strong> Eastern Europe <strong>in</strong> the n<strong>in</strong>eteenthcentury. These books are a hidden treasure trove yet to be m<strong>in</strong>ed for the riches theyconta<strong>in</strong>.The neglect <strong>of</strong> <strong>Yeager</strong>’s achievements <strong>in</strong> monetary history is reflected <strong>in</strong> thisvolume’s lov<strong>in</strong>g tribute by Breit, Elz<strong>in</strong>ga, <strong>and</strong> Willett. They discuss his monetarytheory, his early paper on growth theory, work on capital theory, <strong>in</strong>ternationaltrade, methodology, competitive money, <strong>and</strong> “philosophical aspects <strong>of</strong> politicaleconomy,” but noth<strong>in</strong>g about <strong>Yeager</strong>’s work <strong>in</strong> monetary history beyond not<strong>in</strong>gthat International Monetary Relations presented <strong>in</strong>ternational monetary theory <strong>in</strong> “itsapplication to historical experience.” It is strik<strong>in</strong>g that such deeply <strong>in</strong>formed <strong>and</strong>appreciative scholars as these three should miss this important element <strong>of</strong> <strong>Yeager</strong>’s


12 Roger Kopplscholarly pr<strong>of</strong>ile. I hope this festschrift results <strong>in</strong> greater attention to <strong>Yeager</strong>’s work<strong>in</strong> monetary history.I said that <strong>Yeager</strong> is widely recognized as a monetary theorist <strong>of</strong> the highestorder. Steven Horwitz (Chapter 12) is probably right, however, to describe <strong>Yeager</strong>as possibly “the most underappreciated monetary theorist <strong>of</strong> the twentieth century.”I th<strong>in</strong>k L<strong>and</strong>reth <strong>and</strong> Col<strong>and</strong>er have identified one reason for this neglect. <strong>Yeager</strong>was a pluralist <strong>and</strong> not a committed formalist at a time <strong>of</strong> formalist hegemony.<strong>Yeager</strong> relied on sound microeconomic reason<strong>in</strong>g <strong>and</strong> an encyclopedic knowledge<strong>of</strong> <strong>in</strong>stitutions, economic history, <strong>and</strong> the history <strong>of</strong> economic thought. Any careeristworth his salt would have relied almost exclusively on fashionable mathematicaltechnique. In <strong>Yeager</strong>’s h<strong>and</strong>s, monetary disequilibrium theory was historicallygrounded <strong>in</strong> both senses, that <strong>of</strong> economic history <strong>and</strong> that <strong>of</strong> the history <strong>of</strong>economic thought.In his contribution to this volume, Michael Montgomery (Chapter 9) also givesus an historical perspective on monetary disequilibrium theory. Like <strong>Yeager</strong> (1996),Montgomery traces the theory back to David Hume (1752). Montgomery givespride <strong>of</strong> place to John Stuart Mill, whose “<strong>in</strong>sights” from the Unsettled Questions essay(1844) “represent the start <strong>of</strong> monetary disequilbrium theory as that theory is conceived<strong>of</strong> today.” Montgomery takes aim at facile <strong>in</strong>terpretations <strong>of</strong> the classicals assimpletons who believed that prices <strong>and</strong> wages adjust too rapidly for unemploymentto develop <strong>in</strong> the wake <strong>of</strong> any shock. Montgomery says, “it is quite possible toargue plausibly that none <strong>of</strong> these three propositions – Say’s Law, price/wage flexibility,the neutrality <strong>of</strong> money – accurately characterize Classical macroeconomicthought, at least not <strong>in</strong> the simplistic forms <strong>in</strong> which modern parlance assertsthem.” In explor<strong>in</strong>g the orig<strong>in</strong>s on monetary disequilibrium theory, Montgomerycomes across an <strong>in</strong>terest<strong>in</strong>g puzzle <strong>in</strong> the history <strong>of</strong> economic thought. Why didMill permit only a weakened form <strong>of</strong> the theory <strong>in</strong>to his Pr<strong>in</strong>ciples <strong>of</strong> 1848?In his contribution to this volume, Jürgen Backhaus (Chapter 8) raises another<strong>in</strong>terest<strong>in</strong>g question <strong>in</strong> the history <strong>of</strong> economic thought. Could <strong>Yeager</strong>’s favoriteeconomist, Walter Eucken, have been <strong>in</strong>fluenced by Friedrich Nietzsche? Thequestion may surprise some readers. Eucken was a free-market liberal <strong>and</strong> anarchitect <strong>of</strong> German “Ordo-Liberalismus.” Nietzsche’s philosophy is <strong>of</strong>tenassociated with illiberal views. On the other h<strong>and</strong>, Nietzsche has been given manyconflict<strong>in</strong>g <strong>in</strong>terpretations <strong>and</strong>, as Backhaus shows, the liberal <strong>in</strong>terpretation is atleast a legitimate c<strong>and</strong>idate. And there is an <strong>in</strong>terest<strong>in</strong>g <strong>and</strong> important po<strong>in</strong>t <strong>in</strong>common between them. Eucken, like Nietzsche, suffered a crisis “because he couldnot reconcile scripture <strong>and</strong> evidence.” They “nevertheless came to rather similarconclusions.” The heart <strong>of</strong> Nietzsche’s liberalism, if Backhaus is right, may be hiscelebration <strong>of</strong> the “sovereign <strong>in</strong>dividual” as “the ripest fruit” on the “tree” <strong>of</strong>European culture.The strength <strong>in</strong> Backhaus’s <strong>in</strong>terpretation <strong>of</strong> Nietzsche is its basis <strong>in</strong> economics.How many scholars have exam<strong>in</strong>ed Nietzsche’s writ<strong>in</strong>gs from this particularvantage po<strong>in</strong>t? The two central po<strong>in</strong>ts are Nietzsche’s identification <strong>of</strong> man as the“animal which is able to make promises” while hav<strong>in</strong>g also the capacity <strong>of</strong> “forgetfulness.”Backhaus says, “Although Nietzsche does not fully work out the basic <strong>in</strong>stitutions <strong>of</strong>


A zeal for truth 13a market economy, the key notions are present <strong>and</strong> could readily be furtherdeveloped.” The sort <strong>of</strong> economics suggested by Backhaus’s <strong>in</strong>terpretation is aconstitutional economics, which fits well with <strong>Yeager</strong>’s approach to the subject.These scholarly explorations <strong>of</strong> Nietzsche, Eucken, <strong>and</strong> constitutional economicswould not make a very fitt<strong>in</strong>g tribute to <strong>Yeager</strong> if they were merely scholarly, if theyhad no bite. But they have considerable bite, as Backhaus shows <strong>in</strong> his criticism <strong>of</strong>price <strong>in</strong>dices. Armed with his constitutional <strong>and</strong> Nietzschean perspective, Backhausargues that the real problem with modern price <strong>in</strong>dices lies not <strong>in</strong> the details <strong>of</strong>statistical technique, but <strong>in</strong> the wild variability <strong>of</strong> the unit <strong>of</strong> account <strong>in</strong> today’smonetary constitution. “What is happen<strong>in</strong>g here is that the unit <strong>of</strong> account isconstantly be<strong>in</strong>g falsified. Hence, competition among agencies, such as foliomanag<strong>in</strong>gagencies, should decide on the best <strong>in</strong>dex for price stability.” Thisfalsification <strong>of</strong> the unit <strong>of</strong> account is, presumably, a k<strong>in</strong>d <strong>of</strong> forgetfulness <strong>of</strong>the economic system, a forgetfulness that corrupts money’s promise as a tool<strong>of</strong> economic calculation.Backhaus explored l<strong>in</strong>ks connect<strong>in</strong>g <strong>Yeager</strong> to Eucken <strong>and</strong> Nietzsche. In hiscontribution to this volume, Steven Horwitz, a self-described Austrian economist,connects <strong>Yeager</strong> to Hayek <strong>and</strong> Wicksell. He shows, successfully I th<strong>in</strong>k, that“Austrians have much to learn from <strong>Yeager</strong> <strong>and</strong> that <strong>Yeager</strong>’s work is morecompatible with Austrian macroeconomics than he has been <strong>of</strong>ten will<strong>in</strong>g toadmit.” In so do<strong>in</strong>g he develops a theme he has explored <strong>in</strong> the past, especially<strong>in</strong> his Micr<strong>of</strong>oundations <strong>and</strong> Macroeconomics: An Austrian Perspective (2000). Horwitzdescribes “the capital-<strong>in</strong>terest rate process” as the “[o]ne element that is miss<strong>in</strong>gfrom the <strong>Yeager</strong> monetary disequilibrium story.” Austrian concerns about real <strong>and</strong>natural rates <strong>of</strong> <strong>in</strong>terest, together with a Jevonsian or Hayekian view <strong>of</strong> the <strong>in</strong>tertemporalstructure <strong>of</strong> capital, should be added to <strong>Yeager</strong>’s monetary disequilbriumtheory to produce an even richer <strong>and</strong> more <strong>in</strong>formative macroeconomics. Do<strong>in</strong>g sohas consequences. For example, “Plac<strong>in</strong>g Austrian macroeconomics on thefoundations <strong>of</strong> monetary disequilibrium theory suggests, <strong>in</strong> contrast to the olderAustrian position, that there are situations where the expansion <strong>of</strong> the money supplyare appropriate, <strong>in</strong>dependent <strong>of</strong> any money commodity back<strong>in</strong>g it.”<strong>Yeager</strong>’s monetary disequilibrium theory builds on “The Wicksellian Process”<strong>of</strong> adjust<strong>in</strong>g money hold<strong>in</strong>gs to equilibrium levels. Austrian trade cycle theorybuilds on a different Wicksellian process <strong>of</strong> adjust<strong>in</strong>g <strong>in</strong>terest rates to equilibriumlevels. Horwitz calls on macroeconomists to embed Wicksellian <strong>in</strong>terest adjustment,as enriched by Austrian capital theory, with<strong>in</strong> the context <strong>of</strong> Wicksellian monetaryadjustment, as developed <strong>in</strong> <strong>Yeager</strong>’s monetary disequilibrium theory. The result is“post-Wicksellian macroeconomics.”Horwitz’s contribution builds on his own earlier work <strong>and</strong> on the capital-basedmacroeconomics <strong>of</strong> Roger Garrison. In his contribution to this volume (Chapter13), Garrison explores <strong>Yeager</strong>’s contributions to capital theory. With Garrison, aswith Horwitz, Wicksell is an important source. In this case, the relevant <strong>in</strong>sight isthe “price Wicksell effect,” accord<strong>in</strong>g to which capital values move <strong>in</strong> the oppositedirection from <strong>in</strong>terest rates. An <strong>in</strong>crease <strong>in</strong> capital value caused by lower <strong>in</strong>terestrates will lead to “an <strong>in</strong>crease <strong>in</strong> capital value not reflected <strong>in</strong> an actual <strong>in</strong>crease <strong>in</strong>


14 Roger Koppl(physically def<strong>in</strong>ed) capital.” Tak<strong>in</strong>g the price Wicksell effect seriously helps us tosee why “unlike labor <strong>and</strong> l<strong>and</strong>, capital cannot be measured summarily, accord<strong>in</strong>gto Wicksell, except <strong>in</strong> value terms.”Garrison shows that a little care with units analysis leads us to identify the rightunit for measur<strong>in</strong>g capital. I make the same argument, but <strong>in</strong> a slightly alteredform. We assume that <strong>in</strong>terest is the price <strong>of</strong> capital <strong>and</strong> ask <strong>in</strong> what units we are tomeasure capital. We denote the <strong>in</strong>terest rate r, the quantity <strong>of</strong> capital is K, the wagerate is w, <strong>and</strong> the quantity <strong>of</strong> labor is L. We need a unit for K such that rK will be somany dollars, just as wL is so many dollars. Recall how units analysis tells us that wLis so many dollars. We calculate w <strong>in</strong> dollars per man-year <strong>and</strong> we calculate L <strong>in</strong>man-years. Thus, wL is calculated <strong>in</strong> units that put the dollars from w <strong>in</strong> thenumerator <strong>and</strong> the man-years from w <strong>in</strong> the denom<strong>in</strong>ator, while also putt<strong>in</strong>g theman-years from L <strong>in</strong> the numerator. The two terms for man-years drop out <strong>and</strong> wehave wL computed simply <strong>in</strong> dollars. We calculate r <strong>in</strong> dollars per dollar-year. Forexample, if the <strong>in</strong>terest rate is 5 percent, the debtor must pay <strong>in</strong> <strong>in</strong>terest $0.05 foreach dollar that is borrowed <strong>and</strong> repaid one year later. The debtor must pay $0.05for each dollar-year <strong>of</strong> debt. The units for K are whatever they must be for rK toresolve <strong>in</strong>to simple dollars, which means the units are dollar-years.It matters that capital is measured <strong>in</strong> dollar-years. As Garrison expla<strong>in</strong>s at somelength, <strong>Yeager</strong> (1976) was able to transform this <strong>in</strong>sight about units <strong>in</strong>to a thoroughgo<strong>in</strong>gcritique <strong>of</strong> Cambridge capital controversies. Garrison’s “Child’s Guide tothe Capital Paradoxes” shows, as <strong>Yeager</strong> had <strong>in</strong> 1976, that the supposed paradoxes<strong>of</strong> capital evaporate when put under the comb<strong>in</strong>ed heat <strong>of</strong> units analysis <strong>and</strong> thearithmetic <strong>of</strong> present values. Units analysis reveals “capital’s dimensional, orradical, heterogeneity.” Barges <strong>and</strong> blast furnaces are different <strong>and</strong> can have nocommon unit but dollar-years. In my op<strong>in</strong>ion, this is a def<strong>in</strong>itive solution to the supposed“problem” <strong>of</strong> reswitch<strong>in</strong>g. This solution, however, is so alien to CambridgeUK sensibilities that Cohen <strong>and</strong> Harcourt imag<strong>in</strong>e that it “did not make a mean<strong>in</strong>gfulcontribution to the debate” (2003, as cited <strong>in</strong> Garrison’s contribution to thisvolume). Apparently, the logic <strong>of</strong> this dismissal goes someth<strong>in</strong>g like this: <strong>Yeager</strong>does not fit neatly with<strong>in</strong> our pre-fabricated box labeled “neoclassical,” nor is heone <strong>of</strong> us; thus, his contribution does not count or even have mean<strong>in</strong>g. Fortunately,Mr. <strong>Yeager</strong> has always shown a greater zeal for truth than is here manifested byCohen <strong>and</strong> Harcourt.<strong>Yeager</strong>’s zeal for truth allows him to face tough issues. He “has tackled themhead-on,” as R<strong>and</strong>all Holcombe (Chapter 14) puts it. Laurence Moss (Chapter 15)takes on the “elim<strong>in</strong>ationist politics” <strong>of</strong> genocide <strong>and</strong> ethnic cleans<strong>in</strong>g. In hissecond contribution to this volume, Gordon Tullock (Chapter 16) explores onesuch issue, the f<strong>in</strong>ancial health <strong>of</strong> the welfare state. Holcombe exam<strong>in</strong>es <strong>Yeager</strong>’sethic framework for th<strong>in</strong>k<strong>in</strong>g about such issues, namely, utilitarianism.Holcombe’s paper <strong>in</strong>cludes a skillful summary <strong>of</strong> <strong>Yeager</strong>’s <strong>in</strong>direct utilitarianism,his protests to the contrary notwithst<strong>and</strong><strong>in</strong>g. <strong>Yeager</strong> develops his position atsome length <strong>in</strong> his 2001 book, Ethics as Social Science. As a type <strong>of</strong> utilitarianism,<strong>Yeager</strong>’s position starts with the undefended <strong>and</strong> “fundamental value judgment,”


A zeal for truth 15<strong>of</strong> “approval <strong>of</strong> happ<strong>in</strong>ess <strong>and</strong> disapproval <strong>of</strong> misery” (<strong>Yeager</strong> 2001b: 13, as cited <strong>in</strong>Holcombe’s contribution to this volume).David Hume’s view that it is not possible to derive an “ought” from an “is” hasproved to be an endur<strong>in</strong>g, solid, <strong>and</strong> widely accepted pr<strong>in</strong>ciple. It seems quitepossible, therefore, that any ethical system now or <strong>in</strong> the future will have to build onat least one such undefended ethical pr<strong>in</strong>ciple. Even if we should identify some sort<strong>of</strong> universal ethics upon which, let us imag<strong>in</strong>e, civilization depends, it rema<strong>in</strong>s for usto accept or reject them. In any event, <strong>Yeager</strong>’s system beg<strong>in</strong>s with the <strong>in</strong>nocuousbut undefended postulate <strong>of</strong> beneficence.<strong>Yeager</strong> cites Hayek <strong>in</strong> mak<strong>in</strong>g the case for rules-utilitarianism over actutilitarianism.We cannot reliably calculate the consequences <strong>of</strong> <strong>in</strong>dividual acts,but we can underst<strong>and</strong> the consequences <strong>of</strong> follow<strong>in</strong>g or not a given rule or set <strong>of</strong>rules. <strong>Yeager</strong> taught me that we may <strong>of</strong>ten prefer to throw away <strong>in</strong>formation. Ith<strong>in</strong>k this pr<strong>in</strong>ciple is important <strong>in</strong> both positive <strong>and</strong> normative economics. It mayeasily seem to be foolish or irrational to throw out <strong>in</strong>formation. Advocates <strong>of</strong>“rules” over “discretion,” however, want the central authorities to do preciselythat. A rule-follow<strong>in</strong>g central bank ignores much <strong>of</strong> the <strong>in</strong>formation available to it.In general, rule-follow<strong>in</strong>g agents throw out <strong>in</strong>formation. <strong>Yeager</strong> alerts us to thedangers <strong>of</strong> act<strong>in</strong>g on “fragmentary <strong>and</strong> probably accidentally biased bits <strong>of</strong> concrete<strong>in</strong>formation that one may happen to possess” (2001b: 279, as cited <strong>in</strong> Holcombe).Recent developments <strong>in</strong> psychology po<strong>in</strong>t <strong>in</strong> the same direction. The “fast <strong>and</strong>frugal algorithms” <strong>of</strong> Gigerenzer et al. (1999) throw out <strong>in</strong>formation. Similarly,Cosmides <strong>and</strong> Tooby (1994) have argued that our seem<strong>in</strong>gly irrational adherenceto certa<strong>in</strong> heuristics can produce results that are “better than rational.” In bothcases, the po<strong>in</strong>t is that the heuristic <strong>in</strong>corporates <strong>in</strong>formation about the environmentthat more seem<strong>in</strong>gly rational decision algorithms lack. Long before these relativelyrecent developments <strong>in</strong> psychology, Herbert Simon defended heuristics onsomewhat similar grounds.Holcombe po<strong>in</strong>ts out that <strong>Yeager</strong> goes beyond rules-utilitarianism “<strong>and</strong>advocates <strong>in</strong>direct utilitarianism, which <strong>in</strong>cludes aspects relat<strong>in</strong>g to <strong>in</strong>dividuals’character <strong>and</strong> attitudes.” I should probably note a further dist<strong>in</strong>ction betweenrules-utilitarianism <strong>and</strong> <strong>in</strong>direct utilitarianism. Some rules-utilitarians imag<strong>in</strong>e wecan judge rules one by one. Indirect utilitarians recognize that we cannot alwaysjudge <strong>in</strong>dividual rules reliably, but only systems <strong>of</strong> rules. We might compare<strong>in</strong>dividual rules to <strong>in</strong>dividual genes. The behavior <strong>of</strong> the system depends on thetotal complex <strong>of</strong> rules or genes. These rules or genes may be characterized by arelatively large number <strong>of</strong> “epistatic <strong>in</strong>teractions,” which means the effect <strong>of</strong> anyone depends sensitively upon what others may be present or absent. StuartKauffman (1993, 1994) has studied epistatic <strong>in</strong>teractions among genes.Holcombe tells <strong>of</strong> his discussions with <strong>Yeager</strong> about contractarianism <strong>and</strong> utilitarianism.Contractarianism is an ethical doctr<strong>in</strong>e that imag<strong>in</strong>es what peoplewould choose from beh<strong>in</strong>d a veil <strong>of</strong> ignorance. It has therefore a similarity to Rawls’system. Contractarians espouse the constitutional rules they believe would beunanimously supported beh<strong>in</strong>d the veil <strong>of</strong> ignorance. They say the imag<strong>in</strong>ed terms


16 Roger Kopplhammered out represent “conceptual agreement” to those pr<strong>in</strong>ciples. Holcomberecounts <strong>Yeager</strong>’s response to Holcombe’s contractarianism: “You don’t reallybelieve that, do you?” Part <strong>of</strong> the trouble for <strong>Yeager</strong> is the idea <strong>of</strong> conceptual agreement,which he takes to mean “no agreement.” For Holcombe, the force <strong>of</strong> thiscriticism comes from the <strong>in</strong>sight that contractarianism tends to represent coercivegovernment as a matter <strong>of</strong> agreement. “The contractarian framework suggeststhat, from a normative perspective, we should abide by government’s rules becausethey are someth<strong>in</strong>g we have (conceptually) agreed to, but <strong>in</strong> what sense have weagreed to the coercive power <strong>of</strong> government? The contractarian frameworkaccords government more legitimacy than it deserves.” <strong>Yeager</strong> has <strong>in</strong>fluencedHolcombe’s th<strong>in</strong>k<strong>in</strong>g, but he has not won him over completely. In particular, heworries that <strong>Yeager</strong>’s position “does not adequately safeguard <strong>in</strong>dividual rights.”Holcombe notes that “Economists <strong>of</strong>ten argue that <strong>in</strong>dividuals are the bestjudges <strong>of</strong> their own well-be<strong>in</strong>g, but <strong>Yeager</strong> does not accept this as a universal truth.”I believe <strong>Yeager</strong> is quite right on this po<strong>in</strong>t. Holcombe raises a basic issue <strong>in</strong> liberaltheory that has, I th<strong>in</strong>k, been somewhat miscast by those liberal theorists whodeclare the <strong>in</strong>dividual best able to judge his own <strong>in</strong>terests. We are sometimes toldthat <strong>in</strong> commercial society the <strong>in</strong>dividual judges his own <strong>in</strong>terests <strong>and</strong> his own comparativeadvantage. He decides for himself how to live <strong>and</strong> work. This statementmay seem to suggest that only one person is judg<strong>in</strong>g the best use <strong>of</strong> my time, namelyme. But <strong>in</strong> commercial society many decentralized actors have a role <strong>in</strong> judg<strong>in</strong>ghow I should spend my time. I am one <strong>of</strong> them, but so are my family members, myemployer, potential employers, religious leaders, <strong>and</strong> so on. Important <strong>in</strong> thisgroup, I th<strong>in</strong>k, are employers <strong>and</strong> potential employers. One <strong>of</strong> the functions <strong>of</strong> theentrepreneur is to judge how to use the labor time <strong>of</strong> others. If the entrepreneur hasa comparative advantage <strong>in</strong> mak<strong>in</strong>g such judgments, he will cont<strong>in</strong>ue to be <strong>in</strong> aposition to <strong>of</strong>fer workers a guaranteed wage <strong>in</strong> exchange for his right to direct theirefforts. In some contexts, employers may <strong>in</strong>sist on st<strong>and</strong>ards <strong>of</strong> good character <strong>and</strong>reputation, thus guid<strong>in</strong>g <strong>in</strong>dividuals toward some commonly accepted ethicalst<strong>and</strong>ards. Outside the workplace, the <strong>in</strong>dividual has many sources <strong>of</strong> adviceon how to behave, <strong>in</strong>clud<strong>in</strong>g religion. He may also seek, however, the practicaladvice <strong>of</strong> self-help manuals. The Great Orig<strong>in</strong>al <strong>of</strong> this species <strong>in</strong> America is theauto biography <strong>of</strong> Benjam<strong>in</strong> Frankl<strong>in</strong>, which <strong>in</strong>cludes Frankl<strong>in</strong>’s “Project <strong>of</strong> Self-Improvement.” The advantage <strong>of</strong> <strong>in</strong>dividual autonomy is not so much that the<strong>in</strong>dividual chooses his own path. <strong>Yeager</strong> is right to deny that the <strong>in</strong>dividual is alwaysthe best judge <strong>of</strong> his own well-be<strong>in</strong>g. The advantage consists <strong>in</strong> the <strong>in</strong>creased probability,relative to available alternatives such as central control, that the <strong>in</strong>dividualwill be guided, <strong>in</strong> the different aspects <strong>of</strong> his life, by persons enjoy<strong>in</strong>g a comparativeadvantage <strong>in</strong> provid<strong>in</strong>g such guidance.Laurence Moss shares Holcombe’s concern over human rights. Moss addressesthe “elim<strong>in</strong>ationist politics” <strong>of</strong> genocide <strong>and</strong> ethnic cleans<strong>in</strong>g. Moss’s ma<strong>in</strong> po<strong>in</strong>t isthat mass murder may be perfectly efficient <strong>in</strong> the economic sense, as long as youare among the killers <strong>and</strong> not a victim. “Without a strong commitment to humanrights norms, which must dom<strong>in</strong>ate any economic efficiency argument no matterhow well constructed, the economist turned policy maker is not likely to have much


A zeal for truth 17to <strong>of</strong>fer about end<strong>in</strong>g the ethnic atrocities <strong>of</strong> our age.” Moss’s argument is consistentwith Adam Smith’s remarks on the existence <strong>of</strong> slavery <strong>in</strong> otherwise freecountries. Slavery persists <strong>in</strong> spite <strong>of</strong> its (supposed) economic <strong>in</strong>efficiency because <strong>of</strong>our “love <strong>of</strong> dom<strong>in</strong>ation <strong>and</strong> tyranniz<strong>in</strong>g,” which “will make it impossible for theslaves <strong>in</strong> a free country ever to recover their liberty” (Smith 1982: 186; LJ[A] iii,114). Smith, a found<strong>in</strong>g member <strong>of</strong> the British Anti-Slavery Society, was notopposed to slavery for “economic” reasons, but humanitarian reasons. Moss argues<strong>in</strong> a fundamentally similar ve<strong>in</strong> that the mass murder <strong>of</strong> elim<strong>in</strong>ationist politics canbe perfectly efficient <strong>in</strong> a narrow economic sense. He shows this by construct<strong>in</strong>g amodel <strong>in</strong> which deceptive behavior is concentrated <strong>in</strong> the group that becomes theoppressed m<strong>in</strong>ority. It is not necessary that the oppressed group really be deceptive,only that it be perceived as such. Thus, the Nazi era saw many absurd depictions <strong>of</strong>Jews as conspir<strong>in</strong>g parasites. Moss might have po<strong>in</strong>ted out that the oppress<strong>in</strong>gmajority may ga<strong>in</strong> from elim<strong>in</strong>at<strong>in</strong>g the m<strong>in</strong>ority even when the oppressed group isrecognized to be cooperative <strong>and</strong> honest. If “we” drive “them” out, we lose some <strong>of</strong>the benefits <strong>of</strong> a more ref<strong>in</strong>ed division <strong>of</strong> labor, but we get a larger ga<strong>in</strong> by steal<strong>in</strong>gtheir farms <strong>and</strong> houses. It is easier to perceive a need for elim<strong>in</strong>ationist policies<strong>and</strong> easier to pursue them when “the nation-state is def<strong>in</strong>ed <strong>in</strong> terms <strong>of</strong> commonancestry <strong>and</strong> ethnic descent rather than an aggregated adm<strong>in</strong>istrative unit.” Mossconcludes “that the strict logic <strong>of</strong> economic reason<strong>in</strong>g has for too long accommodatedthe strict logic <strong>of</strong> ethnic cleans<strong>in</strong>g, segregation, <strong>and</strong> forced emigration.The focus on overall economic efficiency <strong>and</strong> the ga<strong>in</strong>s from trade prove to be <strong>in</strong>adequate<strong>in</strong> protect<strong>in</strong>g basic human rights.”Tullock addresses a very different k<strong>in</strong>d <strong>of</strong> problem that may arise from stateaction, namely, the <strong>in</strong>justices <strong>of</strong> an unsusta<strong>in</strong>able welfare state. The advantages <strong>of</strong><strong>in</strong>dividual autonomy come with the risk that the autonomous <strong>in</strong>dividual will fallupon hard times because <strong>of</strong> bad judgment or bad luck. In response to this risk, mostsocial th<strong>in</strong>kers support some form <strong>of</strong> welfare, be it a m<strong>in</strong>imal safety net or anelaborate system <strong>of</strong> “cradle to grave” care. Gordon Tullock addresses problemswith the welfare state as it exists <strong>in</strong> many <strong>of</strong> the world’s richest countries. The threepillars <strong>of</strong> the welfare state are “unemployment relief or aid to the poor, old agepensions, <strong>and</strong> free medical care.” The two that matter for the fiscal health <strong>of</strong>governments are pensions <strong>and</strong> health care. Tullock traces the modern welfare stateto Germany’s Pr<strong>in</strong>ce Bismarck. “The <strong>in</strong>ternational adoption <strong>of</strong> the welfare state, ifplotted on a map, would look much like the spread <strong>of</strong> a contagious disease. It spreadfrom Germany to its neighbors <strong>and</strong> then to their neighbors.” The United States“was the last major country to adopt the welfare state.” The welfare state createdno fiscal crisis when medic<strong>in</strong>e was relatively primitive <strong>and</strong> life expectancy wasrelatively low. In Bismarck’s era, the “germ theory <strong>of</strong> disease was at the time verynew <strong>and</strong> sanitation tended to be careless.” A stay <strong>in</strong> the hospital was dangerous toone’s health. “The advance <strong>of</strong> science has changed all <strong>of</strong> this <strong>and</strong> a very sharp<strong>in</strong>crease <strong>in</strong> life expectancy has resulted.” These factors comb<strong>in</strong>ed with recentdemographic changes are creat<strong>in</strong>g a crisis for the welfare state. Tullock suggeststhat Western governments may have to repudiate their debts under the welfarestate. He po<strong>in</strong>ts to two ways to do it, openly or through <strong>in</strong>flation. “It’s not obvious


18 Roger Kopplwhich is worse,” he concludes, “an <strong>in</strong>flation or overt repudiation <strong>of</strong> the promiseswhich have been implicitly given to almost everyone enrolled <strong>in</strong> the Bismarckianscheme.”All <strong>of</strong> the contributions to this volume bear an <strong>in</strong>timate relationship to <strong>Yeager</strong>’sscholarship. They cover a very broad range <strong>of</strong> topics from technical issues <strong>of</strong>monetary regimes or economic method, to broad issues <strong>of</strong> ethics <strong>and</strong> politicalphilosophy. This is an impressive range <strong>of</strong> topics reflect<strong>in</strong>g the unusual breadth <strong>of</strong><strong>Yeager</strong>’s scholarship. In this essay I have come far short <strong>of</strong> a complete survey <strong>of</strong><strong>Yeager</strong>’s scholarly output. I have ignored completely his work as a translator, hisscholarly contributions to the language Interl<strong>in</strong>gua, his organizational contributionsto the Union Mundial pro Interl<strong>in</strong>gua, his popular writ<strong>in</strong>gs on liberty, <strong>and</strong> so on. Itis hardly to be wondered at, then, that <strong>Yeager</strong>’s career would <strong>in</strong>spire the enthusiasm<strong>and</strong> admiration <strong>of</strong> accomplished scholars. Indeed, many contributions reflectgenu<strong>in</strong>e awe <strong>in</strong> <strong>Yeager</strong>’s extraord<strong>in</strong>ary career <strong>and</strong> personality. On the occasion <strong>of</strong>his 80th birthday, we <strong>of</strong>fer these essays to Lel<strong>and</strong> B. <strong>Yeager</strong> to honor him for all hehas done <strong>and</strong> all he represents. We honor him for his scholarship, his teach<strong>in</strong>g, hishard work, <strong>and</strong> his great erudition. We honor him for his zeal for truth. We honorhim know<strong>in</strong>g that scholars <strong>of</strong> his caliber – persons <strong>of</strong> his caliber – are rare <strong>and</strong> thatwe have been blessed to call him teacher, colleague, mentor, friend.ReferencesBridgman, Percy W. (1955). Reflections <strong>of</strong> a Physicist. New York: Philosophical Library.Cohen, Avi J. <strong>and</strong> Ge<strong>of</strong>frey C. Harcourt (2003). Cambridge Capital Controversies: Responsefrom Avi J. Cohen <strong>and</strong> G.C. Harcourt. Journal <strong>of</strong> Economic Perspectives, 17(4): 232–3.Cosmides, Leda <strong>and</strong> John Tooby (1994). Better than Rational: Evolutionary Psychology<strong>and</strong> the Invisible H<strong>and</strong>. American Economic Review, Papers <strong>and</strong> Proceed<strong>in</strong>gs, 84: 327–32.George, Henry (1886) [1966]. Protection or Free Trade? An Exam<strong>in</strong>ation <strong>of</strong> the Tariff Question, withEspecial Regard for the Interests <strong>of</strong> Labor. New York: Robert Schalkenbach Foundation.George, Henry (1898) [1932]. The Science <strong>of</strong> Political Economy, new edition. London: TheHenry George Foundation <strong>of</strong> Great Brita<strong>in</strong>.Gigerenzer, G., P.M. Todd <strong>and</strong> the ABC Research Group (1999). Simple Heuristics That MakeUs Smart. New York: Oxford University Press.Greenfield, Robert L. <strong>and</strong> Lel<strong>and</strong> B. <strong>Yeager</strong> (1983). A Laissez Faire Approach to MonetaryStability. Journal <strong>of</strong> <strong>Money</strong> Credit <strong>and</strong> Bank<strong>in</strong>g, 15: 302–15.Greenfield, Robert L., W. William Woolsey <strong>and</strong> Lel<strong>and</strong> B. <strong>Yeager</strong> (1995). Is IndirectConvertibility Impossible? Journal <strong>of</strong> <strong>Money</strong> Credit <strong>and</strong> Bank<strong>in</strong>g, 27: 293–7.Horwitz, Steven (2000). Micr<strong>of</strong>oundations <strong>and</strong> Macroeconomics: An Austrian Perspective. New York:Routledge.Hume, David (1752) [1970]. <strong>Money</strong>. In Eugene Rotwe<strong>in</strong> (ed.) David Hume: Writ<strong>in</strong>gs onEconomics. Madison, WI: The University <strong>of</strong> Wiscons<strong>in</strong> Press.Kauffman, Stuart A. (1993). The Orig<strong>in</strong>s <strong>of</strong> Order: Self-Organization <strong>and</strong> Selection <strong>in</strong> Evolution.Oxford: Oxford University Press.Kauffman, Stuart A. (1994). Whispers from Carnot: The Orig<strong>in</strong>s <strong>of</strong> Order <strong>and</strong> Pr<strong>in</strong>ciples<strong>of</strong> Adaptation <strong>in</strong> Complex Nonequilibrium Systems. In George A. Cowan, DavidP<strong>in</strong>es <strong>and</strong> David Meltzer (eds.) Complexity: Metaphors, Models, <strong>and</strong> Reality. Read<strong>in</strong>g, MA:Addison-Wesley.


A zeal for truth 19Klappholz, K. <strong>and</strong> J. Agassi (1959). Methodological Prescriptions <strong>in</strong> Economics. Economica,new series, 26: 60–74.Koppl, Roger <strong>and</strong> Lel<strong>and</strong> B. <strong>Yeager</strong> (1996). Big Players <strong>and</strong> Herd<strong>in</strong>g <strong>in</strong> Asset <strong>Markets</strong>: TheCase <strong>of</strong> the Russian Ruble. Explorations <strong>in</strong> Economic History, 33: 367–83.McCallum, Bennett T. (2004). Monetary Policy <strong>in</strong> Economies with Little or No <strong>Money</strong>.Pacific Economic Review, 9(2): 81–92.Machlup, Fritz (1956). The Inferiority Complex <strong>of</strong> the Social Science. In Mary Sennholz(ed.) Freedom <strong>and</strong> Free Enterprise. Pr<strong>in</strong>ceton, NJ: Van Nostr<strong>and</strong>. Repr<strong>in</strong>ted <strong>in</strong> Machlup,Fritz (1978). Methodology <strong>in</strong> Economics <strong>and</strong> Other Social Sciences. New York: Academic Press.Menger, C. (1871) [1981]. Pr<strong>in</strong>ciples <strong>of</strong> Economics. Translated by James D<strong>in</strong>gwell <strong>and</strong> Bert F.Hoselitz. New York: New York University Press.Mill, John Stuart (1844) [1983]. On the Influence <strong>of</strong> Consumption on Production. InHazlitt, Henry, The Critics <strong>of</strong> Keynesian Economics. Lanham, MD: University Press.Orig<strong>in</strong>ally published <strong>in</strong> Mill, John Stuart (1844). <strong>Essays</strong> on Some Unsettled Questions <strong>in</strong>Political Economy.Mill, John Stuart (1848) [1965]. Pr<strong>in</strong>ciples <strong>of</strong> Political Economy with Some <strong>of</strong> Their Applications toSocial Philosophy. Toronto: University <strong>of</strong> Toronto Press.Schnadt, Norbert <strong>and</strong> John Whittaker (1993). Inflation-pro<strong>of</strong> Currency? The Feasibility <strong>of</strong>Variable Commodity St<strong>and</strong>ards. Journal <strong>of</strong> <strong>Money</strong>, Credit <strong>and</strong> Bank<strong>in</strong>g, 25(2): 214–21.Smith, Adam (1982). Lectures on Jurisprudence. Indianapolis, IN: Liberty Fund, Inc.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1954a). Free Trade: America’s Opportunity. New York: SchalkenbachFoundation.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1954b). Some Questions About Growth Economics. American EconomicReview, 44: 53–63.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1954c). Some Questions About Growth Economics: A Reply. AmericanEconomic Review, 44: 937.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1954d). The Methodology <strong>of</strong> Henry George <strong>and</strong> Carl Menger. AmericanJournal <strong>of</strong> Economics <strong>and</strong> Sociology, 13: 233–8.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1956). A Cash-Balance Interpretation <strong>of</strong> Depression. Southern EconomicJournal, 22(4): 438–47.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1958a). Some Facts about the Canadian Exchange Rate. Current EconomicComment, 20: 39–54.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1958b). A Rehabilitation <strong>of</strong> Purchas<strong>in</strong>g-Power Parity. Journal <strong>of</strong> PoliticalEconomy, 46: 516–30.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1960). Methodenstreit over Dem<strong>and</strong> Curves. Journal <strong>of</strong> Political Economy, 63:53–64.<strong>Yeager</strong>, Lel<strong>and</strong> B. (ed.) (1962). In Search <strong>of</strong> a Monetary Constitution. Cambridge, MA: HarvardUniversity Press.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1966). International Monetary Relations: Theory, History <strong>and</strong> Policy. New York:Harper & Row (2nd edn, 1976).<strong>Yeager</strong>, Lel<strong>and</strong> B. (1968). The Essential Properties <strong>of</strong> the Medium <strong>of</strong> Exchange. Kyklos, 21:45–68. Repr<strong>in</strong>ted <strong>in</strong> Clower, Robert W. (ed.) (1969). Monetary Theory, Selected Read<strong>in</strong>gs,Baltimore: Pengu<strong>in</strong> Books; <strong>and</strong> Carson, Deane (ed.) (1972). <strong>Money</strong> <strong>and</strong> F<strong>in</strong>ance: Read<strong>in</strong>gs <strong>in</strong>Theory, Policy <strong>and</strong> Institutions, 2nd edn. New York: Wiley.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1969). Fluctuat<strong>in</strong>g Exchange Rates <strong>in</strong> the N<strong>in</strong>eteenth Century: TheExperiences <strong>of</strong> Austria <strong>and</strong> Russia. In R.A. Mundell <strong>and</strong> A.K. Swoboda (eds.) MonetaryProblems <strong>of</strong> the International Economy. Chicago, IL: University <strong>of</strong> Chicago Press.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1976). Toward Underst<strong>and</strong><strong>in</strong>g Some Paradoxes <strong>in</strong> Capital Theory.Economic Inquiry, 14: 313–46.


20 Roger Koppl<strong>Yeager</strong>, Lel<strong>and</strong> B. (1981). Experiences with Stopp<strong>in</strong>g Inflation. Wash<strong>in</strong>gton: American EnterpriseInstitute.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1984). The Image <strong>of</strong> the Gold St<strong>and</strong>ard. In M.D. Bordo <strong>and</strong> A.J.Schwartz (eds.) A Retrospective on the Classical Gold St<strong>and</strong>ard, 1821–1931. Chicago, IL:University <strong>of</strong> Chicago Press.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1995). Tacit Preachments Are the Worst K<strong>in</strong>d. Journal <strong>of</strong> EconomicMethodology, 2: 1–33.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1996). The Significance <strong>of</strong> Monetary Disequilibrium. Cato Journal, 6:369–99.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1997). The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> on Monetary Disequilibrium, edited with an<strong>in</strong>troduction by George Selg<strong>in</strong>. Indianapolis, IN: Liberty Press.<strong>Yeager</strong>, Lel<strong>and</strong> B. (2001a). Henry George <strong>and</strong> Austrian Economics. The American Journal <strong>of</strong>Economics <strong>and</strong> Sociology, 60: 1–24. (This is a repr<strong>in</strong>t from 1984, History <strong>of</strong> Political Economy,16: 157–74.)<strong>Yeager</strong>, Lel<strong>and</strong> B. (2001b). Ethics as Social Science: The Moral Philosophy <strong>of</strong> Social Cooperation.Northampton: Edward Elgar.<strong>Yeager</strong>, Lel<strong>and</strong> B. <strong>and</strong> David G. Tuerck (1966). Trade Policy <strong>and</strong> the Price System. Scranton, PA:International Textbook Co.<strong>Yeager</strong>, Lel<strong>and</strong> B. <strong>and</strong> David G. Tuerck (1976). Foreign Trade <strong>and</strong> U.S. Policy: The Case for FreeInternational Trade. New York: Praeger.


2 The <strong>Yeager</strong> mystiqueA pr<strong>of</strong>ile <strong>of</strong> the scholar as teacher<strong>and</strong> colleagueWilliam Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willett *IntroductionLel<strong>and</strong> B. <strong>Yeager</strong> is a scholar <strong>and</strong> teacher <strong>of</strong> exceptional talent to which is addedthe spice <strong>of</strong> an eccentric personality. These qualities attracted to him manygenerations <strong>of</strong> graduate students at the University <strong>of</strong> Virg<strong>in</strong>ia. His lectures werehighly popular, not only for their discipl<strong>in</strong>ed presentation <strong>and</strong> craftsmanship, butfor the contagious excitement <strong>Yeager</strong> generated by his dedication to his subject. Hehad the ability to make economics seem crucial to the lives <strong>of</strong> his students. <strong>Yeager</strong>also won the admiration <strong>and</strong> respect <strong>of</strong> his colleagues because <strong>of</strong> the thoroughness<strong>of</strong> his research <strong>and</strong> his wide-rang<strong>in</strong>g erudition.Our contribution to this Festschrift is a pr<strong>of</strong>ile, not an essay. Its focus is on Lel<strong>and</strong><strong>Yeager</strong>, the teacher <strong>and</strong> colleague. Its substance is based <strong>in</strong> part on accounts providedby students who took his courses at different periods <strong>of</strong> time at the University<strong>of</strong> Virg<strong>in</strong>ia, but most <strong>of</strong> all from those years when the dist<strong>in</strong>ctive approach thatcame to be called the “Virg<strong>in</strong>ia School” was be<strong>in</strong>g formed. We are <strong>in</strong>debted tothese students, too numerous to acknowledge by name, for their submissions. Thepr<strong>of</strong>ile, <strong>in</strong> addition, is drawn from our own experiences, hav<strong>in</strong>g been privileged tohave been <strong>Yeager</strong>’s colleagues dur<strong>in</strong>g most <strong>of</strong> his years <strong>in</strong> Charlottesville.Many <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong>’s students were requested by us to provide writtendetails <strong>of</strong> remembered experiences. Some would have to search their memories bygo<strong>in</strong>g back over 20 years <strong>in</strong> time. We were aware at the outset that there is adistance between observation <strong>and</strong> expression which could make for unreliablereport<strong>in</strong>g. However, we were reassured by how <strong>of</strong>ten these remembrances werecorroborated <strong>in</strong> almost identical accounts by more than one respondent: paralleltales <strong>of</strong> <strong>Yeager</strong> with only slight variations on a theme. Such reports seemed to us tobe trustworthy.Although some responses were sketchy, taken as a whole they assisted us <strong>in</strong>compos<strong>in</strong>g this thumbnail sketch. A number <strong>of</strong> these accounts have been<strong>in</strong>corporated <strong>in</strong>to the text more or less <strong>in</strong>tact. These remembrances <strong>of</strong> Lel<strong>and</strong><strong>Yeager</strong> <strong>in</strong> his classroom, his <strong>of</strong>fice, <strong>and</strong> at home, allowed us to make immediatewhat time had made remote.In addition to their remembrances, we requested copies <strong>of</strong> lecture notes that<strong>Yeager</strong>’s students might have reta<strong>in</strong>ed <strong>and</strong> which they would be will<strong>in</strong>g to share


22 William Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willettwith us. The number <strong>of</strong> excellent <strong>and</strong> complete sets that were sent to us is <strong>in</strong>dicative<strong>of</strong> the coherency with which <strong>Yeager</strong> presented his classroom lectures <strong>and</strong> thismaterial’s last<strong>in</strong>g value.<strong>Yeager</strong> <strong>in</strong> the classroomWhen students entered a class taught by Lel<strong>and</strong> <strong>Yeager</strong> they encountered a man <strong>of</strong>conservative dress, customarily attired <strong>in</strong> a gray suit. His head was long, narrow,<strong>and</strong> rectangular, topped by s<strong>and</strong>y colored hair that was closely trimmed on allsides, <strong>in</strong>clud<strong>in</strong>g the top. <strong>Yeager</strong> was tall, but not as tall as John Kenneth Galbraith;he was lean, but not as lean as David McCord Wright; his posture was straight,<strong>in</strong>deed he had an almost military bear<strong>in</strong>g; he was <strong>of</strong> serious demeanor <strong>and</strong> had apenetrat<strong>in</strong>g gaze.The evidence suggests that Lel<strong>and</strong> <strong>Yeager</strong> was the best teacher <strong>in</strong> the economicsgraduate program dur<strong>in</strong>g his years at Virg<strong>in</strong>ia. This is true notwithst<strong>and</strong><strong>in</strong>g thepresence <strong>of</strong> other great scholars who had <strong>in</strong>fluence <strong>in</strong> their own way upon students.After all, they could encounter James M. Buchanan, the future Nobel Laureate,whose courses resulted <strong>in</strong> more student publications <strong>in</strong> major journals than those <strong>of</strong>anyone else; there was G. Warren Nutter, the controversial Soviet specialist whoquestioned the exaggerated growth rates <strong>of</strong> communist economies that otherSovietologists had accepted as gospel; Gordon Tullock, who was, with Buchanan,creat<strong>in</strong>g a new field <strong>of</strong> study <strong>in</strong> economics that came to be called Public Choice; <strong>and</strong>Ronald H. Coase, whose work on social cost published while he was at Virg<strong>in</strong>ia waseventually to ga<strong>in</strong> him a Nobel prize. But it seems safe to say that none <strong>of</strong> these leftso <strong>in</strong>delible an impr<strong>in</strong>t upon the consciousness <strong>of</strong> their pupils as did <strong>Yeager</strong>.Much has been written about the elusive qualities that make a great teacher. Inone very important sense, they are the same as those that make a great athlete. Thegreat teacher <strong>and</strong> the great athlete both have natural gifts suited for their respectiveendeavors; a person without this natural talent will never be a truly great teacher,no matter how diligent the attempt.In addition to their endowed prowess, great teachers, like great athletes, practicetheir craft, each th<strong>in</strong>k<strong>in</strong>g hard about how to play the game before their respectiveaudiences. The great teacher frets about prepar<strong>in</strong>g the structure as well as thecontent <strong>of</strong> the material for the next class day; the great athlete frets about how bestto tra<strong>in</strong> <strong>and</strong> practice for the next contest.To describe Lel<strong>and</strong> <strong>Yeager</strong>’s gifts <strong>and</strong> devotion to the classroom, <strong>and</strong> to give asense <strong>of</strong> the excitement he generated <strong>in</strong> that sett<strong>in</strong>g, we can do no better than quotethe words <strong>of</strong> one who was there:He was meticulously prepared for every class <strong>and</strong> his presentation was flawless,beg<strong>in</strong>n<strong>in</strong>g with a well organized historical lead <strong>in</strong>to the topic, a detailed explanation<strong>of</strong> the issues followed by current articles, replies, rejo<strong>in</strong>ders, etc. This stuffwas dynamite. Students quickly realized that <strong>Yeager</strong> had it all <strong>and</strong> anyone withhalf a bra<strong>in</strong> knew that they had a once <strong>in</strong> a lifetime chance to wrap up the wholedamn subject – if they could just get every word he uttered written down. So


The <strong>Yeager</strong> mystique 23students bent their heads to the task, their h<strong>and</strong>s a virtual blur, <strong>and</strong> attempted todo the impossible – literally to get every word on paper.Graduate students <strong>in</strong> economics at Virg<strong>in</strong>ia uniformly cited the impeccableorganization <strong>of</strong> <strong>Yeager</strong>’s lectures. While most economists taught until the end <strong>of</strong>the class period, pick<strong>in</strong>g up next time where the prior lecture left <strong>of</strong>f, <strong>Yeager</strong>’slectures almost always had a beg<strong>in</strong>n<strong>in</strong>g, a middle, <strong>and</strong> a conclusion. Each class wasdesigned to correlate with the syllabus.This precision led to an <strong>in</strong>evitable corollary. Class time could not be wasted.Every moment counted. Therefore promptness <strong>and</strong> punctuality on the part <strong>of</strong> theclass were essential. <strong>Yeager</strong> could be reduced to hostile silence <strong>in</strong> the face <strong>of</strong>discourteous latecomers to his class. He would stare at the <strong>of</strong>fender, with his mouthset <strong>in</strong> a grimace. Several respondents commented on this aspect <strong>of</strong> their <strong>Yeager</strong>experience. One <strong>of</strong> them put it this way: <strong>Yeager</strong> was “so concentrated on what hewas do<strong>in</strong>g that a student walk<strong>in</strong>g <strong>in</strong> late for class could throw him <strong>of</strong>f. I recall thatone student who was perhaps ten m<strong>in</strong>utes late caused <strong>Yeager</strong> to start his lectureaga<strong>in</strong> from the beg<strong>in</strong>n<strong>in</strong>g.”<strong>Yeager</strong>’s read<strong>in</strong>g lists were lengthy; this itself was not unusual <strong>in</strong> graduate school.What was unusual, students soon realized, was that their pr<strong>of</strong>essor had not only readevery entry on the list, he had read each one <strong>of</strong> them exhaustively <strong>and</strong> recently.<strong>Yeager</strong>’s students, most <strong>of</strong> them aspir<strong>in</strong>g academics, understood the <strong>in</strong>centivestructure <strong>of</strong> modern higher education. One asked: “How could anyone justify to hisown career, much less to his dean, the <strong>in</strong>ord<strong>in</strong>ate amount <strong>of</strong> preparation that Mr.<strong>Yeager</strong> was putt<strong>in</strong>g <strong>in</strong>to his classes?”One answer given was that “this irrational – by the world’s current st<strong>and</strong>ards –allocation <strong>of</strong> time was entirely consistent with Mr. <strong>Yeager</strong>’s devotion to scholarlyvalues: honesty, responsibility, diligence, <strong>and</strong> love <strong>of</strong> learn<strong>in</strong>g.”When <strong>Yeager</strong> led his students <strong>in</strong>to a book or article, it was not to dabble. Dur<strong>in</strong>gone period <strong>of</strong> <strong>Yeager</strong>’s time at Virg<strong>in</strong>ia, Don Pat<strong>in</strong>k<strong>in</strong>’s <strong>Money</strong>, Interest, <strong>and</strong> Prices hadbecome a m<strong>in</strong>or classic <strong>in</strong> the field <strong>of</strong> monetary theory. It was a highly formalizedextension <strong>of</strong> the quantity theory <strong>of</strong> money put <strong>in</strong>to a general equilibrium framework.<strong>Yeager</strong> considered the work important <strong>and</strong> decided that students <strong>in</strong> hismoney <strong>and</strong> <strong>in</strong>come classes should be acqua<strong>in</strong>ted with the work. And acqua<strong>in</strong>tedthey became! In the words <strong>of</strong> one veteran, “Upon my arrival at UVA, Pat<strong>in</strong>k<strong>in</strong>’sbook acquired an importance that could only be surpassed by some <strong>of</strong> ThomasJefferson’s greatest achievements. . . . Not only was Pat<strong>in</strong>k<strong>in</strong> required read<strong>in</strong>g butone had to eat, breathe, <strong>in</strong>gest, digest, absorb, memorize, verify, quantify, <strong>in</strong>terpret,question every paragraph, every sentence, every word, every nuance <strong>of</strong> Pat<strong>in</strong>k<strong>in</strong>’sopera magna.” This account is consistent with the story that when Pat<strong>in</strong>k<strong>in</strong>lectured at the University <strong>of</strong> Virg<strong>in</strong>ia, he conceded that <strong>Yeager</strong> knew more about<strong>Money</strong>, Interest, <strong>and</strong> Prices than he did.A great athlete can prosper hav<strong>in</strong>g only natural talent <strong>and</strong> dedicated practice. Agreat teacher must have more than mastery <strong>of</strong> the subject <strong>and</strong> diligence. TheSpanish have a word for it: duende. We are told there is no good English equivalentto this word. Duende is that mysterious quality that endears pupils to a great


24 William Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willettteacher <strong>in</strong> the same way that it endears great performers to their audience. Lel<strong>and</strong><strong>Yeager</strong> had duende.For example, like some show people, <strong>Yeager</strong> <strong>in</strong>st<strong>in</strong>ctively knew how to use aprop. A yardstick was to Lel<strong>and</strong> <strong>Yeager</strong> what a viol<strong>in</strong> was to Jack Benny <strong>and</strong> a cigarwas to Groucho Marx. Nearly every student who responded to our <strong>in</strong>quiry mentionedthe yardstick when describ<strong>in</strong>g <strong>Yeager</strong>’s classroom demeanor.Why this effect?Because <strong>in</strong> Lel<strong>and</strong> <strong>Yeager</strong>’s h<strong>and</strong>s, the yardstick was more than a mere straightedge.It was a tool for perfect<strong>in</strong>g, before class began, elaborate three-dimensionaldiagrams that would be referenced <strong>in</strong> the lectures. The yardstick was the implement<strong>Yeager</strong> used to exp<strong>and</strong> the visual experience <strong>of</strong> the student beyond the blackboard’slimits. It was not unusual for students to come <strong>in</strong>to class early <strong>and</strong> f<strong>in</strong>d himprecariously st<strong>and</strong><strong>in</strong>g on a chair or desk, construct<strong>in</strong>g a diagram that needed morespace than the blackboard permitted. <strong>Yeager</strong> would draw l<strong>in</strong>es <strong>and</strong> quadrants thatwent outside the boundaries <strong>of</strong> the chalkboard itself. One student has described hisimpression <strong>of</strong> this scene:What has kept the image so vividly etched <strong>in</strong> my m<strong>in</strong>d these many years is notmy surprise at see<strong>in</strong>g him so engaged, but rather his nonchalance at be<strong>in</strong>gdiscovered. Unlike other pr<strong>of</strong>essors who sometimes staged such activities foreffect, I am certa<strong>in</strong> that Pr<strong>of</strong>essor <strong>Yeager</strong>’s <strong>in</strong>difference reflected his convictionthat no one would th<strong>in</strong>k his actions unusual. After all, the graph needed to becompleted to scale, did it not?This was not the only way that <strong>Yeager</strong> found his yardstick useful. A characteristic <strong>of</strong><strong>Yeager</strong>’s lectures was his penchant for summariz<strong>in</strong>g the ideas <strong>of</strong> other scholars.This presented a problem for him. Be<strong>in</strong>g scrupulous about attribution, he worriedthat his students might mistakenly give him the credit for the particular position orcontribution <strong>of</strong> another. The yardstick provided the solution.Whenever he was exposit<strong>in</strong>g the position <strong>of</strong> another’s writ<strong>in</strong>gs, he would lift theyardstick over his head; he would lower it when his own ideas were be<strong>in</strong>g presented.While <strong>Yeager</strong>’s students today remember the mental image <strong>of</strong> the raised yardstickwith wry amusement, <strong>and</strong> while they might not have chosen to adopt the technique<strong>in</strong> their own classrooms, the image still serves as a rem<strong>in</strong>der <strong>of</strong> the importance <strong>of</strong>ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g high st<strong>and</strong>ards <strong>of</strong> academic <strong>in</strong>tegrity.One <strong>of</strong> the strik<strong>in</strong>g characteristics <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong> as a teacher <strong>and</strong> scholar wasthat his ideas were developed <strong>in</strong> reaction to the ideas <strong>of</strong> others. Some teachers areknown for an ability to get students to track their <strong>in</strong>structor’s thought processes asthe pr<strong>of</strong>essor attempts to develop orig<strong>in</strong>al approaches to a topic. These students arefortunate to see a creative m<strong>in</strong>d at work before them. But they <strong>of</strong>ten are left bereft<strong>of</strong> any knowledge <strong>of</strong> alternative approaches that exist <strong>in</strong> the literature or thehistorical background aga<strong>in</strong>st which the ideas were first generated. <strong>Yeager</strong> wasknown for his ability to get students to cover every angle <strong>of</strong> a topic, as that topic hadbeen developed with<strong>in</strong> the discipl<strong>in</strong>e. His own assessment was ancillary to thestudents becom<strong>in</strong>g aware <strong>of</strong> what others had done.


The <strong>Yeager</strong> mystique 25<strong>Yeager</strong>’s pedagogical style is reflected <strong>in</strong> <strong>Yeager</strong>’s publications. Two <strong>of</strong> his mostimportant books are Foreign Trade <strong>and</strong> U.S. Policy (coauthored with David G. Tuerck)<strong>and</strong> International Monetary Relations. 1 The first volume is a careful enumeration <strong>of</strong>every protectionist argument made aga<strong>in</strong>st free <strong>in</strong>ternational trade, with theauthors then stack<strong>in</strong>g up aga<strong>in</strong>st each one the free trade alternative. The secondvolume is not a presentation <strong>of</strong> <strong>Yeager</strong>’s theories on <strong>in</strong>ternational monetary relationsbut rather it is an encyclopedic presentation <strong>of</strong> the ideas <strong>of</strong> literally hundreds<strong>of</strong> scholars on the subject, each one carefully presented <strong>and</strong> assessed by <strong>Yeager</strong>. Inthis sense, <strong>Yeager</strong>’s writ<strong>in</strong>gs are mirror images <strong>of</strong> the teach<strong>in</strong>g methods he broughtto the University <strong>of</strong> Virg<strong>in</strong>ia classroom.A certa<strong>in</strong> type <strong>of</strong> graduate student likes a certa<strong>in</strong> type <strong>of</strong> teacher. Those attractedto <strong>Yeager</strong> tended to be more philosophical <strong>and</strong> historically m<strong>in</strong>ded than were thefollowers <strong>of</strong> Buchanan <strong>and</strong> Tullock, for example, who tended to be more creative<strong>and</strong> entrepreneurial. In follow<strong>in</strong>g <strong>in</strong> their mentor’s footsteps, <strong>Yeager</strong>’s studentstended to gravitate toward careers <strong>in</strong> which teach<strong>in</strong>g was valued as much asresearch.<strong>Yeager</strong> outside the classroomContribut<strong>in</strong>g to Lel<strong>and</strong> <strong>Yeager</strong>’s mystique as a teacher was his persona outside theclassroom. People got the impression that he was a habitual loner, armored aga<strong>in</strong>stattempts to <strong>in</strong>vade his privacy. But what they did not realize was the number <strong>of</strong>activities <strong>in</strong> which <strong>Yeager</strong> had engaged himself at the highest level <strong>of</strong> achievement.This made the opportunity cost <strong>of</strong> small talk – even lunch – very high, <strong>in</strong> his decisioncalculus.<strong>Yeager</strong>’s consum<strong>in</strong>g devotion to his research, teach<strong>in</strong>g, <strong>and</strong> avocational <strong>in</strong>terestsprovided very little time for casual conversation. This helps expla<strong>in</strong> the periodicalo<strong>of</strong>ness <strong>in</strong> his relationships with his students <strong>and</strong> his colleagues: for <strong>in</strong>dividuals <strong>in</strong>both categories encountered <strong>Yeager</strong> on the same terms. He made no dist<strong>in</strong>ctionbased on departmental hierarchy. Students <strong>and</strong> colleagues alike encountered theses<strong>in</strong>gularities.A deeply perceptive student <strong>of</strong> <strong>Yeager</strong>’s provided a rationale for his reputedshyness <strong>and</strong> distance: “How could anyone have enough time to write a scholarlyarticle or two every year; publish a book every four or five years; meticulouslyprepare for a full course load <strong>of</strong> classes; religiously meet his <strong>of</strong>fice hours; supervisea disproportionate share <strong>of</strong> dissertations; advise students; vigorously pursue hishobby <strong>of</strong> learn<strong>in</strong>g languages; enjoy f<strong>in</strong>e w<strong>in</strong>es; <strong>and</strong> [then also be expected to]engage <strong>in</strong> a lot <strong>of</strong> idle chatter?”This helps expla<strong>in</strong> why a visit to <strong>Yeager</strong> <strong>in</strong> his <strong>of</strong>fice could be a disquiet<strong>in</strong>gexperience. There was no chit-chat, at least from <strong>Yeager</strong>. A student who wasunaware <strong>of</strong> this, or a colleague who, out <strong>of</strong> habit, began a conversation withoutgett<strong>in</strong>g to the po<strong>in</strong>t, was met by what students ruefully called “the stare.” The starewas <strong>Yeager</strong>’s way <strong>of</strong> avoid<strong>in</strong>g small talk: by not reciprocat<strong>in</strong>g. Unfortunately, histactic <strong>of</strong>ten caused the opposite effect. To get a response, one might try even harderto f<strong>in</strong>d a conversational entry po<strong>in</strong>t <strong>and</strong> end up digress<strong>in</strong>g even more from the


26 William Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willettbus<strong>in</strong>ess that had brought the visitor to <strong>Yeager</strong>’s <strong>of</strong>fice <strong>in</strong> the first place. Thefollow<strong>in</strong>g rem<strong>in</strong>iscence is so descriptive <strong>of</strong> the experience that it is worth quot<strong>in</strong>g<strong>in</strong> full:From the moment you entered his <strong>of</strong>fice you knew you were <strong>in</strong> trouble. Yoursimple question like “Will you be <strong>of</strong>fer<strong>in</strong>g International Trade <strong>in</strong> the fall?” wasmet by this stunned look <strong>of</strong> disbelief <strong>and</strong> a penetrat<strong>in</strong>g look straight <strong>in</strong>to youreyes. Pr<strong>of</strong>. <strong>Yeager</strong> said noth<strong>in</strong>g – just “the stare.” To fill this aural void, youbegan to elaborate on why you wanted to take International Trade <strong>and</strong> how itwould advance your progress through the program. This too was met by just“the stare.” The student, now quite <strong>of</strong>f guard, <strong>and</strong> desperately search<strong>in</strong>g for anyjustification for his or her presence, began to babble on about the wonders <strong>of</strong><strong>in</strong>ternational trade <strong>and</strong> how it has improved the lives <strong>of</strong> millions <strong>of</strong> peoplethroughout history. The now perspir<strong>in</strong>g student then began to relate <strong>in</strong>timatedetails about their personal lives (anyth<strong>in</strong>g to stop “the stare”) – how they oncewere a bed wetter or that they had unresolved guilt from childhood aboutstick<strong>in</strong>g p<strong>in</strong>s <strong>in</strong>to butterflies. F<strong>in</strong>ally, realiz<strong>in</strong>g the student was on the verge <strong>of</strong>some k<strong>in</strong>d <strong>of</strong> psychotic break, Pr<strong>of</strong>. <strong>Yeager</strong> would slowly reach across his desk<strong>and</strong> h<strong>and</strong> you a piece <strong>of</strong> paper conta<strong>in</strong><strong>in</strong>g the fall term schedule. Totallydevastated, the student would stumble out <strong>of</strong> the <strong>of</strong>fice – realiz<strong>in</strong>g they had justmade a total fool <strong>of</strong> themselves <strong>in</strong> front <strong>of</strong> the world’s greatest psychoanalyst.This experience was not unusual. Students <strong>and</strong> colleagues alike shared <strong>in</strong> thistype <strong>of</strong> encounter with <strong>Yeager</strong>. One student who was beg<strong>in</strong>n<strong>in</strong>g his doctoral workat Virg<strong>in</strong>ia when <strong>Yeager</strong> was the Director <strong>of</strong> Graduate Studies related this account<strong>of</strong> go<strong>in</strong>g to <strong>Yeager</strong>’s <strong>of</strong>fice for the first time:I came <strong>in</strong> <strong>and</strong> made a few cheery remarks expect<strong>in</strong>g him to pick up the ball <strong>and</strong>tell me all about everyth<strong>in</strong>g <strong>in</strong> the department. He said little or noth<strong>in</strong>g. I thencont<strong>in</strong>ued to fill <strong>in</strong> the blanks. For fifteen m<strong>in</strong>utes, I babbled like a fool. Heknew more about me <strong>in</strong> those fifteen m<strong>in</strong>utes than I had probably revealed tomy wife!But if <strong>Yeager</strong> was a psychoanalyst, he was a peculiar one <strong>in</strong> that his note-tak<strong>in</strong>gwas not with pad <strong>and</strong> pencil or tape recorder. His record<strong>in</strong>g device <strong>of</strong> choice wasthe typewriter. The student who needed a letter <strong>of</strong> recommendation found himselfundergo<strong>in</strong>g a <strong>Yeager</strong>-style non-directive <strong>in</strong>terview. Here is how one described it:I sat <strong>in</strong> a chair across from his desk. He turned away from me toward the typewriteron his right side, typed a few words, <strong>and</strong> then asked me to tell him aboutmyself. As I talked, he typed, neither say<strong>in</strong>g a word nor show<strong>in</strong>g expression. Idiscussed my <strong>in</strong>terest <strong>in</strong> economics, courses I had taken, <strong>and</strong> my dissertationresearch. I then mentioned that I had teach<strong>in</strong>g experience <strong>and</strong> that it was someth<strong>in</strong>gI particularly enjoyed. Cont<strong>in</strong>u<strong>in</strong>g to look at the typewriter, he asked if Ihad any notable skills or <strong>in</strong>novations that I brought to the classroom. Hav<strong>in</strong>g


The <strong>Yeager</strong> mystique 27none, but not wish<strong>in</strong>g to disappo<strong>in</strong>t, I declared that I specialized <strong>in</strong> talk<strong>in</strong>geconomics majors out <strong>of</strong> go<strong>in</strong>g to law school. Mr. <strong>Yeager</strong> lifted his h<strong>and</strong>s <strong>of</strong>f thetypewriter, turned his head <strong>and</strong> body toward me, leaned across the desk, <strong>and</strong>declared <strong>in</strong> a firm voice, “AND JUST HOW DO YOU DO THAT?” Ratherstartled, I quickly admitted that I had said it <strong>in</strong> jest <strong>and</strong> that I had no such skill.He appeared keenly disappo<strong>in</strong>ted.<strong>Yeager</strong>’s silences dur<strong>in</strong>g visits to his <strong>of</strong>fice did not preclude the accomplishment<strong>of</strong> important departmental bus<strong>in</strong>ess. For example, hav<strong>in</strong>g difficulty complet<strong>in</strong>g arequired term paper, a graduate student paid a visit to <strong>Yeager</strong>’s <strong>of</strong>fice to request an<strong>in</strong>complete <strong>in</strong> the course. What ensued illustrates that while <strong>Yeager</strong> was not atalker, he was an attentive listener.He did not say a word. After a long moment <strong>of</strong> silence, I stated that I had donemost <strong>of</strong> the work on the paper, <strong>and</strong> could complete it with<strong>in</strong> two weeks <strong>of</strong> theend <strong>of</strong> the semester. Another long period <strong>of</strong> silence. I then reiterated that I hadreally done a lot <strong>of</strong> work on the paper <strong>and</strong> would be will<strong>in</strong>g to make an oralpresentation <strong>in</strong> class. Another moment <strong>of</strong> silence. But this time, Mr. <strong>Yeager</strong>turned toward his typewriter, typed for about a m<strong>in</strong>ute, pulled out the paper,<strong>and</strong> h<strong>and</strong>ed it to me. It was a short contract, stat<strong>in</strong>g that I agreed to make apresentation <strong>of</strong> my paper <strong>in</strong> class <strong>and</strong> h<strong>and</strong> <strong>in</strong> my f<strong>in</strong>al paper by the first week <strong>in</strong>January. His first <strong>and</strong> f<strong>in</strong>al words were to ask me if I would sign the paper.I did.It would be mislead<strong>in</strong>g to leave the impression that <strong>Yeager</strong> was <strong>in</strong>flexible <strong>in</strong> hisuse <strong>of</strong> the non-directive <strong>in</strong>terview. If the situation called for it, he could be a goodquestioner as well as a careful listener. These occasions were more likely to occurwith foreign students about whose prior tra<strong>in</strong><strong>in</strong>g <strong>Yeager</strong>, as Director <strong>of</strong> GraduateStudies, needed clarification. Such students found him a thoughtful <strong>in</strong>terrogator.But even here, there was no room for small talk. One new graduate student, freshlyarrived from India, remembers:As I entered the room, he gave me a thorough look, as if try<strong>in</strong>g to read my m<strong>in</strong>d.He <strong>in</strong>quired about my work at the University <strong>of</strong> Delhi, courses I took there,books I read <strong>and</strong> pr<strong>of</strong>essors with whom I studied. I noticed that he took notes <strong>of</strong>what I said. As I left his room after gett<strong>in</strong>g my course assignment, I realized thatthis man did not like to make small talk. He did not ask, “how was your trip” or“how did you like Charlottesville,” etc., as most people asked dur<strong>in</strong>g my firstcouple <strong>of</strong> days <strong>in</strong> this country. That, however, suited me well, s<strong>in</strong>ce I came froma tradition where the student–teacher relationship is more formal.The admiration students at Virg<strong>in</strong>ia have for Lel<strong>and</strong> <strong>Yeager</strong> also is the sum <strong>of</strong>many <strong>in</strong>dividual experiences where <strong>Yeager</strong>’s generosity <strong>and</strong> concern were manifested<strong>in</strong> special ways. <strong>Yeager</strong> could spot a student carry<strong>in</strong>g a book, notice the title,<strong>and</strong> <strong>in</strong>vite the student to his <strong>of</strong>fice to discuss the book’s contents. More than one


28 William Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willettstudent expressed their surprise, after serv<strong>in</strong>g as <strong>Yeager</strong>’s research assistant on abook manuscript, to see their name listed on the published book’s cover.The most notable characteristic <strong>of</strong> <strong>Yeager</strong>’s teach<strong>in</strong>g duties outside the classroomwas his generous participation on dissertation committees, even those he did notdirect. That <strong>Yeager</strong> would give such careful attention to early drafts <strong>of</strong> a dissertation,<strong>in</strong> his role as even third reader, <strong>in</strong>duced graduate students to seek him out for theircommittees. One student relates the w<strong>in</strong>dfall he encountered from <strong>Yeager</strong> be<strong>in</strong>ghis third reader. Hav<strong>in</strong>g completed a few chapters <strong>of</strong> his thesis, he sent them to hisfirst reader, Pr<strong>of</strong>essor Gordon Tullock. Three weeks later he received a packageconta<strong>in</strong><strong>in</strong>g his first two chapters, but there was not a word from Tullock <strong>and</strong>noth<strong>in</strong>g from the second reader. The student recounted:But attached to the first chapter were four yellow pages <strong>of</strong> s<strong>in</strong>gle-spaced, typewrittennotes that extended from edge to edge, <strong>and</strong> covered both the front <strong>and</strong>back <strong>of</strong> each page. What these notes conta<strong>in</strong>ed was a detailed l<strong>in</strong>e-by-l<strong>in</strong>e roadmap <strong>of</strong> how to fix my obvious pitiful mess – with specific references to articles toread, possible journals to consult, <strong>and</strong> useful <strong>in</strong>sights <strong>of</strong> how all <strong>of</strong> my stuffrelated to the “big picture.” Egad, I thought, all <strong>of</strong> this from just the third reader!Nevertheless, I set about mak<strong>in</strong>g all the necessary repairs suggested by <strong>Yeager</strong><strong>and</strong> over the months this whole process was repeated several times. SometimesI th<strong>in</strong>k <strong>Yeager</strong> would send me almost as much as I sent him. Still not a wordfrom Tullock or the second reader – <strong>and</strong> who could blame them with <strong>Yeager</strong> onthe job.<strong>Yeager</strong>’s largesse to students <strong>in</strong> the publish<strong>in</strong>g realm was not limited to his researchassistants <strong>and</strong> his doctoral students. Sometimes he would <strong>in</strong>vite students to hisresidence <strong>in</strong> Charlottesville for a weekend where he provided excellent cuis<strong>in</strong>e <strong>and</strong>w<strong>in</strong>e. A conversation with him on occasions like this could sometimes lead to apublishable manuscript. A fasc<strong>in</strong>at<strong>in</strong>g <strong>in</strong>stance is provided by one such lucky houseguest:I happened to ask him some questions on a topic <strong>in</strong> monetary theory. Well,Lel<strong>and</strong> immediately brought out his tape recorder, <strong>and</strong> for the next severalhours I proceeded to ask him questions, which we then discussed fully. Every fewm<strong>in</strong>utes he would summarize the discussion on his tape recorder. Very early thenext morn<strong>in</strong>g I could hear Lel<strong>and</strong> typ<strong>in</strong>g away at his typewriter. When I got up,he presented me with 23 pages <strong>of</strong> transcript – he had typed up all that we hadrecorded the night before. We eventually converted that transcript <strong>in</strong>to anarticle which was published by a major journal. I don’t th<strong>in</strong>k I will ever be ableto duplicate the excitement I felt dur<strong>in</strong>g that discussion with Lel<strong>and</strong> <strong>in</strong>to the weehours <strong>of</strong> the night!Lel<strong>and</strong> <strong>Yeager</strong> was a very different personality at his home than at the University<strong>of</strong> Virg<strong>in</strong>ia. On the grounds he appeared always serious, reserved, <strong>and</strong> diffident. Athome, he was an attentive host, thoughtful <strong>and</strong> warm. This change <strong>in</strong> external


The <strong>Yeager</strong> mystique 29demeanor could surprise those who were recipients <strong>of</strong> this hospitality. It extendednot only to faculty <strong>and</strong> students, but to their spouses <strong>and</strong> children as well. Whenformer students <strong>and</strong> their families were known to be pass<strong>in</strong>g through Charlottesville,<strong>Yeager</strong> <strong>of</strong>fered the use <strong>of</strong> his home for overnight accommodation. A superb d<strong>in</strong>ner,lubricated with w<strong>in</strong>e <strong>and</strong> champagne from his well-stocked cellar, was provided.Anyone able to discern Lel<strong>and</strong> <strong>Yeager</strong>’s utility function would know that w<strong>in</strong>ewould accompany any festive meal at his home. He was a connoisseur whodelighted <strong>in</strong> w<strong>in</strong>e-tast<strong>in</strong>g parties <strong>and</strong> who seemed always ready to accept thechallenge <strong>of</strong> identify<strong>in</strong>g the output <strong>of</strong> even an obscure v<strong>in</strong>tner. When he hostedsuch occasions, the d<strong>in</strong><strong>in</strong>g room table would be laden with w<strong>in</strong>e bottles wrapped <strong>in</strong>foil so as to hide the labels. Platters <strong>of</strong> cheese <strong>and</strong> crackers were <strong>in</strong>terspersed amongthe potables. Their purpose was to clear the palate between tast<strong>in</strong>gs <strong>of</strong> the w<strong>in</strong>e.Participants were asked to write their comments on slips <strong>of</strong> paper provided by theirhost, to rank <strong>in</strong> descend<strong>in</strong>g order <strong>of</strong> quality the various selections, to commentabout the w<strong>in</strong>e’s taste, <strong>and</strong> to identify the country <strong>of</strong> orig<strong>in</strong>, <strong>and</strong>, if possible, theregion where the w<strong>in</strong>ery was located.With<strong>in</strong> the Department <strong>of</strong> Economics, <strong>Yeager</strong>’s skill at mak<strong>in</strong>g this identificationwas legendary. New faculty, <strong>in</strong>formed <strong>of</strong> <strong>Yeager</strong>’s prowess <strong>in</strong> this regard, tended toth<strong>in</strong>k the story was exaggerated. A visit<strong>in</strong>g pr<strong>of</strong>essor from Oxford, whose expertisehad placed him <strong>in</strong> charge <strong>of</strong> w<strong>in</strong>e purchases for his college, was skeptical <strong>of</strong> the talescirculat<strong>in</strong>g <strong>in</strong> the department. He decided to test <strong>Yeager</strong>’s mettle. A w<strong>in</strong>e tast<strong>in</strong>gwas arranged to which the visitor, an Australian by birth, contributed a w<strong>in</strong>e herecently had acquired on a visit home that took him through New Zeal<strong>and</strong>: acountry not generally known for its w<strong>in</strong>e production. All but <strong>Yeager</strong> had been<strong>in</strong>formed <strong>of</strong> the ploy.The assemblage watched <strong>in</strong>tently as <strong>Yeager</strong> poured a sample from this particularbottle. He sipped from the glass, tasted the liquid <strong>and</strong> swallowed a small amount.Then he took another sip. He seemed puzzled at first. Tak<strong>in</strong>g longer than normalto make his written entry, he went on to the rema<strong>in</strong><strong>in</strong>g samples.Later <strong>in</strong> the even<strong>in</strong>g, as guests were reveal<strong>in</strong>g their written evaluations <strong>and</strong> theirguesses as to the various w<strong>in</strong>es’ orig<strong>in</strong>s, it became <strong>Yeager</strong>’s turn. When he came tothis entry, he said, “Well, this is just a guess. I can’t be sure about it. I haveelim<strong>in</strong>ated Europe <strong>and</strong> South Africa. The taste does seem a bit familiar. So I’d say,probably, New Zeal<strong>and</strong>.” The applause that followed astonished <strong>Yeager</strong>. He alsoseemed pleased.Just as knowledge <strong>of</strong> w<strong>in</strong>e was part <strong>of</strong> the <strong>Yeager</strong> mystique at Virg<strong>in</strong>ia, so was hisaversion to the telephone. Colleagues <strong>and</strong> students both soon learned <strong>of</strong> this trait.He could be called at home, but only through a prearranged appo<strong>in</strong>tment – whichserved to elim<strong>in</strong>ate most phone conversations. In his <strong>of</strong>fice, he was known to put thetelephone <strong>in</strong> his desk drawer, to muffle its r<strong>in</strong>g. At home, cushions <strong>and</strong> pillowswould be piled upon the nuisance so that one could hear only the fa<strong>in</strong>test buzz.At one po<strong>in</strong>t <strong>in</strong> his Charlottesville days, <strong>Yeager</strong> was domiciled <strong>in</strong> a small house.When the service representative came to <strong>in</strong>stall the telephone, <strong>Yeager</strong> requestedthat the <strong>in</strong>strument have no bell. But he was <strong>in</strong>formed that regulations requiredeach phone to have a bell. Moreover, at that time, customers were not allowed to


30 William Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willetttamper with the equipment; these were still the days when the telephone companyowned everyth<strong>in</strong>g they placed <strong>in</strong> a customer’s home <strong>and</strong> the telephone had nomut<strong>in</strong>g device.<strong>Yeager</strong>, never one to break rules, had a solution. He <strong>in</strong>quired as to whetheranyth<strong>in</strong>g was stipulated regard<strong>in</strong>g where the bell had to be located. The servicerepresentative <strong>in</strong>formed him there were no such rules. <strong>Yeager</strong> directed that the bellfor his phone should be attached to the utility pole outside his house. Everyonecall<strong>in</strong>g <strong>Yeager</strong>’s residence thereafter provided an externality to any birds perchedon the telephone l<strong>in</strong>es nearby.We would be remiss if we failed to mention <strong>Yeager</strong>’s contributions to his departmentwhen he served as chairman from 1969 to 1972. As we have seen, <strong>Yeager</strong>seemed able to br<strong>in</strong>g <strong>of</strong>f the unexpected. Some thought his shyness, his aversion to<strong>in</strong>terruptions, <strong>and</strong> his disda<strong>in</strong> for busywork would render him unsuccessful for therole <strong>of</strong> adm<strong>in</strong>istrator. Here they would be wrong. His <strong>in</strong>itial term as chairman wasso much appreciated by his colleagues that he was asked to cont<strong>in</strong>ue.What made him so popular was the unobtrusiveness with which he went aboutthese duties. He applied the golden rule to chair<strong>in</strong>g a department: treat<strong>in</strong>g his colleaguesas he would have wanted to be treated. This meant that few questionnairesfrom higher levels <strong>of</strong> the adm<strong>in</strong>istration came their way, <strong>Yeager</strong> hav<strong>in</strong>g disposed <strong>of</strong>them himself. It meant a m<strong>in</strong>imum <strong>of</strong> departmental meet<strong>in</strong>gs or notices requir<strong>in</strong>g aresponse. In short, <strong>Yeager</strong> smoothed the way for his colleagues to get their work done.<strong>Yeager</strong> as polymath l<strong>in</strong>guistLel<strong>and</strong> <strong>Yeager</strong> was omnil<strong>in</strong>gual. But he rarely spoke <strong>of</strong> his skills <strong>in</strong> foreignlanguages. Indeed, he took it for granted that everyone <strong>in</strong> the academy would beversatile <strong>in</strong> <strong>and</strong> knowledgeable about other tongues. His colleagues <strong>and</strong> studentslearned about <strong>Yeager</strong>’s remarkable achievements <strong>in</strong> this area not because <strong>Yeager</strong>volunteered such <strong>in</strong>formation or through displays <strong>of</strong> one-upmanship. For somecolleagues, the revelation came through a visit to <strong>Yeager</strong>’s home, where a casualbrowse through his bookcases revealed volumes pr<strong>in</strong>ted <strong>in</strong> an astonish<strong>in</strong>g array <strong>of</strong>languages. For students, the news came through the University’s grapev<strong>in</strong>e ordirectly through an encounter with him.Foreign languages were much more a subject <strong>of</strong> <strong>in</strong>terest <strong>in</strong> an economics programdur<strong>in</strong>g <strong>Yeager</strong>’s years at the University <strong>of</strong> Virg<strong>in</strong>ia than they would be today.At one time, a read<strong>in</strong>g knowledge <strong>of</strong> two foreign languages was required forcompletion <strong>of</strong> the doctorate. Later this requirement was relaxed to only one.Today, none would be required.<strong>Yeager</strong> would have found any language requirement an easy hurdle. Dur<strong>in</strong>g histime on the Virg<strong>in</strong>ia faculty, he was reputed to know more languages than anyoneelse. The precise number is difficult to verify. However, the <strong>of</strong>ficials who adm<strong>in</strong>isteredthe exams relied upon <strong>Yeager</strong>’s skills <strong>in</strong> those l<strong>in</strong>guistic areas where no one<strong>in</strong> the various language departments felt fluent.Those students who found themselves be<strong>in</strong>g exam<strong>in</strong>ed by <strong>Yeager</strong> soon realizedthat this economics pr<strong>of</strong>essor was no c<strong>in</strong>ch. On one occasion a foreign student


The <strong>Yeager</strong> mystique 31wanted to count his native language towards the PhD requirement. <strong>Yeager</strong> knewthe language <strong>and</strong> was asked to adm<strong>in</strong>ister the test. The student failed. It seems that<strong>Yeager</strong> had exam<strong>in</strong>ed him <strong>in</strong> the more formal dialect <strong>of</strong> the language, the version<strong>in</strong> which scholarly research appeared. Unfortunately, the c<strong>and</strong>idate’s knowledgewas limited to a prov<strong>in</strong>cial dialect.Another doctoral student, who was president <strong>of</strong> the Graduate Economics Club,was work<strong>in</strong>g with <strong>Yeager</strong> (<strong>in</strong> <strong>Yeager</strong>’s capacity as Director <strong>of</strong> Graduate Studies) tobr<strong>in</strong>g Maurice Allais to the University <strong>of</strong> Virg<strong>in</strong>ia for a colloquium. <strong>Yeager</strong> passedon all the correspondence between himself <strong>and</strong> Allais to the club’s president for aresponse. The correspondence was <strong>in</strong> French.Nonplussed by what he considered <strong>Yeager</strong>’s challenge to him, the club’s presidentdecided to retaliate. With the aid <strong>of</strong> a graduate student <strong>in</strong> another department,he responded to <strong>Yeager</strong> with a letter written <strong>in</strong> Sanskrit. <strong>Yeager</strong> was oblivious tothe ruse. In Sanskrit, he <strong>in</strong>nocently replied with enthusiasm, say<strong>in</strong>g how pleased hewas that the club’s president knew this language.Just as remarkable as the portfolio <strong>of</strong> languages <strong>Yeager</strong> knew was his ear forspeak<strong>in</strong>g them. One graduate student, from France, was asked by <strong>Yeager</strong> if hewould, for a stipend, converse with him <strong>in</strong> French once a week. The student reportson his first session with <strong>Yeager</strong>:We spoke <strong>and</strong> he told me <strong>in</strong> French, us<strong>in</strong>g the right vocabulary <strong>and</strong> the rightgrammar, how he had learnt it with cassettes while driv<strong>in</strong>g his car. I was amazedthat he had never been <strong>in</strong> France because he could speak, rather slowly, butcorrectly, mak<strong>in</strong>g almost no gender mistake (which is exceptional for Englishspeak<strong>in</strong>gpeople) <strong>and</strong> with very little accent. This was the evidence <strong>of</strong> histremendous will <strong>and</strong> strength. How many people have really learnt a languageby themselves? Certa<strong>in</strong>ly very few but he was one <strong>of</strong> them.Another student, at work <strong>in</strong> Norway on a doctoral dissertation <strong>in</strong> comparativeeconomic systems, was correspond<strong>in</strong>g with <strong>Yeager</strong> about his research f<strong>in</strong>d<strong>in</strong>gs.In reply to one <strong>of</strong> his letters, as an aside, <strong>Yeager</strong> requested the student to purchasefor him the works <strong>of</strong> a Norwegian author <strong>in</strong> Norwegian. If you guessed it wasRagnar Frisch, you would be wrong. What the omnil<strong>in</strong>gual pr<strong>of</strong>essor wanted was acomplete set <strong>of</strong> Henrik Ibsen’s works.The question arises, why did Lel<strong>and</strong> <strong>Yeager</strong> spend so much <strong>of</strong> his time learn<strong>in</strong>glanguages? Most <strong>of</strong> us who feel the desire to go through the arduous process <strong>of</strong>becom<strong>in</strong>g bil<strong>in</strong>gual do so for pragmatic reasons: to meet an academic requirement,to prepare for a visit to a foreign country, to be able to read some body <strong>of</strong> literature<strong>in</strong> the orig<strong>in</strong>al language. But these reasons do not expla<strong>in</strong> <strong>Yeager</strong>’s never end<strong>in</strong>gl<strong>in</strong>guistic quest. Even as a youngster, <strong>Yeager</strong> was deeply immersed <strong>in</strong> work<strong>in</strong>g withforeign words. Dur<strong>in</strong>g World War II, when he was only 19, <strong>Yeager</strong> was a Japanesecryptanalytic translator for the US Army; <strong>in</strong> other words, he was a code breaker.But this does not expla<strong>in</strong> his zeal for exp<strong>and</strong><strong>in</strong>g his language horizons.The quantity <strong>of</strong> languages, the variety <strong>of</strong> languages, <strong>and</strong> the degree with whichhe mastered them suggests other motives. For not only did <strong>Yeager</strong> equip himself


32 William Breit, Kenneth Elz<strong>in</strong>ga, <strong>and</strong> Thomas D. Willettwith knowledge <strong>of</strong> the major languages <strong>of</strong> Europe, spoken <strong>in</strong> places that he mightexpect to visit, but he also devoured more exotic tongues. Even this was not enoughto satisfy him. At some po<strong>in</strong>t he turned his attention to languages native to nocountry. We are not here referr<strong>in</strong>g to dead languages such as Lat<strong>in</strong> but artificiallanguages, languages created for the purpose <strong>of</strong> supplant<strong>in</strong>g native tongues. Two <strong>of</strong>the most prom<strong>in</strong>ent <strong>of</strong> these are Esperanto <strong>and</strong> Interl<strong>in</strong>gua. <strong>Yeager</strong> made himselfan expert <strong>in</strong> both <strong>of</strong> these, even ris<strong>in</strong>g to the position <strong>of</strong> President <strong>of</strong> the Interl<strong>in</strong>guaInstitute.<strong>Yeager</strong>’s lust for languages is uncomplicated. Languages <strong>and</strong> l<strong>in</strong>guistics appealto him for the same reason that the market economy appeals to him. Just as theexistence <strong>of</strong> markets br<strong>in</strong>gs order to the allocation <strong>of</strong> resources, knowledge <strong>of</strong>language can br<strong>in</strong>g order to <strong>in</strong>terpersonal communication. 2 Esperanto <strong>and</strong> Interl<strong>in</strong>guawere languages <strong>in</strong>vented <strong>in</strong> the hopes <strong>of</strong> br<strong>in</strong>g<strong>in</strong>g a worldwide efficiency topeaceful discourse among diverse groups. This is not far afield from what <strong>Yeager</strong>would have hoped for through a social regime <strong>of</strong> free <strong>in</strong>ternational trade.<strong>Yeager</strong>: four decades <strong>in</strong> the v<strong>in</strong>eyardsThe portrait <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong> that emerges from the forgo<strong>in</strong>g pages displays an<strong>in</strong>dividual rich <strong>in</strong> accomplishment, unique <strong>in</strong> personality, <strong>and</strong> extraord<strong>in</strong>ary <strong>in</strong> hisfacility with words. To his students, he was a rare, exotic father-figure, eccentric butfull <strong>of</strong> care <strong>and</strong> nurture. In the entrepreneurial academy <strong>of</strong> today, it is hard toimag<strong>in</strong>e another Lel<strong>and</strong> <strong>Yeager</strong> com<strong>in</strong>g on the scene.Economists today <strong>in</strong>creas<strong>in</strong>gly work <strong>in</strong> collaborative endeavors; graduate education<strong>in</strong> economics <strong>in</strong>creas<strong>in</strong>gly is done through specialized workshops; researchresults are sent around prelim<strong>in</strong>arily <strong>in</strong> work<strong>in</strong>g paper form; <strong>and</strong> it is important toan economist’s career to be engaged <strong>in</strong> network<strong>in</strong>g: giv<strong>in</strong>g papers at the workshops<strong>of</strong> other <strong>in</strong>stitutions <strong>and</strong> at specialized conferences. <strong>Yeager</strong> is too much the loner tobe comfortable <strong>in</strong> such a milieu; <strong>and</strong> he would not expose his ideas until they were,<strong>in</strong> his judgment, <strong>in</strong> f<strong>in</strong>al form. Strategic network<strong>in</strong>g would be a foreign concept tohim. In short, he is an <strong>in</strong>dividualist.All <strong>of</strong> which br<strong>in</strong>gs us to his flirtation with Ayn R<strong>and</strong>’s Objectivism. It is unlikelythat any scholar <strong>of</strong> comparable reputation <strong>and</strong> accomplishment has devoted asmuch attention to this philosophical system usually placed <strong>in</strong> the extremist category.However, <strong>Yeager</strong> the <strong>in</strong>dividualist found much <strong>in</strong> Ayn R<strong>and</strong> that appealed.He referred to himself not as a disciple but as a fellow traveler. It is clear that hewas deeply <strong>in</strong>terested <strong>in</strong> her writ<strong>in</strong>gs. One student, whom <strong>Yeager</strong> knew to be anadherent to R<strong>and</strong>’s ideas, told <strong>of</strong> be<strong>in</strong>g approached by <strong>Yeager</strong> at a departmentalpicnic when other students <strong>and</strong> faculty were play<strong>in</strong>g s<strong>of</strong>tball. <strong>Yeager</strong> sat downbeside him <strong>and</strong> said, “Ridpath, expla<strong>in</strong> to me the objectivist position on free will.”After a brief talk, <strong>Yeager</strong> strolled <strong>of</strong>f, the student surmis<strong>in</strong>g that <strong>Yeager</strong> had accomplishedhis purpose.In his Southern Economic Association presidential address, <strong>Yeager</strong> refers toR<strong>and</strong> as a writer “whom I respect.” But the homage he paid to her was <strong>in</strong>spired <strong>in</strong>part by the rationale she provided for act<strong>in</strong>g with simple decency. 3


The <strong>Yeager</strong> mystique 33The common idea that R<strong>and</strong> espoused a narrow view <strong>of</strong> the virtue <strong>of</strong> selfishnesswas, <strong>in</strong> <strong>Yeager</strong>’s judgment, superficial. To <strong>Yeager</strong>, R<strong>and</strong> provided a rationale forthe development <strong>of</strong> personal st<strong>and</strong>ards that lead one to behave <strong>in</strong> a highly ethicalmanner, subord<strong>in</strong>at<strong>in</strong>g narrow <strong>in</strong>terests to one’s more endur<strong>in</strong>g <strong>in</strong>terests. For sheshowed that <strong>in</strong> the long run one’s ethical behavior was conducive to one’s ownhapp<strong>in</strong>ess. <strong>Yeager</strong> liked the argument that adopt<strong>in</strong>g as the behavioral rule “alwaysact <strong>in</strong> a decent manner” would improve one’s chances <strong>of</strong> happ<strong>in</strong>ess. This made self<strong>in</strong>terest consistent with the high moral st<strong>and</strong>ards his students <strong>and</strong> colleaguesassociated with him.Thomas Robert Malthus considered life as a game <strong>of</strong> chance. If Malthus iscorrect, it is clear that Lel<strong>and</strong> <strong>Yeager</strong> has been dealt a good h<strong>and</strong>: a penetrat<strong>in</strong>g<strong>in</strong>tellect, a passion for gett<strong>in</strong>g th<strong>in</strong>gs straight, a facility for languages, a sensitivepalate, <strong>and</strong> (as this Festschrift attests) admir<strong>in</strong>g students <strong>and</strong> colleagues.Notes* The authors would like to express their <strong>in</strong>debtedness to many former students <strong>of</strong> Lel<strong>and</strong><strong>Yeager</strong> who k<strong>in</strong>dly shared some memoirs <strong>of</strong> their Virg<strong>in</strong>ia days, thereby provid<strong>in</strong>g<strong>in</strong>valuable help <strong>in</strong> the preparation <strong>of</strong> this pr<strong>of</strong>ile. They are too numerous to name, but afew <strong>of</strong> them must be s<strong>in</strong>gled out for special mention: Peire Brisson, Charles W. Campbell,William F. Campbell, Vladi Catto, James A. Dorn, Umesh C. Gulati, Barry Hirsch,Joseph M. Jadlow, Kelfala M. Kallon, William A. McEachern, John Mullahy, Marv<strong>in</strong>Phaup, Lawrence B. Pulley, Alan Rab<strong>in</strong>, <strong>and</strong> John Ridpath.1 New York: Praeger (1976); New York: Harper & Row (1966), respectively.2 In his Presidential Address to the Southern Economic Association <strong>in</strong> 1975, <strong>Yeager</strong>relates the market mechanism to languages <strong>and</strong> ethical codes as be<strong>in</strong>g results <strong>of</strong> humanaction but not <strong>of</strong> human design. See (1976) Economics <strong>and</strong> Pr<strong>in</strong>ciples. Southern EconomicJournal, 42(April): 565.3 Ibid., at p. 566.


3 The Virg<strong>in</strong>ia renaissance <strong>in</strong>political economyThe 1960s revisited *James M. BuchananIntroductionFrom a perspective <strong>of</strong> the early twenty-first century, the faculty roster <strong>of</strong> theJames Wilson Department <strong>of</strong> Economics at the University <strong>of</strong> Virg<strong>in</strong>ia <strong>in</strong> the early1960s merits attention on several counts. 1 But the “powers that were” at Mr.Jefferson’s university did not value that particular faculty highly. Recall that thosewere years heavily laden with ideological baggage, <strong>and</strong> that faculty was clearlynonconventional. The university, <strong>in</strong> its wisdom, allowed the 1960s program <strong>in</strong>“Virg<strong>in</strong>ia Political Economy,” despite its external success, to return to orthodoxy asWh<strong>in</strong>ston, Coase, Tullock, Buchanan departed permanently, <strong>and</strong> Nutter left for anextended period. 2 The negative aspects <strong>of</strong> the Virg<strong>in</strong>ia story have been recounted,at least <strong>in</strong> part, <strong>and</strong> I shall not elaborate on these aspects here. 3My aim <strong>in</strong> this paper is more positive; I shall discuss the orig<strong>in</strong>s, the construction,<strong>and</strong> the operation <strong>of</strong> the Virg<strong>in</strong>ia program, rather than its deliberate destruction bythe university adm<strong>in</strong>istration. I should add the disclaimer that my discussion isbased on my own remembered history rather than on a documented record.From idea to actualityWarren Nutter <strong>and</strong> I were fellow graduate students at the University <strong>of</strong> Chicago <strong>in</strong>the years immediately follow<strong>in</strong>g World War II. I recall a conversation <strong>in</strong> early 1948dur<strong>in</strong>g which we expressed our shared conviction that our discipl<strong>in</strong>e, economics,seemed to be drift<strong>in</strong>g away from its moor<strong>in</strong>gs <strong>in</strong> classical political economy. Wequite explicitly discussed the need for an <strong>in</strong>stitutional–organizational <strong>in</strong>itiative thatmight serve to br<strong>in</strong>g the classical foundations back to center stage. Like manyconversations, that one was filed away, especially s<strong>in</strong>ce we were relatively immaturegraduate students with no academic st<strong>and</strong><strong>in</strong>g.The Virg<strong>in</strong>ia program, however, had its orig<strong>in</strong>s <strong>in</strong> that particular conversation.In 1956, both Warren Nutter <strong>and</strong> I were appo<strong>in</strong>ted to faculty positions at theUniversity <strong>of</strong> Virg<strong>in</strong>ia, <strong>and</strong> I was appo<strong>in</strong>ted Chairman <strong>of</strong> the James WilsonDepartment <strong>of</strong> Economics. Both <strong>of</strong> us had completed our apprenticeship, so tospeak. I had fulfilled my obligation to return to southern academia with st<strong>in</strong>ts atboth the University <strong>of</strong> Tennessee <strong>and</strong> Florida State University. Nutter had put <strong>in</strong>some token years at Yale University. Both <strong>of</strong> us had published <strong>in</strong> pr<strong>of</strong>essional


The Virg<strong>in</strong>ia renaissance <strong>in</strong> political economy 35journals <strong>and</strong> Nutter had almost completed a major work on Soviet <strong>in</strong>dustrialgrowth for the National Bureau <strong>of</strong> Economic Research. In other words we now hadsome st<strong>and</strong><strong>in</strong>g <strong>in</strong> academia, at least enough to give us the confidence necessary tomove readily <strong>in</strong>to an entrepreneurial role. And, by early 1957, we found ourselves<strong>in</strong> a position where we could, <strong>in</strong>deed, act as academic entrepreneurs.The University <strong>of</strong> Virg<strong>in</strong>ia <strong>in</strong> the 1950s was a good, if not an outst<strong>and</strong><strong>in</strong>g,university. And its tradition <strong>in</strong> economics was fully respectable with an establishedgraduate program. David McCord Wright, a colorful <strong>and</strong> eccentric but productivescholar, had resigned before our appo<strong>in</strong>tment. But Rutledge V<strong>in</strong><strong>in</strong>g rema<strong>in</strong>ed as asource <strong>of</strong> imag<strong>in</strong>ative <strong>in</strong>spiration, as well as irritation, to faculty colleagues. RaymondMikesell was the <strong>in</strong>ternational policy “wonk” who found the Charlottesvilledistance from Wash<strong>in</strong>gton ideal for his purposes. James Schles<strong>in</strong>ger had jo<strong>in</strong>ed thefaculty earlier as a fresh Harvard PhD; he seemed to Nutter <strong>and</strong> me to be a welleducatedman, <strong>in</strong>terested <strong>in</strong> much, but not really a Chicago-type economist at all.Tipton R. Snavely, who had served as departmental chairman for more than threedecades, was required to rel<strong>in</strong>quish that position at age 65.We found ourselves with several opportunities to make new faculty appo<strong>in</strong>tments<strong>in</strong> 1957. Warren Smith had resigned late <strong>in</strong> 1956; Clark Hyde, an economichistorian, died <strong>in</strong> early 1957; Raymond Mikesell resigned to take a special chair atthe University <strong>of</strong> Oregon. My first task, as chairman, was to fill faculty positions.How to proceed? My criteria were never articulated, then or now, but they haverema<strong>in</strong>ed unchanged. I prefer colleagues who exhibit creative, critical <strong>in</strong>telligence<strong>and</strong> who demonstrate a will<strong>in</strong>gness to challenge orthodox or conventional wisdom.It was my good fortune to read Lel<strong>and</strong> <strong>Yeager</strong>’s paper “Some Questions aboutGrowth Economics” <strong>in</strong> the American Economic Review (1954). I did not know <strong>Yeager</strong>at all; but I had read enough <strong>of</strong> the growth models that were cropp<strong>in</strong>g up everywhere<strong>in</strong> the 1950s to recognize the empt<strong>in</strong>ess that they reflected. Here was aneconomist who fit my requirements – someone who knew enough about suchmodels to challenge them on their own ground <strong>and</strong> who pulled absolutely nopunches <strong>in</strong> call<strong>in</strong>g spades by their rightful names. I had scarcely put the articledown before I commenced to search out <strong>Yeager</strong>’s possible <strong>in</strong>terest <strong>in</strong> a position onour faculty.I do not now recall any <strong>of</strong> the particulars <strong>of</strong> the negotiation, but <strong>Yeager</strong> agreed toaccept an appo<strong>in</strong>tment, <strong>and</strong> he came to Virg<strong>in</strong>ia, br<strong>in</strong>g<strong>in</strong>g with him two graduatestudents from the University <strong>of</strong> Maryl<strong>and</strong>, Daniel Edwards <strong>and</strong> José Vergara. Onevery solid appo<strong>in</strong>tment had then been made. The construction <strong>of</strong> the Virg<strong>in</strong>iaprogram was on schedule.Note that <strong>in</strong> this narrative account I <strong>of</strong>ten use the pronoun “we” rather than “I”<strong>in</strong> discuss<strong>in</strong>g the constructive choices made <strong>in</strong> the Charlottesville sett<strong>in</strong>g <strong>of</strong> the late1950s <strong>and</strong> early 1960s. I do this advisedly to convey the relevant po<strong>in</strong>t that from theoutset I considered that Warren Nutter <strong>and</strong> I were coequal partners <strong>in</strong> theentrepreneurial enterprise. My nom<strong>in</strong>al role as faculty chairman did noth<strong>in</strong>g tomitigate the shared responsibility; <strong>and</strong>, it should be noted, Nutter assumed thechairmanship after I completed a five-year term <strong>in</strong> 1961. The jo<strong>in</strong>t leadership wasimportant s<strong>in</strong>ce each <strong>of</strong> us ga<strong>in</strong>ed confidence from the other. Neither, s<strong>in</strong>gly <strong>and</strong>alone, might have been able to carry forward the remembered Chicago purpose.


36 James M. BuchananNonetheless, some imputation can be tried, <strong>and</strong> primary responsibility can beassigned for particular choices. The discovery, recruitment, <strong>and</strong> appo<strong>in</strong>tment <strong>of</strong>Lel<strong>and</strong> <strong>Yeager</strong> was my own affair, almost exclusively. But neither Warren Nutternor I could claim sponsorship for Alex<strong>and</strong>re Kafka, the second major addition tothe new faculty. Kafka was, almost literally, appo<strong>in</strong>ted by Gottfried Haberler.Along with Warren Nutter, I felt myself to be little more than an acquiescor <strong>in</strong> theHaberler campaign to <strong>in</strong>sure that Kafka secure appo<strong>in</strong>tment to the Virg<strong>in</strong>iafaculty. We, along with others <strong>in</strong> the faculty <strong>and</strong> adm<strong>in</strong>istration, were bombardedwith telephone calls, letters, <strong>and</strong> personal chats, both directly from Haberler <strong>and</strong>others, seldom if at all from Kafka himself. Kafka’s credentials were passable, <strong>and</strong>with Mikesell’s resignation, we did need strength <strong>in</strong> <strong>in</strong>ternational economics. And,as it turned out, this essentially “external” appo<strong>in</strong>tment was highly productive forour program. Kafka gave us an entree <strong>in</strong>to academic <strong>and</strong> quasi-academic (forexample, the <strong>in</strong>ternational agencies) circles that we could never have atta<strong>in</strong>ed.And, let us now admit that his Central European manners added a bit <strong>of</strong> charm <strong>and</strong>grace to our brash disturbance <strong>of</strong> the tranquility <strong>of</strong> Mr. Jefferson’s lawn.Ronald H. Coase was the third major addition to our faculty at Virg<strong>in</strong>ia. AndWarren Nutter deserves full credit for the discovery, recruitment, <strong>and</strong> appo<strong>in</strong>tment<strong>of</strong> Coase. Warren had participated, perhaps <strong>in</strong> the summer <strong>of</strong> 1957, <strong>in</strong> one <strong>of</strong> thelong conferences sponsored by the William Volker Fund. Coase was one <strong>of</strong> thethree ma<strong>in</strong> speakers at the conference, convened, I th<strong>in</strong>k, at Chapel Hill. WarrenNutter returned to Charlottesville mightily impressed with Coase, <strong>and</strong> heimmediately commenced to exam<strong>in</strong>e the prospects <strong>of</strong> pry<strong>in</strong>g Coase away from theUniversity <strong>of</strong> Buffalo, which had been his academic home s<strong>in</strong>ce his migration fromLondon some years before. After lengthy, <strong>and</strong> sometimes tortuous negotiations, thedeal was made, <strong>and</strong>, after a full year’s delay, Coase shifted to Charlottesville.With the additions <strong>of</strong> <strong>Yeager</strong>, Kafka, <strong>and</strong> Coase, the senior staff was basically <strong>in</strong>place. Junior appo<strong>in</strong>tments were made, <strong>in</strong>clud<strong>in</strong>g, importantly, Andrew Wh<strong>in</strong>ston,one <strong>of</strong> the best colleagues with whom I personally have worked. We also addedJames Ferguson, a protégé <strong>and</strong> self-appo<strong>in</strong>ted Stigler clone, who kept us alert toChicago-style bumptiousness. And a bit later we appo<strong>in</strong>ted John Moes, aDutchman with a Berkeley degree, who was more helpful to me, as departmentalchair with necessary chores, than almost anyone on the faculty. Unfortunately,Moes got at cross-purposes with Coase early on, with the result that he was notmoved along a tenure track.To this po<strong>in</strong>t <strong>in</strong> the narrative <strong>of</strong> the construction process I have not mentionedGordon Tullock, who many will associate directly with the whole Virg<strong>in</strong>ia enterprise,<strong>and</strong> properly so. But Tullock enters the story only with the complementarynarrative to be discussed <strong>in</strong> the follow<strong>in</strong>g section.The Thomas Jefferson Center for Studies <strong>in</strong> PoliticalEconomy <strong>and</strong> Social PhilosophyAs we had discussed ten years before, both Warren Nutter <strong>and</strong> I felt that someth<strong>in</strong>gmore than the appo<strong>in</strong>tment <strong>of</strong> good faculty members with<strong>in</strong> an ongo<strong>in</strong>g program


The Virg<strong>in</strong>ia renaissance <strong>in</strong> political economy 37was needed to br<strong>in</strong>g attention to <strong>and</strong> concentrate renewed <strong>in</strong>terest <strong>in</strong> the traditionthat found its orig<strong>in</strong>s <strong>in</strong> Adam Smith <strong>and</strong> the eighteenth-century moral philosophers.“Economics as moral philosophy,” or as Alex<strong>and</strong>er Rosenberg puts it,“economics as contractarian political philosophy” (1992: 251) – this describes ourpurpose, then <strong>and</strong> now, <strong>and</strong> the words “<strong>and</strong> social philosophy” were explicitlyadded to the name <strong>of</strong> the center we sought to establish. We believed that it wasessential to set up some such center complementary with, but <strong>in</strong>dependent <strong>of</strong>, theregular departmental program.The establishment <strong>of</strong> the Thomas Jefferson Center was easier than we hadthought possible. At the University <strong>of</strong> Virg<strong>in</strong>ia <strong>in</strong> 1957 there were only two adm<strong>in</strong>istratorsthat mattered: William L. Duren, Dean <strong>of</strong> the Faculties, <strong>and</strong> ColgateDarden, President <strong>of</strong> the University. When we proposed such a center, the responsewas immediate <strong>and</strong> favorable. Full speed ahead, with Darden’s contribution be<strong>in</strong>gthe “Thomas Jefferson” designation, advanced <strong>in</strong> part <strong>in</strong> the misguided hope thatthe trustees <strong>of</strong> the Monticello Foundation might prove a source <strong>of</strong> f<strong>in</strong>ancial support.(As it turned out, the trustees did not have the foggiest idea <strong>of</strong> what we wereabout.)But, once established, the very existence <strong>of</strong> the Thomas Jefferson Center gave usthe basis for seek<strong>in</strong>g external funds. In this quest, we were very fortunate to securea large (for 1957), five-year grant from the William Volker Fund for the purpose <strong>of</strong>br<strong>in</strong>g<strong>in</strong>g to Charlottesville, for periods <strong>of</strong> a semester each, a series <strong>of</strong> dist<strong>in</strong>guishedscholars <strong>in</strong> political economy. The <strong>in</strong>clusive program became excit<strong>in</strong>g <strong>in</strong>deed aslectures, sem<strong>in</strong>ars, <strong>and</strong> <strong>in</strong>formal discussions were led by scholars such as FrankKnight, F. A. Hayek, Michael Polanyi, Bruno Leoni, Bertil Ohl<strong>in</strong>, Maurice Allais,T. W. Hutchison, Duncan Black, <strong>and</strong> O. H. Taylor.Included <strong>in</strong> the center’s project were funds for a postdoctoral fellowship, <strong>and</strong>Gordon Tullock was the first recipient. Warren Nutter is responsible for br<strong>in</strong>g<strong>in</strong>gTullock to my attention. Nutter <strong>and</strong> Tullock had been members <strong>of</strong> the undergraduatedebat<strong>in</strong>g team at the University <strong>of</strong> Chicago <strong>in</strong> the early 1940s, <strong>and</strong> Nutterknew that Tullock had resigned from the US Foreign Service after a n<strong>in</strong>e-year st<strong>in</strong>t.Further, Nutter knew that Tullock had written a massive book recit<strong>in</strong>g his personalexperience <strong>in</strong> the federal bureaucracy – a book that conta<strong>in</strong>ed, amid the personalanecdotes, a new theory <strong>of</strong> bureaucracy. 4 I met Tullock briefly at the meet<strong>in</strong>gs <strong>in</strong>Philadelphia <strong>in</strong> December 1957, <strong>and</strong> I read the massive volume, warts <strong>and</strong> all.I agreed with Warren Nutter that Tullock was worth encourag<strong>in</strong>g; we awardedGordon the first postdoctoral fellowship at the center.Dur<strong>in</strong>g his research year at the center, Gordon commenced his work on majorityrule, <strong>and</strong>, a year later, he <strong>and</strong> I decided that we should write a jo<strong>in</strong>tly-authoredbook on the economics <strong>of</strong> politics, tak<strong>in</strong>g a constitutional perspective. The Calculus <strong>of</strong>Consent: Logical Foundations <strong>of</strong> Constitutional Democracy (1962) was the ultimate result.But after his <strong>in</strong>itial fellowship year, Tullock jo<strong>in</strong>ed the faculty at the University <strong>of</strong>South Carol<strong>in</strong>a. It was only <strong>in</strong> 1961, when we had an open<strong>in</strong>g at Virg<strong>in</strong>ia, thatTullock was appo<strong>in</strong>ted to the faculty <strong>in</strong> Charlottesville. And this appo<strong>in</strong>tment wasalmost solely on my own responsibility. Nutter was perhaps a bit reluctant to br<strong>in</strong>gTullock back as a permanent colleague. Tullock had no PhD <strong>in</strong> economics; he was


38 James M. Buchananeccentric along many dimensions; <strong>and</strong> he <strong>and</strong> I, <strong>in</strong> our work <strong>in</strong> politics, weredepart<strong>in</strong>g a bit from the strictly classical foundations that Warren Nutter held dearto heart <strong>and</strong> m<strong>in</strong>d. But Nutter accepted my arguments; he could scarcely deny thatTullock represented precisely the critical <strong>and</strong> imag<strong>in</strong>ative qualities that we sought<strong>in</strong> colleagues. Lel<strong>and</strong> <strong>Yeager</strong>’s strong support for appo<strong>in</strong>t<strong>in</strong>g Tullock to the facultyshould be mentioned here. With the addition <strong>of</strong> Gordon Tullock to a facultyposition, the basic construction was complete. The program, both for the JamesWilson Department <strong>of</strong> Economics <strong>and</strong> the Thomas Jefferson Center for Studies <strong>in</strong>Political Economy <strong>and</strong> Social Philosophy, was alive <strong>and</strong> well.Dividends were not slow <strong>in</strong> com<strong>in</strong>g. With some fellowship support from the<strong>in</strong>itial Volker grant <strong>and</strong> some additional support from other foundations, notablyEarhart <strong>and</strong> Relm, graduate students <strong>of</strong> high potential began to be attracted to theprogram. Excit<strong>in</strong>g research commenced to appear; “political economy,” broadlydef<strong>in</strong>ed, seemed to experience a genu<strong>in</strong>e rebirth <strong>in</strong> those heady years <strong>in</strong> Charlottesville.Later appo<strong>in</strong>tments filled <strong>in</strong> the gaps, <strong>and</strong> William Breit, Harold Hochman,<strong>and</strong> Roger Sherman added to the excitement dur<strong>in</strong>g the end-years <strong>of</strong> the criticaldecade.The program <strong>in</strong> operationSeveral elements were needed to put the sort <strong>of</strong> graduate-research program wewanted <strong>in</strong> operat<strong>in</strong>g order. First, solid <strong>in</strong>struction <strong>in</strong> price theory, aimed towardconvey<strong>in</strong>g a genu<strong>in</strong>e underst<strong>and</strong><strong>in</strong>g <strong>of</strong> the coord<strong>in</strong>at<strong>in</strong>g properties <strong>of</strong> marketstructures, was essential. Without this ground<strong>in</strong>g, no program worthy <strong>of</strong> the name“economics” could exist. Second, a comprehensive <strong>and</strong> critical underst<strong>and</strong><strong>in</strong>g <strong>of</strong>the post-Keynesian program <strong>in</strong> macroeconomics was a necessary part <strong>of</strong> anypr<strong>of</strong>essional qualifications. Third, basic mathematical competence was neededwhile, at the same time, we sought to <strong>in</strong>sure aga<strong>in</strong>st undue <strong>in</strong>vestment <strong>of</strong> scarcestudent resources <strong>in</strong> mathematization per se. Fourth, graduate students neededsome h<strong>and</strong>s-on guidance <strong>in</strong>to analytical writ<strong>in</strong>g that <strong>in</strong>volved coherent construction<strong>of</strong> arguments. F<strong>in</strong>ally, <strong>and</strong> perhaps most important <strong>of</strong> all, graduate students neededdirection, counsel<strong>in</strong>g, <strong>and</strong> supervision <strong>in</strong> curriculum choices, tim<strong>in</strong>g <strong>of</strong> requirements<strong>and</strong> threshold commitments, <strong>and</strong> <strong>in</strong> organiz<strong>in</strong>g themselves for the rigors <strong>of</strong> aresearch career. The anarchy that seemed to be so characteristic <strong>of</strong> many graduateprograms needed to be replaced with order.Warren Nutter assumed the direct <strong>and</strong> ma<strong>in</strong> responsibility for the first <strong>of</strong> theseelements. His true <strong>in</strong>terest was always <strong>in</strong> what some called “old-fashioned” pricetheory, <strong>and</strong> he taught the students well. At the end <strong>of</strong> their first year, the Virg<strong>in</strong>iagraduate students knew basic Marshallian economics, as amended <strong>and</strong> modernizedby George Stigler <strong>and</strong> Milton Friedman <strong>and</strong> as translated by Warren Nutter.Lel<strong>and</strong> <strong>Yeager</strong> admirably fulfilled the second role <strong>in</strong> the Virg<strong>in</strong>ia program. Inmy still-held view, <strong>Yeager</strong> taught the best year-long course <strong>in</strong> macroeconomics <strong>in</strong>existence dur<strong>in</strong>g those noteworthy years. He guaranteed that the students wereexposed to, <strong>and</strong> that they learned, the whole range <strong>of</strong> ideas that then were <strong>in</strong>cludedunder the rubric “macroeconomics.” Us<strong>in</strong>g Don Pat<strong>in</strong>k<strong>in</strong>’s book, <strong>Money</strong>, Interest,


The Virg<strong>in</strong>ia renaissance <strong>in</strong> political economy 39<strong>and</strong> Prices (1956), as a basis for critical discourse, <strong>Yeager</strong> led students throughKeynesianism with a balanced evaluation <strong>of</strong> the classical precursors, while at thesame time present<strong>in</strong>g them with some underst<strong>and</strong><strong>in</strong>g <strong>of</strong> the then-emerg<strong>in</strong>gmonetarism just be<strong>in</strong>g developed by Milton Friedman. We did not claim that theVirg<strong>in</strong>ia program embodied a research concentration <strong>in</strong> macroeconomics. But wedid guarantee that students who went through the program would recognize thefield when they saw it, <strong>and</strong> that they possessed the confidence <strong>of</strong> their own criticalassessment <strong>of</strong> ongo<strong>in</strong>g research.We were highly fortunate <strong>in</strong> be<strong>in</strong>g able to <strong>in</strong>sure that our students received them<strong>in</strong>imal tra<strong>in</strong><strong>in</strong>g <strong>in</strong> mathematics without, at the same time, com<strong>in</strong>g to be overawedby techniques. Dur<strong>in</strong>g the early years this feat was accomplished for us by RobertDavis, himself a mathematician rather than an economist, who understood boththe value <strong>and</strong> the limits <strong>of</strong> his subject matter. Our students were not put through thetorture <strong>of</strong> learn<strong>in</strong>g mathematics from an economist who, himself, did not reallyknow what the subject was all about.My own role <strong>in</strong> the operation <strong>of</strong> the teach<strong>in</strong>g program was largely limited to thefourth element noted above. In my second-year course <strong>in</strong> public f<strong>in</strong>ance theory,which was really political economy, I developed, at Virg<strong>in</strong>ia, a teach<strong>in</strong>g methodthat proved highly successful, both for me <strong>and</strong>, I believe, for the students. I requiredshort weekly-written papers from students – th<strong>in</strong>k pieces, not research papers – onanalytical topics that seemed challeng<strong>in</strong>g. And I graded these papers carefully onstyle as well as content. Students learned how to organize an argument <strong>and</strong> topresent it well. The success <strong>of</strong> this course was measured by the surpris<strong>in</strong>gly largenumber <strong>of</strong> these short analytical papers, by graduate students, that found their wayultimately <strong>in</strong>to publication <strong>in</strong> pr<strong>of</strong>essional journals.As noted previously, perhaps the most important contribut<strong>in</strong>g factor to thesuccessful operation <strong>of</strong> the program at Virg<strong>in</strong>ia was organizational. And <strong>in</strong> thisrespect, Lel<strong>and</strong> <strong>Yeager</strong> deserves particular commendation. Shortly after he jo<strong>in</strong>edthe faculty, <strong>Yeager</strong> assumed duties as coord<strong>in</strong>ator <strong>of</strong> the graduate program <strong>in</strong> thedepartment, <strong>and</strong> it was his effort, almost alone, that did <strong>in</strong>deed br<strong>in</strong>g order <strong>in</strong>to thewhole operation. Graduate students knew where they were, what their challengeswere, <strong>and</strong> how they measured up to these. There was an organizational coherenceto the graduate program at Virg<strong>in</strong>ia that was, <strong>and</strong> is, perhaps not present <strong>in</strong> manyuniversities. (My own experience is worth not<strong>in</strong>g. I left Virg<strong>in</strong>ia for UCLA <strong>in</strong> 1968,only to f<strong>in</strong>d that, with comparable faculty <strong>and</strong> graduate students, the UCLA graduateprogram was essentially anarchy, with almost no coherence. Students weremore or less left alone to work out their own program <strong>of</strong> progress or retrogression.)Neither Ronald Coase, Rutledge V<strong>in</strong><strong>in</strong>g, nor Gordon Tullock were importantcontributors <strong>in</strong> the direct <strong>in</strong>structional experience <strong>of</strong> Virg<strong>in</strong>ia’s graduate students.Coase’s appo<strong>in</strong>tment to a major pr<strong>of</strong>essorship was justified on the argument thatundergraduate <strong>in</strong>struction needed attention <strong>and</strong>, <strong>in</strong> particular, that an outst<strong>and</strong><strong>in</strong>glecturer might provide a means <strong>of</strong> shor<strong>in</strong>g up a relatively weak economics major.Coase was, <strong>and</strong> rema<strong>in</strong>s, an outst<strong>and</strong><strong>in</strong>g lecturer, but the effort to exploit thesetalents <strong>in</strong> elementary teach<strong>in</strong>g was a total failure. Coase’s lectures are good becausethey reflect long hours <strong>of</strong> <strong>in</strong>tense preparation, someth<strong>in</strong>g that is not possible on a


40 James M. Buchananregularly scheduled basis. In addition, Coase’s m<strong>in</strong>d was (is) simply too imag<strong>in</strong>ativelyunique to allow him to lecture on st<strong>and</strong>ard textbook material. RonaldCoase’s <strong>in</strong>fluence on the Virg<strong>in</strong>ia program was largely exercised through facultycolleagues, although he did adm<strong>in</strong>ister the written PhD prelim<strong>in</strong>ary exam<strong>in</strong>ationsfor several semesters.The <strong>in</strong>tellectual climate <strong>in</strong> the faculty, <strong>and</strong> among graduate students, waspermeated with opportunity-cost th<strong>in</strong>k<strong>in</strong>g, either objectively (Coase 1938, 1960) orsubjectively (Buchanan 1969). And scholars <strong>in</strong> political economy were com<strong>in</strong>g<strong>in</strong>creas<strong>in</strong>gly to accept Wicksell’s unanimity norm as a benchmark for any evaluation<strong>of</strong> collectively considered options (Wicksell 1896). Given these two elements<strong>of</strong> analysis, Coase’s resolution <strong>of</strong> “the problem <strong>of</strong> social cost” emerged quitenaturally (1960), <strong>and</strong> I dist<strong>in</strong>ctly recall the shared surprise those <strong>of</strong> us at Virg<strong>in</strong>ia feltwhen we learned that Coase’s sem<strong>in</strong>ar presentation at the University <strong>of</strong> Chicagohad stirred such controversy. Political economy at Virg<strong>in</strong>ia was, <strong>in</strong>deed, quitedifferent from that at Chicago.Rutledge V<strong>in</strong><strong>in</strong>g’s graduate course attracted only a few students, <strong>in</strong> part becausehe refused to adjust either to orthodox subject matter or method. As base, V<strong>in</strong><strong>in</strong>g’sideas were difficult to transmit, <strong>and</strong>, <strong>in</strong> fact, they were well <strong>in</strong> advance <strong>of</strong> his time(V<strong>in</strong><strong>in</strong>g 1984). A temporal displacement <strong>of</strong> four decades, until the years whencomputer simulations could generate stochastic patterns as desired, would haveallowed V<strong>in</strong><strong>in</strong>g to present his provocative ideas on economic diagnoses much morestraightforwardly. Nonetheless, V<strong>in</strong><strong>in</strong>g’s critical stress on the relevance <strong>of</strong> rules wasan important <strong>and</strong> cont<strong>in</strong>u<strong>in</strong>g element <strong>in</strong> the constitutional direction that politicaleconomy was to take, a direction that is further discussed <strong>in</strong> the next section.Gordon Tullock occupied the role <strong>of</strong> conversational gadfly, com<strong>in</strong>g <strong>of</strong>f his considerabletalents as at least one-half <strong>of</strong> a true Renaissance man (the scientific <strong>and</strong>historical, but relative illiteracy <strong>in</strong> arts <strong>and</strong> letters), who kept us all on our toes withhis <strong>in</strong>sistence that Homo economicus was alive <strong>and</strong> kick<strong>in</strong>g almost everywhere.Tullock also provided me, personally, with a feedback <strong>of</strong> confidence required topush research <strong>and</strong> analysis toward the “political” part <strong>of</strong> the two-word subject“political economy,” a thrust that Warren Nutter would never have supportedother than reluctantly. Tullock <strong>and</strong> I <strong>in</strong>formally organized a new coequal partnership,perhaps somewhat irritat<strong>in</strong>g to Nutter, when we sponsored an <strong>in</strong>itial exploratoryconference <strong>in</strong> 1963, from which the orig<strong>in</strong>s <strong>of</strong> what later became the PublicChoice Society may be traced. For purposes <strong>of</strong> this narrative, I should emphasize,however, that the strictly def<strong>in</strong>ed “public choice” emphasis arrived relatively late <strong>in</strong>the Virg<strong>in</strong>ia decade.Constitutional political economyModern public choice theory can be subdivided <strong>in</strong>to two dist<strong>in</strong>ct research programs.The first <strong>in</strong>cludes analyses <strong>of</strong> particular outcomes that emerge underparticular rules <strong>and</strong> <strong>in</strong>stitutions that are used or may be used for reach<strong>in</strong>g collectivedecisions, along with the analyses <strong>of</strong> the behavior <strong>of</strong> the agents who are constra<strong>in</strong>edto act with<strong>in</strong> these rules. The second research program <strong>in</strong>cludes analyses <strong>of</strong> the


The Virg<strong>in</strong>ia renaissance <strong>in</strong> political economy 41choices that may be made among alternative sets <strong>of</strong> rules. This program, latterlychristened as “constitutional political economy,” focuses on ultimate constitutionalchoices.The po<strong>in</strong>t to be made here is that there is much more <strong>in</strong>tellectual l<strong>in</strong>kage betweenthe <strong>in</strong>itial Virg<strong>in</strong>ia emphasis on political economy, as described <strong>in</strong> the operationsboth <strong>of</strong> the economics department <strong>and</strong> the Thomas Jefferson Center, <strong>and</strong> modernconstitutional political economy than there is with public choice theory <strong>in</strong> its more“positive” or “scientific” aspects. From the outset, those <strong>of</strong> us who were <strong>in</strong>strumental<strong>in</strong> putt<strong>in</strong>g together the Virg<strong>in</strong>ia program understood, even if vaguely <strong>and</strong><strong>in</strong>directly, that the ultimate objective to be sought <strong>in</strong> provid<strong>in</strong>g students with anexplanatory underst<strong>and</strong><strong>in</strong>g <strong>of</strong> how a market order works is “constitutional” ratherthan strictly “scientific.” That is to say, economics is valuable because it enablescitizens to make more <strong>in</strong>formed choices about the basic organizational structure <strong>of</strong>society. In one sense the whole focus is on “welfare economics,” if broadly enoughdef<strong>in</strong>ed, <strong>and</strong> on the conditions under which markets fail <strong>and</strong> markets succeed,always by comparison with alternative political <strong>in</strong>sti tutions. From this start<strong>in</strong>gpo<strong>in</strong>t, the emergence <strong>of</strong> the more positive research program that concentrates on“how politics works” was a natural consequence.Early on <strong>in</strong> this sort <strong>of</strong> <strong>in</strong>quiry <strong>in</strong>to the “political economy,” as it was observed oras it might be, some identification <strong>of</strong> the necessary elements <strong>in</strong> the constitutionalframework for the operation <strong>of</strong> a market order was required. In this process, thecentral role <strong>of</strong> monetary rules <strong>and</strong> <strong>in</strong>stitutions becomes evident. How is the operation<strong>of</strong> a market economy affected by the existence <strong>of</strong> this or that set <strong>of</strong> monetary<strong>in</strong>stitutions? And, perhaps more importantly, what are the comparative work<strong>in</strong>gproperties <strong>of</strong> alternative sets <strong>of</strong> rules, alternative monetary constitutions?Dur<strong>in</strong>g his first year on the faculty at Virg<strong>in</strong>ia, Lel<strong>and</strong> <strong>Yeager</strong> <strong>and</strong> I discussed therelevance <strong>and</strong> importance <strong>of</strong> these questions. And <strong>Yeager</strong> agreed to undertake theorganizational <strong>and</strong> adm<strong>in</strong>istrative role <strong>in</strong> putt<strong>in</strong>g together a series <strong>of</strong> lectures, eachone <strong>of</strong> which was designed to present the argument for one <strong>of</strong> the several monetaryconstitutions or to analyze critically particular elements <strong>of</strong> such constitutions.Funds were raised specifically for this lecture series. And, dur<strong>in</strong>g 1959, the lectureswere presented. 5 Under <strong>Yeager</strong>’s editorship, these lectures were published <strong>in</strong> 1962by Harvard University Press.This lecture series, <strong>and</strong> the book, were important for a reason that is <strong>in</strong>dependent<strong>of</strong> the precise content <strong>of</strong> any or all <strong>of</strong> the lectures themselves. The project signaled ashift <strong>of</strong> economists’ attention away from discussions concern<strong>in</strong>g the direction <strong>and</strong>impact <strong>of</strong> policy choices made with<strong>in</strong> the exist<strong>in</strong>g structure <strong>of</strong> rules <strong>and</strong> by agentsduly authorized under such rules toward discussion <strong>of</strong> the structure itself. In otherwords, the emphasis was specifically constitutional. These lectures marked a return tosome <strong>of</strong> the earlier discussion <strong>in</strong> the 1930s by such economists as Irv<strong>in</strong>g Fisher <strong>and</strong>Henry Simons <strong>and</strong> by such politicians as Wright Patman, discussion that had fortoo long been superseded both by the Keynesian neglect <strong>of</strong> monetary <strong>in</strong>fluencesgenerally <strong>and</strong> by the implicit presumption that there were no <strong>in</strong>stitutional alternativesto Federal Reserve structure, as it existed.Unfortunately, the Virg<strong>in</strong>ia effort organized by Lel<strong>and</strong> <strong>Yeager</strong> had little last<strong>in</strong>g


42 James M. Buchananimpact. It did not stimulate much direct or immediate <strong>in</strong>terest <strong>in</strong> monetaryconstitutions, due <strong>in</strong> part perhaps to the untimely dat<strong>in</strong>g <strong>of</strong> publication, 1962, atthe precise onset <strong>of</strong> the apogee years <strong>of</strong> the translation <strong>of</strong> the “Keynesian wisdom”<strong>in</strong>to practical politics.When, however, attention came aga<strong>in</strong> to be focused on monetary <strong>in</strong>stitutionsafter the demonstrable failures evidenced by the stagflation-<strong>in</strong>flation <strong>of</strong> the 1970s<strong>and</strong> 1980s, the 1962 book emerged <strong>in</strong>to a new position <strong>of</strong> current relevance. Laterefforts that <strong>in</strong>troduced a constitutional approach to analyses <strong>of</strong> monetary arrangementswere, <strong>in</strong> one sense, based on the <strong>Yeager</strong> enterprise. (See Brennan <strong>and</strong>Buchanan 1981; Buchanan 1983.)The Virg<strong>in</strong>ia decade <strong>in</strong> perspectiveWe are four decades removed from the academic history that I have recalled. Ihave, somewhat arbitrarily perhaps, def<strong>in</strong>ed the “Virg<strong>in</strong>ia decade <strong>in</strong> politicaleconomy” to <strong>in</strong>clude the years 1957 through 1967, the years dur<strong>in</strong>g which theprogram was <strong>in</strong>itiated, developed, matured, <strong>and</strong> “died” <strong>in</strong> its own fashion. Despiteits with<strong>in</strong>-university, beyond-economics evaluation, the program was an externalsuccess, as measured by almost any objective set <strong>of</strong> criteria.It is easy to speculate about “what might have been” had the university leadershipnot been bl<strong>in</strong>ded by its ideological baggage. How might Virg<strong>in</strong>ia’s program <strong>in</strong>political economy have fared if the university had chosen to reta<strong>in</strong> AndrewWh<strong>in</strong>ston <strong>and</strong> Ronald Coase on its faculty, neither <strong>of</strong> whom wanted to leave theCharlottesville scene, had not Gordon Tullock’s promotion been thrice denied,had Warren Nutter’s major work on Soviet <strong>in</strong>dustrial growth not been “sent toCoventry” by American Sovietologists, with the consequent feedback <strong>in</strong>to our ownuniversity sett<strong>in</strong>g?Even with these questions answered differently from the history we livedthrough, perhaps Virg<strong>in</strong>ia’s decade would still have stood as a period apart. By theearly 1960s tensions had already developed between Coase <strong>and</strong> V<strong>in</strong><strong>in</strong>g, <strong>and</strong> I hadbeen personally upset by the cavalier treatment accorded to John Moes. Nutter wasnever wholly sympathetic to the extension <strong>of</strong> analysis to politics, <strong>and</strong> had Coaserema<strong>in</strong>ed on the faculty, it would surely have been more difficult for Tullock <strong>and</strong>me to shift research emphasis so strongly <strong>in</strong> that direction. After 1963, publicchoice, as a research program on its own <strong>and</strong> dist<strong>in</strong>ct from political economy, waswait<strong>in</strong>g to be born. But I wonder aloud whether such birth could have happened atall <strong>in</strong> Charlottesville.At least from my own private <strong>and</strong> quite personal perspective, <strong>in</strong> the new century,it seems best to discard all speculation about the might have beens <strong>and</strong> enjoy <strong>and</strong>appreciate the remembered history <strong>of</strong> that which was accomplished <strong>in</strong> a relativelyshort span <strong>of</strong> years. We were fortunate <strong>in</strong> the sense that the University <strong>of</strong> Virg<strong>in</strong>iawas sufficiently prestigious to <strong>in</strong>sure that our program had significant spillovereffects on academia well beyond Mr. Jefferson’s serpent<strong>in</strong>e walls, while at the sametime the university was sufficiently prov<strong>in</strong>cial to <strong>in</strong>sure that our efforts would not besmothered immediately by the dom<strong>in</strong>ant academic ideology. We simply exploited


The Virg<strong>in</strong>ia renaissance <strong>in</strong> political economy 43a w<strong>in</strong>dow <strong>of</strong> opportunity that rarely opens <strong>in</strong> the academy. I am sure that those <strong>of</strong>us <strong>in</strong>volved, whether alive or dead, are quite will<strong>in</strong>g to leave to others who are moredetached <strong>in</strong> time, place, <strong>and</strong> value stance any ultimate assessment <strong>of</strong> the <strong>in</strong>clusiveenterprise.Notes* Lel<strong>and</strong> <strong>Yeager</strong> played a critically important role <strong>in</strong> Virg<strong>in</strong>ia’s “decade <strong>of</strong> the 1960s” <strong>in</strong>political economy. Rather than exam<strong>in</strong>e this role <strong>in</strong> isolation, I exam<strong>in</strong>e the <strong>in</strong>clusiveresearch program <strong>in</strong> retrospect; the “<strong>Yeager</strong> difference” emerges clearly.1 An <strong>in</strong>complete list<strong>in</strong>g <strong>in</strong>cludes: James Buchanan, Ronald Coase, James Ferguson,Alex<strong>and</strong>re Kafka, John Moes, Warren Nutter, James Schles<strong>in</strong>ger, Gordon Tullock,Rutledge V<strong>in</strong><strong>in</strong>g, Andrew Wh<strong>in</strong>ston, <strong>and</strong> Lel<strong>and</strong> <strong>Yeager</strong>.2 James Schles<strong>in</strong>ger also resigned from the faculty near the end <strong>of</strong> the decade discussed. I donot <strong>in</strong>clude his name here, nor do I refer to him <strong>in</strong> the narrative account, because,although he was a fully participat<strong>in</strong>g member <strong>of</strong> the <strong>in</strong>stitutional <strong>and</strong> research faculty,he did not consider himself to be a part <strong>of</strong> the “team” <strong>in</strong> Virg<strong>in</strong>ia political economy. Nordid those <strong>of</strong> us on the team consider Schles<strong>in</strong>ger as a participant <strong>in</strong> the academicexperience.3 See James M. Buchanan (1988, 1992). By necessity, for purposes <strong>of</strong> narrative cont<strong>in</strong>uity,there will be some overlap between the earlier treatments <strong>and</strong> that <strong>in</strong> this paper. Foranother perspective, see William Breit (1986).4 A revised <strong>and</strong> shortened version <strong>of</strong> this book was published as The Politics <strong>of</strong> Bureaucracy(1965).5 These <strong>in</strong>cluded: Clark Warburton on the quantity theory; Murray Rothbard <strong>and</strong> ArthurKemp on the gold st<strong>and</strong>ard; Benjam<strong>in</strong> Graham on commodity-reserve money; GeorgeTolley on 100 percent bank<strong>in</strong>g; Milton Friedman <strong>and</strong> Jacob V<strong>in</strong>er on central bank<strong>in</strong>dependence. There were additional lectures by Clarence Philbrook, James Buchanan,Willford K<strong>in</strong>g, <strong>and</strong> Richard Selden.ReferencesBreit, William (1986). Virg<strong>in</strong>ia Political Economy Lecture: Creat<strong>in</strong>g the “Virg<strong>in</strong>ia School”: Charlottesvilleas an Academic Environment <strong>in</strong> the 1960s. Fairfax, VA: George Mason University,Center for Study <strong>of</strong> Public Choice monograph.Brennan, Ge<strong>of</strong>frey <strong>and</strong> James M. Buchanan (1981). Monopoly <strong>in</strong> <strong>Money</strong> <strong>and</strong> Inflation: The Casefor a Constitution to Discipl<strong>in</strong>e Government. Hobart Paper 88. London: Institute <strong>of</strong> EconomicAffairs.Buchanan, James M. (1969). Cost <strong>and</strong> Choice: An Inquiry <strong>in</strong> Economic Theory. Chicago:Markham.Buchanan, James M. (1983). Monetary Research, Monetary Rules, <strong>and</strong> Monetary Regimes.Cato Journal, 3(Spr<strong>in</strong>g): 143–6.Buchanan, James M. (1988). Nutter Memorial Lecture: Political Economy: 1957–82.In Ideas, Their Orig<strong>in</strong>s, <strong>and</strong> Their Consequences: Lectures to Commemorate the Life <strong>and</strong> Work <strong>of</strong>G. Warren Nutter. Wash<strong>in</strong>gton, DC: American Enterprise Institute, 119–30.Buchanan, James M. (1992). Virg<strong>in</strong>ia Political Economy: Some Personal Reflections. InBetter than Plow<strong>in</strong>g: And Other Personal <strong>Essays</strong>. Chicago, IL: University <strong>of</strong> Chicago Press,93–107.Buchanan, James M. <strong>and</strong> Gordon Tullock (1962). The Calculus <strong>of</strong> Consent: Logical Foundations <strong>of</strong>Constitutional Democracy. Ann Arbor, MI: University <strong>of</strong> Michigan Press.


44 James M. BuchananCoase, Ronald H. (1938). Bus<strong>in</strong>ess Organization <strong>and</strong> the Accountant. Accountant, 1October–17 December; a series <strong>of</strong> twelve articles.Coase, Ronald H. (1960). The Problem <strong>of</strong> Social Cost. Journal <strong>of</strong> Law <strong>and</strong> Economics, 3: 1–44.Pat<strong>in</strong>k<strong>in</strong>, Don (1956). <strong>Money</strong>, Interest, <strong>and</strong> Prices: An Integration <strong>of</strong> Monetary <strong>and</strong> Value Theory.Evanston, IL: Row, Peterson.Rosenberg, Alex<strong>and</strong>er (1992). Economics – Mathematical Politics or Science <strong>of</strong> Dim<strong>in</strong>ish<strong>in</strong>g Returns?Chicago, IL: University <strong>of</strong> Chicago Press.Tullock, Gordon (1965). The Politics <strong>of</strong> Bureaucracy. Wash<strong>in</strong>gton, DC: Public Affairs Press.V<strong>in</strong><strong>in</strong>g, Rutledge (1984). On Apprais<strong>in</strong>g the Performance <strong>of</strong> an Economic System. Cambridge:Cambridge University Press.Wicksell, Knut (1896). F<strong>in</strong>anztheoretische Untersuchungen. Jena: Gustav Fischer.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1954). Some Questions about Growth Economics. American EconomicReview, 44(1): 53–63.<strong>Yeager</strong>, Lel<strong>and</strong> B. (ed.) (1962). In Search <strong>of</strong> a Monetary Constitution. Cambridge, MA: HarvardUniversity Press.


4 Lel<strong>and</strong>A personal appreciationGordon TullockI first met Lel<strong>and</strong> when I received a postdoctoral fellowship at the University <strong>of</strong>Virg<strong>in</strong>ia. See<strong>in</strong>g as I really didn’t have a doctorate, s<strong>in</strong>ce a DJ doesn’t count, thiswas very unusual. However, I can claim other unusual po<strong>in</strong>ts <strong>in</strong> my appo<strong>in</strong>tment.The center had received a large sum <strong>of</strong> money to establish a dist<strong>in</strong>guished visit<strong>in</strong>gscholar <strong>and</strong> a visit<strong>in</strong>g post doc. I was the first recipient <strong>of</strong> the visit<strong>in</strong>g post doc funds.One <strong>of</strong> my colleagues said that they had a dist<strong>in</strong>guished fellowship <strong>and</strong> an undist<strong>in</strong>guishedfellowship. He, unk<strong>in</strong>dly, ma<strong>in</strong>ta<strong>in</strong>ed that although they cont<strong>in</strong>ued hav<strong>in</strong>gdist<strong>in</strong>guished <strong>and</strong> undist<strong>in</strong>guished fellows, I was the most truly undist<strong>in</strong>guished <strong>of</strong>them all.This was not Lel<strong>and</strong>, <strong>of</strong> course, <strong>and</strong> I believe that he had much to do with myreceiv<strong>in</strong>g the fellowship. I had written my Politics <strong>of</strong> Bureaucracy <strong>and</strong> was hav<strong>in</strong>gtrouble gett<strong>in</strong>g it published. I arranged to have some prepr<strong>in</strong>ts made <strong>and</strong> distributedthem to friends, one <strong>of</strong> which was my former debate partner at the University<strong>of</strong> Chicago, Warren Nutter. He distributed it around the department <strong>and</strong> Lel<strong>and</strong>read it <strong>and</strong> was much pleased. I believe he then began a campaign to get otherpeople to read it. He never claimed credit for this, so I can’t be sure, but I rema<strong>in</strong>grateful to him for, <strong>in</strong> a way, gett<strong>in</strong>g me started <strong>in</strong> economics. Without thisfellowship <strong>and</strong> the people I met <strong>in</strong> Virg<strong>in</strong>ia I would probably have cont<strong>in</strong>ued <strong>in</strong><strong>in</strong>ternational studies with ma<strong>in</strong> emphasis on purely political problems. S<strong>in</strong>ce Ibelieve that my approach to the economics <strong>of</strong> politics was earlier than Buchanan’s,Lel<strong>and</strong> had a major role <strong>in</strong> gett<strong>in</strong>g public choice started even if he himself seldomwrote on it.The period at Virg<strong>in</strong>ia was immensely important for my own <strong>in</strong>tellectual development<strong>and</strong> my contact with Lel<strong>and</strong> was an important part <strong>of</strong> that development.He was not himself deeply <strong>in</strong>terested <strong>in</strong> public choice but <strong>in</strong> more conventionaleconomics. In a way it’s <strong>in</strong>correct to refer to him as be<strong>in</strong>g a conventional economistbecause he was an extremely orig<strong>in</strong>al th<strong>in</strong>ker. He not only greatly improved myknowledge <strong>of</strong> economics, but he did the same for many, many other scholars. Hisimpact on his students was greater than most other teachers I have known. Hislectures were so admired that his students actually pr<strong>in</strong>ted up their very carefulnotes on those lectures. Lel<strong>and</strong>, with characteristic modesty, objected to this, but itsurely meant that the economic <strong>in</strong>fluence <strong>of</strong> Virg<strong>in</strong>ia <strong>and</strong>, <strong>in</strong> particular, Lel<strong>and</strong> wasmagnified.


46 Gordon TullockIn any event, I ga<strong>in</strong>ed a great deal from my association with Lel<strong>and</strong>. It should bekept <strong>in</strong> m<strong>in</strong>d that at the time I met him I had had one course <strong>in</strong> economics last<strong>in</strong>g10 weeks. Admittedly it was taught by Henry Simons <strong>and</strong> it made an immenseimpression on me. From then on I followed the economic journals as a sort <strong>of</strong>hobby. I was engaged, firstly as a completely unimportant member <strong>of</strong> the military<strong>in</strong> Europe, followed by complet<strong>in</strong>g my law school tra<strong>in</strong><strong>in</strong>g, <strong>and</strong> then after a veryshort period <strong>of</strong> legal practice <strong>in</strong> a downtown <strong>of</strong>fice, I jo<strong>in</strong>ed the diplomatic service<strong>and</strong> went <strong>of</strong>f to Ch<strong>in</strong>a.In Ch<strong>in</strong>a I followed the practice <strong>of</strong> a junior Foreign Service Officer, whichmeant that I engaged <strong>in</strong> m<strong>in</strong>or clerical activities <strong>and</strong> worked on report<strong>in</strong>g thepolitical side <strong>of</strong> the local government <strong>and</strong> society. All this meant that I had very little<strong>in</strong> the way <strong>of</strong> economic tra<strong>in</strong><strong>in</strong>g other than my read<strong>in</strong>g <strong>of</strong> economic journals <strong>in</strong> theUSS library. At the time I had no idea <strong>of</strong> leav<strong>in</strong>g the diplomatic service or, <strong>in</strong>particular, <strong>of</strong> becom<strong>in</strong>g an academic <strong>of</strong> any sort, certa<strong>in</strong>ly not as an economist.I wrote my Politics <strong>of</strong> Bureaucracy as an effort to regularize <strong>and</strong> improve politicaltheory. I th<strong>in</strong>k I did not at that time regard it as an economic work. In a wayLel<strong>and</strong>’s read<strong>in</strong>g it <strong>and</strong> recommend<strong>in</strong>g it to other people, <strong>in</strong>directly, led me tobecome more <strong>in</strong>terested <strong>in</strong> economics <strong>and</strong> less <strong>in</strong> foreign policy. The year that Ispent as a post doc <strong>in</strong> Virg<strong>in</strong>ia f<strong>in</strong>ished <strong>of</strong>f a shift <strong>in</strong> which I cont<strong>in</strong>ued to be<strong>in</strong>terested <strong>in</strong> political science <strong>and</strong> <strong>in</strong> foreign policy, but realized that economics wasdeeply relevant to all <strong>of</strong> that area.Thus Lel<strong>and</strong>, by first attract<strong>in</strong>g attention to my work <strong>in</strong> Virg<strong>in</strong>ia <strong>and</strong> hencelead<strong>in</strong>g to my receiv<strong>in</strong>g a post doc, which led to a firm <strong>in</strong>doctr<strong>in</strong>ation <strong>in</strong> a year atVirg<strong>in</strong>ia <strong>in</strong> economic methods – particularly, <strong>of</strong> course, Chicagoan economicmethods – <strong>in</strong> essence revolutionized my own <strong>in</strong>tellectual development. I was, <strong>and</strong>rema<strong>in</strong>, deeply grateful for his <strong>in</strong>fluence.I should say <strong>in</strong> pass<strong>in</strong>g that I also enjoyed my social relations with him when Iwas <strong>in</strong> Virg<strong>in</strong>ia <strong>and</strong> s<strong>in</strong>ce I left Virg<strong>in</strong>ia when, as occasionally happens, we meet asships that pass <strong>in</strong> the night. His particular fields <strong>of</strong> study are different from m<strong>in</strong>e.Further, he has an apparent great ability to learn foreign languages where I have anequally apparent great <strong>in</strong>ability to do so. This means that <strong>in</strong> whole areas he is ableto do th<strong>in</strong>gs that I can only admire from a distance. I can, however, recognize hisgreat contributions <strong>in</strong> these areas.Altogether his <strong>in</strong>fluence on me was great, but I suspect that his <strong>in</strong>fluence on hisstudents <strong>and</strong> other colleagues was even greater. We badly need more members <strong>of</strong>the pr<strong>of</strong>ession that, if they’re not able to meet the high st<strong>and</strong>ards that Lel<strong>and</strong> set,can at least provide an approximation, perhaps a poor approximation. Thus his<strong>in</strong>fluence is not by any means entirely through his publications, excellent thoughthey are, or directly through his students, but to a large extent through the students<strong>of</strong> his students. We all should be grateful to the improvement <strong>in</strong> economics thatcomes out <strong>of</strong> his work.I cannot trace direct <strong>in</strong>fluence between his work <strong>and</strong> the sharp improvement <strong>in</strong>monetary economics s<strong>in</strong>ce his orig<strong>in</strong>al work. Still, hav<strong>in</strong>g a first-class m<strong>in</strong>d devotedto these problems cannot have avoided be<strong>in</strong>g one <strong>of</strong> the causes <strong>of</strong> the greatimprovement <strong>in</strong> rationality <strong>in</strong> that area.


Lel<strong>and</strong>, a personal appreciation 47In addition, <strong>of</strong> course, his teach<strong>in</strong>g <strong>and</strong> writ<strong>in</strong>g have greatly improved therationality <strong>of</strong> economic policies <strong>in</strong> many areas, even if we cannot trace the exactchannels <strong>of</strong> <strong>in</strong>fluence. Once aga<strong>in</strong> his <strong>in</strong>fluence by way <strong>of</strong> his students <strong>and</strong> that <strong>of</strong>his students’ students is great. Altogether, we hope you’ll cont<strong>in</strong>ue his work formany years <strong>and</strong> also hope that other people will follow <strong>in</strong> his footsteps both dur<strong>in</strong>gthe rest <strong>of</strong> his life <strong>and</strong> afterwards.


5 Monopoly politics <strong>and</strong> itsunsurpris<strong>in</strong>g effectsJames C. Miller III 1In 1964, I was study<strong>in</strong>g for an MA <strong>in</strong> Economics at the University <strong>of</strong> Georgia when,at the urg<strong>in</strong>g <strong>of</strong> Pr<strong>of</strong>essors George Horton <strong>and</strong> Aubrey Drury, both graduates <strong>of</strong>the University <strong>of</strong> Virg<strong>in</strong>ia’s economics PhD program, I applied for <strong>and</strong> receivedadmission to the same program. Sometime dur<strong>in</strong>g the spr<strong>in</strong>g <strong>of</strong> 1965 I visited theUniversity <strong>and</strong> met with the director <strong>of</strong> (economics) graduate study, one Lel<strong>and</strong><strong>Yeager</strong>. In contrast with Pr<strong>of</strong>s. Horton <strong>and</strong> Drury, Mr. <strong>Yeager</strong> was stiff, formal,<strong>and</strong> very shy. I was sure the meet<strong>in</strong>g hadn’t gone well. And I was taken back aboutone th<strong>in</strong>g. When Mr. <strong>Yeager</strong> asked what I was plann<strong>in</strong>g to do over the summer, Isaid I wanted to f<strong>in</strong>ish my MA thesis. He responded, “Why? You’ll be work<strong>in</strong>g on aPhD, right? That’s your term<strong>in</strong>al degree.” So, <strong>in</strong>stead, dur<strong>in</strong>g the summer I readeconomics <strong>and</strong> attended some lectures <strong>in</strong> Charlottesville, <strong>in</strong>clud<strong>in</strong>g an unforgettableseries by Ronald Coase. It was good advice.Dur<strong>in</strong>g my first semester at Virg<strong>in</strong>ia I took Mr. <strong>Yeager</strong>’s course <strong>in</strong> price theory.It was rigorous. The lectures were extraord<strong>in</strong>arily well organized <strong>and</strong> well delivered– so much so it was apparent that while Mr. <strong>Yeager</strong> welcomed questions, it pa<strong>in</strong>edhim to be knocked <strong>of</strong>f-stride <strong>and</strong> <strong>of</strong>f-script. The reason is that he had thoughtthrough carefully what needed to be conveyed to us fledgl<strong>in</strong>g economists <strong>and</strong>wanted to make sure we got it all!It was this class that led to my first crisis <strong>in</strong> graduate school. For some reason, theuniversity schedule for the f<strong>in</strong>al exam conflicted with some other important event,<strong>and</strong> so, at Mr. <strong>Yeager</strong>’s suggestion, we all agreed to have the exam at an earlierdate. I know I wrote all this down <strong>and</strong> had it <strong>in</strong> my m<strong>in</strong>d as well as <strong>in</strong> my notes. Butsome way, somehow, I forgot – <strong>and</strong> missed the exam. Hat <strong>in</strong> h<strong>and</strong>, <strong>and</strong> lump <strong>in</strong>throat, I went to Mr. <strong>Yeager</strong>’s <strong>of</strong>fice, dur<strong>in</strong>g his odd <strong>of</strong>fice hours, <strong>and</strong> apologized.He was nonplussed. Rather than giv<strong>in</strong>g me a quick make-up written exam, he saidhe would give me an oral make-up exam – at the end <strong>of</strong> the second semester!Apparently, he thought stew<strong>in</strong>g for a semester would do me good. It did, <strong>and</strong> Ididn’t miss another exam.Everyone who has had the honor <strong>and</strong> <strong>in</strong>tellectual rigor <strong>of</strong> be<strong>in</strong>g a student orcolleague <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong>’s can attest that he is a most serious <strong>and</strong> honorable<strong>in</strong>tellectual. In my dictionary, under “scholar,” I see a pr<strong>of</strong>ile <strong>of</strong> Mr. <strong>Yeager</strong>.What follows is an application <strong>of</strong> some <strong>of</strong> the basic pr<strong>in</strong>ciples <strong>of</strong> price theory Mr.<strong>Yeager</strong> taught me, along with some public choice I learned from Mssrs. Buchanan,


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 49Tullock, Tollison, <strong>and</strong> Cra<strong>in</strong>. Specifically, I address, first, the applicability <strong>of</strong> economicpr<strong>in</strong>ciples to the political marketplace. As I outl<strong>in</strong>e <strong>in</strong> Monopoly Politics, 2campaigns are a manifestation <strong>of</strong> the market for political representation. Just as <strong>in</strong>commercial markets, where sellers compete for consumers, <strong>in</strong> political markets,c<strong>and</strong>idates compete for voters. The propensity <strong>of</strong> commercial enterprises to limitthe ability <strong>of</strong> new entrants has its counterpart <strong>in</strong> political markets, where <strong>in</strong>cumbentshave a propensity to limit the ability <strong>of</strong> challengers to mount successfulcampaigns.Second, I describe the benefits <strong>of</strong> <strong>in</strong>cumbency – <strong>and</strong> the obverse, the obstaclesfaced by challengers. I describe not only the natural advantages such as hav<strong>in</strong>g<strong>in</strong>vested <strong>in</strong> advertis<strong>in</strong>g <strong>and</strong> other messages to become well known, but also, <strong>and</strong>more importantly, the contrived advantages <strong>of</strong> <strong>in</strong>cumbency (<strong>and</strong> the obstaclesimposed on challengers). These <strong>in</strong>clude the taxpayer-f<strong>in</strong>anced advantages <strong>of</strong> subsidizedcommunications for <strong>in</strong>cumbents (TV <strong>and</strong> radio studios, franked mail, etc.)<strong>and</strong> the ways the <strong>of</strong>fice is abused to <strong>in</strong>crease the chances <strong>of</strong> reelection, but, moreimportantly, the ways campaign rules are “rigged” to benefit <strong>in</strong>cumbents <strong>and</strong>penalize challengers.Third, I describe <strong>in</strong> more detail the steps a c<strong>and</strong>idate has to undertake just to runfor Federal <strong>of</strong>fice. I show that comply<strong>in</strong>g with current Federal election laws <strong>and</strong> therules promulgated by the Federal Election Commission (FEC) impose a differentiallyheavy burden on challengers. I also show that the new Bipartisan CampaignReform Act (BCRA) <strong>of</strong> 2002 further <strong>in</strong>creases the advantage enjoyed by <strong>in</strong>cumbents<strong>and</strong> heightens the discrim<strong>in</strong>ation faced by challengers. F<strong>in</strong>ally, I show thatthe requirements are so burdensome that, <strong>in</strong> effect, they amount to a c<strong>and</strong>idate’shav<strong>in</strong>g to secure a “license” from the government <strong>in</strong> order to compete for politicalrepresentation. Such requirements not only <strong>in</strong>crease costs, especially for challengers,but limit c<strong>and</strong>idates’ <strong>and</strong> their supporters’ freedom to control how they runtheir own campaigns.Fourth, I describe how political markets would perform without the anticompetitiveconstra<strong>in</strong>ts presently <strong>in</strong>corporated <strong>in</strong> Federal campaign laws <strong>and</strong> regulations.I conclude that with their removal the market for political representationwould be much more competitive <strong>and</strong> that voters would be better served, just asconsumers are better served by competition <strong>in</strong> commercial markets.Campaigns <strong>and</strong> the market for political representationAlthough most Americans spend little time consider<strong>in</strong>g the government’s impacton their daily lives, the importance <strong>of</strong> decisions made <strong>in</strong> political markets rivals that<strong>of</strong> decisions made <strong>in</strong> the commercial sector. A quick look at the size <strong>of</strong> the Federal<strong>and</strong> state governments clearly <strong>in</strong>dicates the magnitude <strong>of</strong> political decision-mak<strong>in</strong>g.For fiscal year 2001, Federal expenditures topped $1,936 billion, while the 50 statesspent nearly $1,293 billion. Comb<strong>in</strong>ed, these two levels <strong>of</strong> government accountedfor 32 percent <strong>of</strong> the nation’s GDP ($10,082 billion).Just how we, through governments, go about decid<strong>in</strong>g what to spend <strong>and</strong> how t<strong>of</strong><strong>in</strong>ance those expenditures has been the subject <strong>of</strong> <strong>in</strong>tensive study. 3 One key


50 James C. Miller IIIoutcome <strong>of</strong> the research is a recognition that elected <strong>of</strong>ficials respond to <strong>in</strong>centivesjust as do producers <strong>and</strong> sellers <strong>in</strong> commercial markets. Elected <strong>of</strong>ficials competefor voters <strong>in</strong> elections, just as producers <strong>and</strong> sellers compete for consumers <strong>in</strong> thecommercial marketplace. Accord<strong>in</strong>gly, the type <strong>of</strong> analysis economists haveapplied rout<strong>in</strong>ely to assess the efficiency <strong>and</strong> effectiveness <strong>of</strong> commercial marketscan also be used to assess efficiency <strong>and</strong> effectiveness <strong>of</strong> political markets. Thatthis is possible becomes clearer when we recognize that <strong>in</strong> most relevant wayscommercial <strong>and</strong> political markets are very much alike.In commercial markets, providers compete for consumers’ dollars. In politicalmarkets, c<strong>and</strong>idates compete for citizens’ votes. In commercial markets, the ability<strong>of</strong> providers to step up to the plate, make <strong>of</strong>fer<strong>in</strong>gs to the public, <strong>and</strong> communicatewhat they have to <strong>of</strong>fer is <strong>of</strong> vital importance <strong>in</strong> assur<strong>in</strong>g consumers <strong>of</strong> the mostvalue for their money. In broad terms, markets are said to be efficient (<strong>and</strong> effective<strong>in</strong> serv<strong>in</strong>g consumers’ wants) when competition is vigorous <strong>and</strong> sellers have ampleopportunities to communicate their <strong>of</strong>fer<strong>in</strong>gs.In a similar manner, political c<strong>and</strong>idates compete for the attention <strong>of</strong> citizens,solicit<strong>in</strong>g their votes at the ballot box. Just as with commercial markets, politicalmarkets are efficient (<strong>and</strong> effective <strong>in</strong> respond<strong>in</strong>g to citizens’ preferences) whenc<strong>and</strong>idates are able to step up to the plate, make <strong>of</strong>fer<strong>in</strong>gs to the public, <strong>and</strong>communicate what they have to <strong>of</strong>fer to prospective voters. 4There are differences between commercial markets <strong>and</strong> political markets, butthey are not particularly material for the analysis at h<strong>and</strong>. In the latter, the voterschoose a s<strong>in</strong>gle person to represent their <strong>in</strong>terests. But choos<strong>in</strong>g a representative <strong>in</strong>a political market is very much like choos<strong>in</strong>g a retailer <strong>in</strong> a commercial market. 5The retailer serves as the consumer’s “agent” <strong>in</strong> pick<strong>in</strong>g a l<strong>in</strong>e <strong>of</strong> products orservices from which to choose. Consumers typically do not survey all the goods orservices <strong>of</strong>fered for sale, but <strong>in</strong>stead rely on stores such as Wal-Mart, W<strong>in</strong>n-Dixie,<strong>and</strong> their local <strong>in</strong>surance broker to search through the available product <strong>and</strong>service <strong>of</strong>fer<strong>in</strong>gs <strong>and</strong> carry a select few. This makes the consumer’s effort to f<strong>in</strong>d agood buy much simpler, but <strong>in</strong> do<strong>in</strong>g so he or she puts a certa<strong>in</strong> amount <strong>of</strong> trust<strong>in</strong> the judgment <strong>of</strong> the retailer chosen. If, however, the consumer f<strong>in</strong>ds over timethat the retailer selects poor product or service l<strong>in</strong>es, he or she will pick a better“agent.”In political markets, voters choose an agent to represent them <strong>in</strong> collectivedecision-mak<strong>in</strong>g. Rather than survey all <strong>of</strong> the political issues fac<strong>in</strong>g Congress,<strong>in</strong>quire <strong>in</strong>to the pros <strong>and</strong> cons <strong>of</strong> each, form an op<strong>in</strong>ion, <strong>and</strong> then take part <strong>in</strong> amassive referendum on each <strong>and</strong> every one, voters choose representatives whosejob it is to review all <strong>of</strong> these issues <strong>and</strong> make <strong>in</strong>formed judgments. Just as <strong>in</strong>commercial markets, if citizens f<strong>in</strong>d that their agent does not serve them well, theywill choose someone else – that is, unless obstacles prevent or otherwise impedetheir ability to select the best person.Political markets have equivalents to franchises <strong>in</strong> commercial markets. Theyare <strong>in</strong>terest groups <strong>and</strong>, especially, political parties. In commercial markets consumersnormally frequent those establishments that have earned their trust asagents. They gravitate towards these places because they have learned that a


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 51particular establishment consistently gives good advice, <strong>of</strong>fers low prices, has outst<strong>and</strong><strong>in</strong>gservice, or any number <strong>of</strong> other factors <strong>of</strong> importance. The reputationearned by establishments from meet<strong>in</strong>g customers’ expectations consistently can beleveraged through franchis<strong>in</strong>g. A consumer travel<strong>in</strong>g far from home knows that theMcDonald’s on the road will serve the same menu, with the same quality, to whichthey are accustomed. This reliance on a firm’s reputation to deliver value is thepr<strong>in</strong>cipal reason for franchises.In political markets the equivalent to a commercial franchise is a political party,or to a lesser extent <strong>in</strong>terest groups. Individuals faced with limited time <strong>and</strong>resources may choose to rely upon the label, Democrat or Republican. Or perhapsthe citizen may take note <strong>of</strong> the op<strong>in</strong>ions <strong>of</strong>fered by the many <strong>in</strong>terest groups suchas the National Rifle Association, Greenpeace, labor unions, or the countless otherorganizations that take positions on political philosophy <strong>and</strong>/or policy issues.These groups do more than just <strong>in</strong>form voters: they also pressure the c<strong>and</strong>idates torema<strong>in</strong> true to the pr<strong>in</strong>ciples they espouse. If a c<strong>and</strong>idate (or elected <strong>of</strong>ficial)diverges too far, the group may withdraw its support, just as Burger K<strong>in</strong>g might pullits franchise from stores that fail to perform. 6Incentives to <strong>in</strong>novate exist <strong>in</strong> both markets. Bus<strong>in</strong>ess firms spend considerableresources to develop new products <strong>and</strong> services – to ga<strong>in</strong> advantage over their competitors.In a similar manner, c<strong>and</strong>idates (<strong>and</strong> their parties) put a great deal <strong>of</strong> effort<strong>and</strong> expense <strong>in</strong>to mak<strong>in</strong>g them more appeal<strong>in</strong>g to voters <strong>and</strong> ga<strong>in</strong><strong>in</strong>g an advantageover their opponents. This can take the form <strong>of</strong> research<strong>in</strong>g an issue, develop<strong>in</strong>g aunique solution, <strong>and</strong> communicat<strong>in</strong>g it to prospective voters. It can also take theform <strong>of</strong> poll<strong>in</strong>g <strong>in</strong> an effort to probe <strong>and</strong> assess the op<strong>in</strong>ions <strong>and</strong> wishes <strong>of</strong> the public.For politicians <strong>and</strong> bus<strong>in</strong>esses alike, the most important development is irrelevant ifnobody knows about it. The popular say<strong>in</strong>g, “Build a better mousetrap <strong>and</strong> theworld will beat a path to your door,” is not quite accurate, as the world needs to be<strong>in</strong>formed <strong>and</strong> sold on the new idea.Would-be agents <strong>in</strong> both commercial <strong>and</strong> political markets solicit our support.In commercial markets, it is called advertis<strong>in</strong>g; <strong>in</strong> political markets, it is calledcampaign<strong>in</strong>g. With respect to purpose there is really no difference between the two.In commercial markets producers promote their prices, qualities, <strong>and</strong> services, <strong>and</strong>sometimes even po<strong>in</strong>t out the <strong>in</strong>ferior features <strong>of</strong> their competitors’ <strong>of</strong>fer<strong>in</strong>gs, while<strong>in</strong> political markets, c<strong>and</strong>idates promote their agendas, their character, theirhistories on the issues, <strong>and</strong> on occasion suggest flaws <strong>in</strong> their opponents’ characteror the positions they take. In both cases the purpose is to <strong>in</strong>form about attributesthat are expected to be decisive to the <strong>in</strong>tended recipient.As mentioned earlier, for commercial markets to be efficient <strong>and</strong> effective, theymust be competitive. That is, providers must be free to make <strong>of</strong>fer<strong>in</strong>gs <strong>and</strong> “compete”for bus<strong>in</strong>ess. That simple notion is what underlies the antitrust laws <strong>and</strong> theirenforcement. The reason is that, as Adam Smith observed over two centuries ago,People <strong>of</strong> the same trade seldom meet together, even for merriment <strong>and</strong>diversion, but the conversation ends <strong>in</strong> a conspiracy aga<strong>in</strong>st the public, or <strong>in</strong>some contrivance to raise prices. 7


52 James C. Miller IIIJust as the ability to collude <strong>and</strong> exclude rivals <strong>in</strong> commercial markets leads tohigher pr<strong>of</strong>its, higher prices, lower quality, <strong>and</strong> less <strong>in</strong>novation, collusive <strong>and</strong> exclusionarybehavior <strong>in</strong> political markets makes life better for elected <strong>of</strong>ficials to thedetriment <strong>of</strong> voters. Elected <strong>of</strong>ficials who are able to exclude, or even disadvantage,rivals have more power <strong>and</strong> <strong>in</strong>fluence, can more easily ignore their constituents,<strong>and</strong> can enjoy an easier lifestyle, fac<strong>in</strong>g less pressure to <strong>in</strong>novate, campaign, <strong>and</strong>engage <strong>in</strong> fundrais<strong>in</strong>g. The effects on citizens <strong>and</strong> voters, however, are like theeffects <strong>of</strong> monopoly on consumers. The range <strong>of</strong> options is limited, the overallquality <strong>of</strong> service is dim<strong>in</strong>ished, accountability suffers, <strong>of</strong>ficials more frequentlyrespond to vested <strong>in</strong>terests rather than the electorate at large, deliberations are lesstransparent, <strong>and</strong> citizens have less <strong>in</strong>formation about the c<strong>and</strong>idates, their qualifications,<strong>and</strong> their positions. In the same way that a monopolistic commercialmarket is <strong>in</strong>efficient <strong>and</strong> <strong>in</strong>effective <strong>in</strong> serv<strong>in</strong>g consumers, a monopolistic politicalmarket is <strong>in</strong>efficient <strong>and</strong> <strong>in</strong>effective <strong>in</strong> serv<strong>in</strong>g the <strong>in</strong>terests <strong>of</strong> citizens.The methods elected <strong>of</strong>ficials use to advantage themselves <strong>and</strong> to erect obstaclesto challengers is covered <strong>in</strong> the next section. But it is important to focus on the factthat political agents have the same <strong>in</strong>centives to restrict competition as do bus<strong>in</strong>essenterprises. Their legal liability, however, is far different. To limit anticompetitivepractices <strong>in</strong> commercial markets, there are Federal <strong>and</strong> state antitrust laws,enforced by two Federal agencies, the Department <strong>of</strong> Justice <strong>and</strong> the Federal TradeCommission, numerous state Attorneys General, <strong>and</strong> the private antitrust bar.There is no corollary <strong>in</strong> political markets. Elected <strong>of</strong>ficials face no sanctions foranticompetitive activity. To be sure, there are Federal election laws, <strong>and</strong> the FEC,among other th<strong>in</strong>gs, is responsible for monitor<strong>in</strong>g campaign contributions <strong>and</strong> howthey are spent. But as we shall see, these laws <strong>and</strong> the FEC impose far greater harmby protect<strong>in</strong>g <strong>in</strong>cumbents <strong>and</strong> disadvantag<strong>in</strong>g challengers, than any good they do<strong>in</strong> assur<strong>in</strong>g the <strong>in</strong>tegrity <strong>of</strong> the electoral process.Benefits enjoyed by <strong>in</strong>cumbents <strong>and</strong> obstacles faced bychallengersFor competition <strong>in</strong> political markets to be vigorous there must be a reasonably levelplay<strong>in</strong>g field – one free <strong>of</strong> artificial advantages for one or more c<strong>and</strong>idates versusothers. This is not to suggest a need for rules to restrict natural advantages. Indeed,<strong>in</strong> an ideal system the natural advantages <strong>of</strong> the c<strong>and</strong>idates would sh<strong>in</strong>e through,whether these are a more popular platform, superior organizational or communicationskills, or even name recognition from previous accomplishments. 8 Whatdoes need to be restricted, <strong>and</strong> what hampers the efficiency <strong>and</strong> effectiveness <strong>of</strong>political markets, are contrived advantages for certa<strong>in</strong> c<strong>and</strong>idates. Without exception,contrived advantages are on the side <strong>of</strong>, <strong>and</strong> are orchestrated by, <strong>in</strong>cumbents.Aside from legitimate, natural advantages, there are two types <strong>of</strong> contrivedadvantages associated with <strong>in</strong>cumbency. The first type is associated with abuse <strong>of</strong>the <strong>of</strong>fice for political ga<strong>in</strong> – <strong>in</strong>creas<strong>in</strong>g the probability <strong>of</strong> reelection. The second ismore pernicious – rigg<strong>in</strong>g the campaign rules to advantage <strong>in</strong>cumbents <strong>and</strong> to


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 53h<strong>in</strong>der challengers. The first is expla<strong>in</strong>ed <strong>in</strong> this section; the second is expla<strong>in</strong>ed <strong>in</strong>the section that follows.Members <strong>of</strong> Congress provide themselves with a full range <strong>of</strong> free services thatare not available to their more cash-starved challengers. Members <strong>of</strong> Congresshave free mail privileges (referred to as the frank), 9 telephone <strong>and</strong> Internet access, 10<strong>and</strong> well-designed web pages. 11 Some people may be surprised at the magnitude <strong>of</strong>these free services. For example, <strong>in</strong> a recent election cycle, <strong>of</strong> the 20 largest spenderson the frank, 11 Members spent more on this privilege than their challengers spenton their entire campaigns. 12 And benefits such as frank do help. Albert Cover <strong>and</strong>Bruce Brumberg found that a control group receiv<strong>in</strong>g franked mail had a higherop<strong>in</strong>ion <strong>of</strong> the <strong>in</strong>cumbent than those who did not. 13Members <strong>of</strong> Congress also derive a significant advantage through casework out<strong>of</strong> their district or state home <strong>of</strong>fices. The <strong>in</strong>creas<strong>in</strong>g flow <strong>of</strong> <strong>in</strong>decipherable <strong>and</strong>ambiguous new laws (<strong>and</strong> ensu<strong>in</strong>g regulations) <strong>in</strong>crease the dem<strong>and</strong> for caseworkservices – which, <strong>of</strong> course, only <strong>in</strong>cumbents can provide. Evidence <strong>of</strong> this can befound <strong>in</strong> the growth <strong>of</strong> House <strong>and</strong> Senate staff assigned to Members’ district <strong>and</strong>state <strong>of</strong>fices. From 1980 to 1997, the number <strong>of</strong> House staffers assigned to <strong>of</strong>fices <strong>in</strong>the districts <strong>in</strong>creased from 2,534 to 3,209, <strong>and</strong> for the Senate <strong>of</strong>fices <strong>in</strong> the states,the number <strong>in</strong>creased from 953 to 1,366. (The proportion <strong>of</strong> local-<strong>of</strong>fice staff vs. totalstaff <strong>in</strong>creased as well: from 34 percent to 44 percent for the House <strong>and</strong> from 25percent to 31 percent for the Senate.) 14 Academic research shows how beneficialconstituent services are <strong>in</strong> garner<strong>in</strong>g support <strong>and</strong> creat<strong>in</strong>g a positive image <strong>of</strong> the<strong>in</strong>cumbent. 15 And it is apparent that this has not gone unnoticed by the <strong>in</strong>cumbentsthemselves. For example, Morris Fior<strong>in</strong>a found that <strong>in</strong>cumbents respond to closeelections by <strong>in</strong>creas<strong>in</strong>g allocations to casework. 16Some might argue there is noth<strong>in</strong>g wrong with such a response by the <strong>in</strong>cumbent.They might suggest that the <strong>in</strong>cumbent is only seek<strong>in</strong>g to connect moreclosely with the voters, <strong>and</strong> that such a response is a sign <strong>of</strong> competition. To someextent this is true. Members <strong>of</strong> Congress have legitimate reasons to communicatewith constituents <strong>and</strong> to help them on occasion. There are two problems, however.First, the evidence is stark that the system is abused for political ga<strong>in</strong>. Second, thisactivity is funded by taxpayers, a source not available to challengers. In any event,the widespread abuse <strong>of</strong> these free services constitutes a contrived advantage thatmakes the play<strong>in</strong>g field less even, the political market less competitive, <strong>and</strong> citizensless well served.Incumbents also have at their disposal the ability to send district- or state-specificspend<strong>in</strong>g back to their constituents. This practice, more commonly known as “porkspend<strong>in</strong>g,” can play a large role <strong>in</strong> protect<strong>in</strong>g <strong>in</strong>cumbents from challenge. This isparticularly true for more senior <strong>in</strong>cumbents, who because <strong>of</strong> their tenure are moreeffective at br<strong>in</strong>g<strong>in</strong>g money back to their districts or states. Rational voters recogniz<strong>in</strong>gthat the flow <strong>of</strong> pork is an <strong>in</strong>creas<strong>in</strong>g function <strong>of</strong> tenure will be more apt toreturn their Congressman for another term. 17 Research has found that <strong>in</strong>cumbentsare effective <strong>in</strong> tak<strong>in</strong>g advantage <strong>of</strong> these contrived advantages. Robert Ste<strong>in</strong> <strong>and</strong>Kenneth Bickers found that vulnerable <strong>in</strong>cumbents aggressively pursue pork


54 James C. Miller IIIspend<strong>in</strong>g, 18 <strong>and</strong> separately that the success <strong>of</strong> <strong>in</strong>cumbents <strong>in</strong> br<strong>in</strong>g<strong>in</strong>g back agencygrants <strong>in</strong>fluences a potential challenger’s decision to run. 19 Accord<strong>in</strong>g to the organizationCitizens Aga<strong>in</strong>st Government Waste, this tool, like so many others, hasbeen grow<strong>in</strong>g over recent years, doubl<strong>in</strong>g from $6.6 billion to more than $13 billionover the five-year period 1993 to 1998.As mentioned <strong>in</strong> the previous section, voters have an <strong>in</strong>centive to reelect moresenior Members due to their effectiveness <strong>in</strong> deliver<strong>in</strong>g pork spend<strong>in</strong>g. This <strong>in</strong>centivealso extends to the committee system, whereby Members jockey to obta<strong>in</strong> keypositions on various committees that have oversight roles <strong>in</strong> important areas. Gett<strong>in</strong>gassigned to a powerful committee can enable an <strong>in</strong>cumbent to ga<strong>in</strong> additionalcontributions or support from voters who want to keep their representative <strong>in</strong> aposition <strong>of</strong> power. For example, Bennett <strong>and</strong> Loucks found that be<strong>in</strong>g appo<strong>in</strong>ted tothe House Bank<strong>in</strong>g Committee <strong>in</strong>creases a Member’s contributions from f<strong>in</strong>ancepolitical action committees (PACs). 20 Additionally, Mark Cra<strong>in</strong> <strong>and</strong> John Sullivanfound that for Members belong<strong>in</strong>g to the majority party, <strong>in</strong>cumbents assigned tocommittees hav<strong>in</strong>g significant control over <strong>in</strong>dustries under their jurisdictionsignificantly <strong>in</strong>creased their vote marg<strong>in</strong>s between the 1988 <strong>and</strong> 1990 elections. 21These empirical results, <strong>and</strong> the others like them, 22 are not surpris<strong>in</strong>g, given thetremendous power exercised by those committees <strong>and</strong> by the members who serveon them. 23Another contrived advantage is the ability <strong>of</strong> <strong>in</strong>cumbents to pressure donors forcampaign contributions when there is little evidence <strong>of</strong> challenge, <strong>and</strong> to carry overthese resources from election to election, cont<strong>in</strong>ually grow<strong>in</strong>g their reserves <strong>in</strong>order to ward <strong>of</strong>f any potential challenge. Janet Box-Steffensmeier found warchests particularly effective <strong>in</strong> deterr<strong>in</strong>g high-quality challengers. 24 This is notsurpris<strong>in</strong>g, given that challengers must recognize the enormous resources stackedup aga<strong>in</strong>st them. This benefit no doubt helps to expla<strong>in</strong> why, for <strong>in</strong>stance, after the1996 election cycle <strong>in</strong>cumbents’ average cash on h<strong>and</strong> was over $175,000, <strong>and</strong>those <strong>in</strong>cumbents who won with more than 60 percent <strong>of</strong> the vote had cash on h<strong>and</strong>averag<strong>in</strong>g more than $230,000. 25The role <strong>of</strong> Federal election laws <strong>and</strong> FEC rules <strong>in</strong>limit<strong>in</strong>g competitionOf even greater importance <strong>and</strong> effect are the contrived advantages for <strong>in</strong>cumbentscreated by the Federal campaign laws <strong>and</strong> regulations. It is important to bear <strong>in</strong>m<strong>in</strong>d the asymmetry between commercial markets <strong>and</strong> political markets withrespect to monopolization. In commercial markets, there is no organized forum forthe exchange <strong>of</strong> <strong>in</strong>formation <strong>and</strong> discussion <strong>of</strong> ways to limit competition. Indeed, ifthere were such a forum, not to mention if the forum succeeded <strong>in</strong> orchestrat<strong>in</strong>gactions to limit competition, the participants would be liable for crim<strong>in</strong>al prosecutionunder the Federal antitrust laws. On the other h<strong>and</strong>, <strong>in</strong> political markets,<strong>in</strong>cumbents have the means as well as the <strong>in</strong>centive to limit competition. They makethe laws. They not only have a legal forum <strong>in</strong> which to discuss ways <strong>of</strong> limit<strong>in</strong>g competition,their actions to carry out policies to limit competition do not create for


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 55them legal liability <strong>of</strong> any sort. Although usually debated <strong>in</strong> high-sound<strong>in</strong>g, public<strong>in</strong>terest rhetoric, these laws (<strong>and</strong> subsequent enabl<strong>in</strong>g regulations) are understoodto have great impact <strong>in</strong> limit<strong>in</strong>g the ability <strong>of</strong> challengers to mount seriouscampaigns. 26Ways Federal campaign laws limit competitionThe ways Federal <strong>and</strong> state election <strong>and</strong> campaign-f<strong>in</strong>ance laws limit competitionare varied. Only some <strong>of</strong> the major ones are addressed here. 27Perhaps recogniz<strong>in</strong>g the threat from third-party challengers, ballot access lawshave been structured to reduce competition. Theodore Lowi concluded that statebans on “fusion tickets” (the nom<strong>in</strong>ation <strong>of</strong> the same c<strong>and</strong>idate by more than onepolitical party) have a simple objective – to elim<strong>in</strong>ate competition. 28 In a similarve<strong>in</strong>, Hamilton <strong>and</strong> Ladd found that ballot structure affects turnout (particularlyfor lesser-known c<strong>and</strong>idates), party-l<strong>in</strong>e vot<strong>in</strong>g, <strong>and</strong> election results <strong>in</strong> partis<strong>and</strong>istricts. 29Additionally, some states allow <strong>in</strong>cumbents to have significant control <strong>in</strong> theprimary process. For example: <strong>in</strong> Virg<strong>in</strong>ia <strong>in</strong>cumbents can dem<strong>and</strong> a primary ifthey had been nom<strong>in</strong>ated that way the previous election cycle; Louisiana’s openseat primary system, which favors <strong>in</strong>cumbents, only saw one <strong>in</strong>cumbent defeated <strong>in</strong>22 years; <strong>and</strong> Connecticut requires a c<strong>and</strong>idate for a party’s nom<strong>in</strong>ation to receiveat least 15 percent <strong>of</strong> the votes at the nom<strong>in</strong>at<strong>in</strong>g convention to qualify for theprimary. Also, <strong>in</strong>cumbents work with their state legislatures <strong>and</strong> governors t<strong>of</strong>ormulate redistrict<strong>in</strong>g plans <strong>in</strong> such a way as to protect, <strong>and</strong> possibly improve, theirchances for reelection. David Gopoian <strong>and</strong> Darrell West found that <strong>in</strong>cumbentswere more likely to ga<strong>in</strong>, rather than lose, from redistrict<strong>in</strong>g because legislaturestended to give <strong>in</strong>cumbents <strong>of</strong> both parties a greater proportion <strong>of</strong> their party’svoters. 30 Not surpris<strong>in</strong>gly, additional research has found that if there is a bias <strong>in</strong> theredistrict<strong>in</strong>g process it tends to favor the state’s dom<strong>in</strong>ant party. 31Passage <strong>of</strong> FECA <strong>in</strong> 1974 dramatically changed the l<strong>and</strong>scape <strong>in</strong> which campaignsare funded <strong>and</strong> undertaken. The Act created a tax-return check-<strong>of</strong>f forfund<strong>in</strong>g presidential campaigns, placed limits on spend<strong>in</strong>g by presidential c<strong>and</strong>idateswho accept match<strong>in</strong>g funds, <strong>and</strong> limited the amounts <strong>in</strong>dividuals couldcontribute to presidential <strong>and</strong> congressional campaigns. (The Act also limitedspend<strong>in</strong>g on congressional campaigns, but the US Supreme Court later held thisprovision unconstitutional.) 32In research<strong>in</strong>g the academic literature <strong>in</strong> the process <strong>of</strong> writ<strong>in</strong>g Monopoly Politics,I found overwhelm<strong>in</strong>g agreement among scholars that the major effect <strong>of</strong> the Acthas been to help <strong>in</strong>cumbents further fend <strong>of</strong>f challengers. (Although I have notfollowed the literature as <strong>in</strong>tensely s<strong>in</strong>ce 1999, I am aware <strong>of</strong> no further researchthat is <strong>of</strong> a contrary nature.) I also found evidence that the pr<strong>in</strong>cipal motivation forthe Act was self-<strong>in</strong>terest. Peter Aranson <strong>and</strong> Melv<strong>in</strong> H<strong>in</strong>ich showed that the limitson contributions disproportionally constra<strong>in</strong> challengers more than <strong>in</strong>cumbents<strong>and</strong> thereby benefit <strong>in</strong>cumbents. 33 Abrams <strong>and</strong> Settle found that the Democrats’support <strong>of</strong> the 1974 bill was based on self-<strong>in</strong>terest – that <strong>in</strong> the absence <strong>of</strong> limits


56 James C. Miller IIIGerald Ford would have won the 1976 presidential election. 34 As another example,Bender found that even <strong>in</strong> the bill-form<strong>in</strong>g stage, when various spend<strong>in</strong>g limitswere considered, Members’ votes were highly correlated with forecasts <strong>of</strong> theeffects such limits would have had on their chances for reelection. 35 And <strong>in</strong> Buckley,the Supreme Court recognized that:S<strong>in</strong>ce an <strong>in</strong>cumbent is subject to these limitations to the same degree as hisopponent, the Act, on its face, appears to be evenh<strong>and</strong>ed. The appearance <strong>of</strong>fairness, however, may not reflect political reality. Although some <strong>in</strong>cumbentsare defeated <strong>in</strong> every congressional election, it is axiomatic that an <strong>in</strong>cumbentusually beg<strong>in</strong>s the race with significant advantages. 36To see how the 1974 Act <strong>and</strong> subsequent restra<strong>in</strong>ts on contributions help <strong>in</strong>cumbents,recall that a common theme <strong>in</strong> these reforms is that it makes rais<strong>in</strong>g moneymore difficult <strong>and</strong> spend<strong>in</strong>g it less effective. Research has shown that constra<strong>in</strong><strong>in</strong>gboth <strong>in</strong>cumbent <strong>and</strong> challenger fundrais<strong>in</strong>g/spend<strong>in</strong>g harms challengers muchmore than <strong>in</strong>cumbents. A slew <strong>of</strong> research has shown that the marg<strong>in</strong>al ga<strong>in</strong> <strong>in</strong>votes per dollar <strong>of</strong> spend<strong>in</strong>g is substantially greater for challengers. 37 That is, adollar spent by a challenger will <strong>in</strong>crease his or her vote (or vote marg<strong>in</strong>) more thana dollar spent by an <strong>in</strong>cumbent will <strong>in</strong>crease his or her vote (or vote marg<strong>in</strong>). Thepr<strong>in</strong>cipal reason is that challengers (<strong>and</strong> their platforms) are typically not as wellknown as the <strong>in</strong>cumbents they are challeng<strong>in</strong>g. Also, s<strong>in</strong>ce they typically spend farless on their campaigns than do <strong>in</strong>cumbents, their expenditures are especiallyproductive <strong>in</strong> gett<strong>in</strong>g name recognition <strong>and</strong> <strong>in</strong> communicat<strong>in</strong>g <strong>in</strong>formation aboutthemselves <strong>and</strong> their platforms. On the other h<strong>and</strong>, <strong>in</strong>cumbents usually have extensivename recognition already, <strong>and</strong> their positions on issues are fairly well known.In addition, they will have taken advantage <strong>of</strong> free press coverage <strong>and</strong> the manyother perks <strong>of</strong> <strong>of</strong>fice discussed above. As Jeff Milyo observed:The evidence . . . strongly suggests that marg<strong>in</strong>al spend<strong>in</strong>g by <strong>in</strong>cumbents haslittle impact on their electoral success. Even shocks to spend<strong>in</strong>g <strong>of</strong> $100,000 ormore produce no discernible impact on <strong>in</strong>cumbent vote shares. 38In sum, an <strong>in</strong>cumbent knows that additional spend<strong>in</strong>g on his or her owncampaign will be <strong>of</strong> marg<strong>in</strong>al value <strong>in</strong> <strong>in</strong>creas<strong>in</strong>g votes (or vote marg<strong>in</strong>), but thatspend<strong>in</strong>g by an opponent will have a dramatic, threaten<strong>in</strong>g effect. <strong>Money</strong> forchallengers is therefore absolutely essential if a race is to be competitive, <strong>and</strong> if the<strong>in</strong>terests <strong>of</strong> citizens are to be served. Challengers tend to be relatively unknown, <strong>and</strong>without significant resources it is nearly impossible for them to have any chance atsuccess. Thus, it is <strong>in</strong> the <strong>in</strong>terest <strong>of</strong> the <strong>in</strong>cumbent to limit fundrais<strong>in</strong>g overall <strong>and</strong>to encumber the effectiveness <strong>of</strong> spend<strong>in</strong>g.One <strong>in</strong>dication <strong>of</strong> the effectiveness <strong>of</strong> limits on a challenger’s ability to accumulatethe resources necessary to wage a competitive campaign can be found<strong>in</strong> discussions around various proposals to reform the campaign f<strong>in</strong>ance laws.


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 57Consider the proposal <strong>in</strong> one <strong>of</strong> the early versions <strong>of</strong> the McCa<strong>in</strong>-Fe<strong>in</strong>gold/Shays-Meehan bill to limit spend<strong>in</strong>g <strong>in</strong> House races to $600,000 per election cycle.Accord<strong>in</strong>g to Bradley Smith (now a Member <strong>of</strong> the FEC), <strong>in</strong> 1996, every <strong>in</strong>cumbentwho spent less than $500,000 won versus a meager 3 percent <strong>of</strong> challengerswho spent that little. Yet challengers who spent between $500,000 <strong>and</strong> $1 millionwon 40 percent <strong>of</strong> the time, <strong>and</strong> <strong>of</strong> the six who spent more than $1 million, five <strong>of</strong>them won. With respect to the proposal’s variable limits for Senate races (from$1.50 million to $8.25 million per election cycle), <strong>in</strong> 1994 <strong>and</strong> 1996 every challengerwho met the limit lost <strong>and</strong> every <strong>in</strong>cumbent won. 39 It is not surpris<strong>in</strong>g, then,that <strong>in</strong>cumbents do not like their odds aga<strong>in</strong>st well-funded challengers <strong>and</strong> seek tolimit their ability to raise such resources <strong>and</strong> to spend them effectively.The Act also advantages <strong>in</strong>cumbents <strong>in</strong> another way not so generally recognized.By plac<strong>in</strong>g restrictions on the ability <strong>of</strong> c<strong>and</strong>idates to communicate what they have to<strong>of</strong>fer, the Act <strong>in</strong>creases the role <strong>and</strong> <strong>in</strong>fluence <strong>of</strong> the media, which are expresslyexempted from FECA <strong>and</strong> BCRA with respect to news stories, commentaries, <strong>and</strong>editorials. Incumbents have a considerable advantage here: they have taxpayerpaidpress spokesmen; they make news, <strong>and</strong> thus have more access to the media; <strong>and</strong>they have access to “<strong>in</strong>side <strong>in</strong>formation,” which they use to curry favor with thepress (the implicit barga<strong>in</strong> be<strong>in</strong>g “my <strong>in</strong>sider <strong>in</strong>formation <strong>in</strong> exchange for yourfavorable coverage”). The report<strong>in</strong>g requirements also accentuate the role <strong>of</strong> themedia <strong>in</strong> campaigns (<strong>and</strong> dim<strong>in</strong>ish the role <strong>of</strong> the c<strong>and</strong>idates): <strong>in</strong> effect, this<strong>in</strong>formation is a subsidy to the media – giv<strong>in</strong>g it stories that it otherwise would nothave been able to secure so easily. 40Bipartisan Campaign Reform Act <strong>of</strong> 2002With the Bipartisan Campaign Reform Act <strong>of</strong> 2002, Congress had an opportunityto address some <strong>of</strong> the anticompetitive features <strong>of</strong> FECA. On the whole, however,it made matters worse.Title I <strong>of</strong> the BCRA makes it more difficult for political parties to engage <strong>in</strong> educationalactivities that mention the names <strong>of</strong> c<strong>and</strong>idates. While it has the laudablegoal <strong>of</strong> limit<strong>in</strong>g the <strong>in</strong>fluence <strong>of</strong> “special <strong>in</strong>terest money,” it also limits the ability <strong>of</strong>parties to support challengers. Aga<strong>in</strong>, anyth<strong>in</strong>g that makes it more difficult forc<strong>and</strong>idates to get out their messages reduces the competitiveness <strong>of</strong> the politicalmarketplace. 41Section 213 <strong>of</strong> the BCRA says that a political party may engage <strong>in</strong> <strong>in</strong>dependentexpenditures on behalf <strong>of</strong> a c<strong>and</strong>idate or contribute to the c<strong>and</strong>idate’s campaign –but not both. This change further limits the ability <strong>of</strong> challengers, especially, toacquire the requisite funds to mount a serious campaign.Section 304 <strong>of</strong> the BCRA says, <strong>in</strong> effect, that contribution limits are warranted,but when a challenger appears on the horizon who is prepared to augment his orher campaign treasury out <strong>of</strong> his or her own pocket, the contribution limits arerevised upward – but only for the oppos<strong>in</strong>g c<strong>and</strong>idate(s). Furthermore, the c<strong>and</strong>idatewill<strong>in</strong>g to provide full, or even partial, fund<strong>in</strong>g for his or her campaign must


58 James C. Miller IIIsay so <strong>in</strong> advance, thus tipp<strong>in</strong>g <strong>of</strong>f the competition to the campaign strategy. Whiletechnically the provisions conta<strong>in</strong>ed <strong>in</strong> Section 304 would benefit a challengerfac<strong>in</strong>g a self-f<strong>in</strong>anc<strong>in</strong>g <strong>in</strong>cumbent, the real import <strong>of</strong> the provision is to limit theability <strong>of</strong> challengers to mount successful campaigns, s<strong>in</strong>ce over the past years selff<strong>in</strong>anc<strong>in</strong>gappears one <strong>of</strong> the few ways challengers have been successful <strong>in</strong> creat<strong>in</strong>gcompetitive races. 42Section 305 <strong>of</strong> the BCRA requires c<strong>and</strong>idates advertis<strong>in</strong>g over the electronic(radio, TV) <strong>and</strong> pr<strong>in</strong>t media to reserve a portion <strong>of</strong> the message for a complete identification<strong>of</strong> the c<strong>and</strong>idate on whose behalf the advertisement is placed. Althoughthe amount <strong>of</strong> time/space required may not seem all that <strong>in</strong>trusive, the restra<strong>in</strong>tconstitutes a significant dim<strong>in</strong>ution <strong>in</strong> the effectiveness <strong>of</strong> ads, given that they areusually quite short <strong>in</strong> duration or space. Also, there is the further encumbrance thatthe requirement makes the ads somewhat <strong>of</strong>f-putt<strong>in</strong>g <strong>and</strong> therefore even lesseffective. Aga<strong>in</strong>, anyth<strong>in</strong>g that makes the expenditure <strong>of</strong> funds (such as on advertisements)less effective gives further advantage to the <strong>in</strong>cumbent.Sections 312 <strong>and</strong> 314 <strong>of</strong> the BCRA impose more severe crim<strong>in</strong>al penalties forviolations <strong>of</strong> Federal election laws <strong>and</strong> require the US Sentenc<strong>in</strong>g Commission toestablish sentenc<strong>in</strong>g guidel<strong>in</strong>es for such violations. While not tak<strong>in</strong>g issue with thenotion <strong>of</strong> requir<strong>in</strong>g compliance with bona fide law, it is notable that such <strong>in</strong>creasedpenalties, comb<strong>in</strong>ed with the lack <strong>of</strong> familiarity with the Act’s various provisionsfaced by most challengers, makes it even less likely that a challenger would ventureto enter a political contest. 43In a most blatant “everyone is equal, but <strong>in</strong>cumbents are more equal thanothers” provision, Section 403 <strong>of</strong> the Act gives <strong>in</strong>cumbents, but not challengers, theright to <strong>in</strong>tervene personally before the court <strong>in</strong> any challenge to the constitutionality<strong>of</strong> any <strong>and</strong> all provisions <strong>of</strong> the Act. So, if the constitutionality <strong>of</strong> a particularprovision whose effect is to advantage <strong>in</strong>cumbents <strong>and</strong> h<strong>in</strong>der challengers isquestioned, the <strong>in</strong>cumbent will be heard, but the challenger will not. 44The only provision <strong>of</strong> the BCRA that would seem to address the overwhelm<strong>in</strong>gadvantage enjoyed by <strong>in</strong>cumbents <strong>and</strong> the obstacles faced by challengers is Section307, which <strong>in</strong>creases the <strong>in</strong>dividual contribution limit from $1,000 per electioncycle to $2,000, <strong>in</strong>creases the <strong>in</strong>dividual aggregate (Federal-election) limit from$20,000 to $25,000, <strong>and</strong> <strong>in</strong>dexes both limits for <strong>in</strong>flation. Two th<strong>in</strong>gs are notableabout these changes, however. First, the uneven treatment given to other limits iscurious: the PAC contribution limit is neither changed nor <strong>in</strong>dexed, <strong>and</strong> thecontribution limits for state parties are raised, but are not <strong>in</strong>dexed for <strong>in</strong>flation.Second, the doubl<strong>in</strong>g <strong>of</strong> the <strong>in</strong>dividual contribution limit places it <strong>in</strong> real termsbelow the limit the Supreme Court found constitutional <strong>in</strong> Buckley; an adjustmentfor <strong>in</strong>flation alone (not to mention the higher cost <strong>and</strong> greater scope <strong>of</strong> most Federalcampaigns today) would raise the limit to over $3,000. 45 The 25 percent <strong>in</strong>crease <strong>in</strong>the aggregate limit doesn’t even beg<strong>in</strong> to adjust for <strong>in</strong>flation.Thus, by further limit<strong>in</strong>g the ability <strong>of</strong> contributors to fund campaigns, which <strong>in</strong>turn makes it more difficult for c<strong>and</strong>idates to acquire requisite resources, the BCRAcomes down even harder on challengers <strong>and</strong> further <strong>in</strong>creases the monopoly powerfound <strong>in</strong> the market for (Federal) political representation.


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 59Federal election/campaign laws are equivalent to requir<strong>in</strong>ga licenseDeal<strong>in</strong>g with the various Federal election <strong>and</strong> campaign laws <strong>and</strong> regulations hasbecome so burdensome that <strong>in</strong> a real sense a citizen must obta<strong>in</strong> a license from theFederal government <strong>in</strong> order to run for public <strong>of</strong>fice. Consider that before a citizenmay campaign for Federal <strong>of</strong>fice he or she must file certa<strong>in</strong> forms, <strong>in</strong> certa<strong>in</strong> ways,with the FEC <strong>and</strong> agree to abide by its rules <strong>and</strong> regulations. 46The c<strong>and</strong>idate must have his or her campaign file an <strong>in</strong>itial FEC report (directlywith the FEC, <strong>in</strong> the case <strong>of</strong> a run for the House <strong>of</strong> Representatives, <strong>and</strong> with theSecretary <strong>of</strong> the Senate <strong>in</strong> the case <strong>of</strong> a run for the Senate) <strong>and</strong> send a copy to therelevant state agency. The c<strong>and</strong>idate must set up a formal campaign committee,recruit a treasurer, <strong>and</strong> have that person make the fil<strong>in</strong>g <strong>and</strong> all subsequent reportsto the FEC. 47 (The c<strong>and</strong>idate files only FEC Form 2: Statement <strong>of</strong> C<strong>and</strong>idacy.)When I served as treasurer <strong>of</strong> my spouse’s campaign for Congress <strong>in</strong> 1998, Ireceived, after the <strong>in</strong>itial fil<strong>in</strong>g, the follow<strong>in</strong>g from the FEC: (a) a pamphlet oncommittee treasurers, (b) a copy <strong>of</strong> the FEC’s latest newsletter, The Record, (c) a copy<strong>of</strong> FEC Disclosure Form 3: Report <strong>of</strong> Receipts <strong>and</strong> Disbursements for anAuthorized Committee, together with <strong>in</strong>structions, (d) a list <strong>of</strong> state <strong>of</strong>fices wherecopies <strong>of</strong> all reports must be filed, (e) a repr<strong>in</strong>t <strong>of</strong> an article describ<strong>in</strong>g how to filedisclosure reports electronically, (f) a copy <strong>of</strong> the report<strong>in</strong>g schedule for the year,(g) a notice about the FEC’s fax l<strong>in</strong>e, (h) an announcement <strong>of</strong> upcom<strong>in</strong>g FECconferences (with no <strong>in</strong>dication whether they are optional or compulsory), (i) acompendium <strong>of</strong> Federal election campaign laws, <strong>and</strong> ( j) a copy <strong>of</strong> the latest issue <strong>of</strong>the Code <strong>of</strong> Federal Regulations deal<strong>in</strong>g with Federal elections. The number <strong>of</strong> pagestotaled 618, <strong>and</strong> the package weighed 1 pound, 12.5 ounces. And that’s not theend. Whether respond<strong>in</strong>g to <strong>of</strong>ten-<strong>in</strong>decipherable questions from the FEC’s staffabout fil<strong>in</strong>gs or guess<strong>in</strong>g about appropriate (vs. <strong>in</strong>appropriate) language to use <strong>in</strong>answer<strong>in</strong>g their questions or questions on the various FEC forms, the c<strong>and</strong>idate isrem<strong>in</strong>ded constantly that <strong>in</strong> order to run for <strong>of</strong>fice he or she has to secure <strong>and</strong>ma<strong>in</strong>ta<strong>in</strong> a license from the Federal government. 48To see what ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g this license is all about, consider that a mistake on areport, no matter how immaterial, can result <strong>in</strong> frustrat<strong>in</strong>g <strong>and</strong> time-consum<strong>in</strong>gdeal<strong>in</strong>gs with the FEC. As an example, consider the letter <strong>of</strong> <strong>in</strong>quiry I receivedfollow<strong>in</strong>g a midyear report submitted more than one full year after I had lost aprimary election for the US Senate. In part it reads:Your report discloses a . . . loan from the c<strong>and</strong>idate on L<strong>in</strong>e 13(a) <strong>of</strong> the DetailedSummary Page. It appears that this loan was used to f<strong>in</strong>ance expenditures madedirectly by the c<strong>and</strong>idate (pert<strong>in</strong>ent portion attached). Please note that expensesadvanced by the c<strong>and</strong>idate or other committee staff members constitute debtsrather than loans; <strong>and</strong> should be reported <strong>in</strong> the follow<strong>in</strong>g manner: the advanceshould be itemized as a contribution on Schedule A <strong>and</strong> listed as a memo entry.If, however, the advance was paid <strong>in</strong> the same report<strong>in</strong>g period <strong>in</strong> which it wasmade, the fil<strong>in</strong>g <strong>of</strong> a Schedule A is not required. When the repayment is made,


60 James C. Miller IIIthe transaction should be itemized on a Schedule B support<strong>in</strong>g L<strong>in</strong>e 17. If theultimate payee (vendor) requires itemization, it should be listed on Schedule B asa memo entry directly below the entry itemiz<strong>in</strong>g the repayment <strong>of</strong> the advance.Cont<strong>in</strong>uous report<strong>in</strong>g (on Schedule D) <strong>of</strong> all outst<strong>and</strong><strong>in</strong>g debts is required.Please amend your report, if necessary.What is not clear from the letter is that the problem stemmed from a transcriptionerror <strong>in</strong> my report to the FEC, <strong>in</strong>dicat<strong>in</strong>g that a major deposit to the campaignaccount had been made the day after the campaign had written a major check to avendor.The learn<strong>in</strong>g curve <strong>and</strong> costs <strong>in</strong>volved <strong>in</strong> deal<strong>in</strong>g with such report<strong>in</strong>g requirementsare substantial <strong>and</strong> amount to ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g a license to run for Federal<strong>of</strong>fice. 49Political markets <strong>in</strong> the absence <strong>of</strong> Federal laws <strong>and</strong>rules limit<strong>in</strong>g competitionThose who have been most adamant about the need for stricter regulation <strong>of</strong> Federalelection campaigns no doubt will respond to the criticisms leveled above by suggest<strong>in</strong>gthat the alternative – the elim<strong>in</strong>ation <strong>of</strong> anticompetitive restra<strong>in</strong>ts – wouldbe far worse. That is not the case. As outl<strong>in</strong>ed briefly below, a regime where currentanticompetitive restrictions were removed would be far more competitive, <strong>and</strong>elected <strong>of</strong>ficials would respond much more efficiently <strong>and</strong> effectively to citizens’preferences.An important caveat: the regime posited does not contemplate the removal <strong>of</strong>any laws <strong>and</strong> implement<strong>in</strong>g regulations affect<strong>in</strong>g who is allowed to contribute,fraud, <strong>and</strong> other crim<strong>in</strong>al acts. That is a whole separate issue. What is posited is therepeal <strong>of</strong> anticompetitive laws <strong>and</strong> the elim<strong>in</strong>ation <strong>of</strong> anticompetitive regulations.Under this regime, corporations <strong>and</strong> unions would still not be allowed to contributedirectly, voter fraud would still be a crime, <strong>and</strong> so would buy<strong>in</strong>g votes, brib<strong>in</strong>gelected <strong>of</strong>ficials, etc. Although there are variations on what might be characterizedas a regime free (or relatively free) <strong>of</strong> anticompetitive restra<strong>in</strong>ts, the follow<strong>in</strong>gdiscussion assumes the repeal <strong>of</strong> virtually all <strong>of</strong> FECA <strong>and</strong> BCRA. It also assumesthe disestablishment <strong>of</strong> the FEC <strong>and</strong> the withdrawal <strong>of</strong> all its rules. 50How would political markets perform under such a regime? Much more efficiently<strong>and</strong> effectively than at present – <strong>and</strong> relatively free <strong>of</strong> the unsavory practicescritics are likely to propound as the <strong>in</strong>evitable consequence <strong>of</strong> any free<strong>in</strong>g up <strong>of</strong>current legal <strong>and</strong> regulatory requirements.First, three “macro” issues. It will be said that with no limits on contributions,total expenditures on Federal campaigns would be exorbitant. Judged by spend<strong>in</strong>gon the commercial-market analogue – advertis<strong>in</strong>g – this is very unlikely. In MonopolyPolitics, I conservatively estimate that spend<strong>in</strong>g (<strong>of</strong> all types) on Federal campaignsper dollar <strong>of</strong> “sales” is only half <strong>of</strong> what is spent on advertis<strong>in</strong>g (per dollar <strong>of</strong> sales) <strong>in</strong>the commercial sector. 51 Lift<strong>in</strong>g the lid on contributions would not likely result <strong>in</strong>more than a doubl<strong>in</strong>g <strong>of</strong> campaign spend<strong>in</strong>g. In any event, the greatest <strong>in</strong>crease <strong>in</strong>


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 61expenditures would be on the part <strong>of</strong> challengers, <strong>and</strong> this would make the politicalmarket more efficient <strong>and</strong> more effective.In addition, it will be argued that without limits on contributions some groups <strong>in</strong>society would have “undue <strong>in</strong>fluence” on elected <strong>of</strong>ficials. The question is one <strong>of</strong>degree. Undoubtedly, some contributors have “undue <strong>in</strong>fluence” now. Would thepractice be more widespread <strong>in</strong> the regime posited? Interests could contributemore, but to some extent their contributions would cancel out, as others, withopposite <strong>in</strong>terests, competed for favors. On the other h<strong>and</strong>, “<strong>in</strong>terests” <strong>and</strong> otherswould have alternatives to “purchas<strong>in</strong>g” <strong>in</strong>fluence with elected <strong>of</strong>ficials – support<strong>in</strong>gchallengers. As we shall see below, this makes all the difference.It will also be argued that a lack <strong>of</strong> limits on contributions would lead to generalcorruption <strong>in</strong> political contests. Yet the evidence on this issue suggests otherwise.The states <strong>of</strong> Virg<strong>in</strong>ia <strong>and</strong> Texas have no limits on contributions by <strong>in</strong>dividuals <strong>in</strong>statewide elections, <strong>and</strong> there appears to be no more corruption <strong>in</strong> these politicalmarkets than <strong>in</strong> states hav<strong>in</strong>g strict limits on contributions.Without limits on contributions <strong>and</strong> limits on the productivity <strong>of</strong> expenditures(such as the form <strong>and</strong> content <strong>of</strong> messages), political markets would be much, muchmore competitive. Challengers would f<strong>in</strong>d it much easier to accumulate theresources necessary to mount effective campaigns. (For one th<strong>in</strong>g, <strong>in</strong> the absence <strong>of</strong>disclosure, a contributor want<strong>in</strong>g to support a challenger would not have to worrythat the <strong>in</strong>cumbent might f<strong>in</strong>d out <strong>and</strong> seek retribution.) In contrast, to a considerableextent, it really does not matter how much money <strong>in</strong>cumbents acquire, for, asdiscussed above, the marg<strong>in</strong>al product <strong>of</strong> <strong>in</strong>cumbent spend<strong>in</strong>g (<strong>in</strong> terms <strong>of</strong> votes orvote share) tends to be <strong>in</strong>consequential, whereas it tends to be quite positive forchallengers. The old adage <strong>in</strong> politics, “It doesn’t matter how much money youropponent raises; what matters is whether you can raise enough to be competitive,”is operative here.The absence <strong>of</strong> a requirement for c<strong>and</strong>idates to obta<strong>in</strong> a Federal “license” beforerunn<strong>in</strong>g for <strong>of</strong>fice (committee, treasurer, <strong>in</strong>itial fil<strong>in</strong>g, periodic fil<strong>in</strong>gs, respond<strong>in</strong>g to<strong>in</strong>quiries, etc.), <strong>and</strong> the removal <strong>of</strong> threat <strong>of</strong> prosecution because <strong>of</strong> violations <strong>of</strong>laws with which few are familiar, would make it possible for more citizens to run forFederal <strong>of</strong>fice. Also, with more resources with which to make a run, c<strong>and</strong>idateswould be better able to communicate their agendas <strong>and</strong> their qualifications.In a more competitive political market, elected <strong>of</strong>ficials would be more accountable.Without the assurance <strong>of</strong> so many contrived advantages <strong>in</strong> election contests,<strong>in</strong>cumbents would no longer have so much “freedom” to ignore the wishes <strong>of</strong>citizens. They would have less room to maneuver <strong>and</strong> would be less responsive to“<strong>in</strong>terest groups.”For those who believe transparency with respect to contributions is highly desirable,there would be a “market test” <strong>of</strong> that proposition. As did Governor GeorgeW. Bush when he ran for president <strong>in</strong> 2000, those seek<strong>in</strong>g <strong>of</strong>fice might voluntarilypublish their contributors (<strong>and</strong> amounts) on the Internet. This could be a readysource <strong>of</strong> differentiation between c<strong>and</strong>idates <strong>and</strong> an important sell<strong>in</strong>g po<strong>in</strong>t. Ac<strong>and</strong>idate might publish on the Internet contributions not now required to bereported to the FEC. C<strong>and</strong>idates might also make other strategic decisions, such as


62 James C. Miller IIIrefus<strong>in</strong>g to accept funds from bus<strong>in</strong>ess, or labor, or other “<strong>in</strong>terest” groups, if theythought such tactics would <strong>in</strong>crease their chances for election.The po<strong>in</strong>t is, a regime <strong>in</strong> which anticompetitive campaign laws <strong>and</strong> regulationswere elim<strong>in</strong>ated would not degenerate <strong>in</strong>to “the law <strong>of</strong> the jungle.” To the contrary,political markets would be more orderly <strong>and</strong> far more responsive to the <strong>in</strong>terests <strong>of</strong>the electorate.Notes1 Chairman <strong>of</strong> The CapAnalysis Group, an affiliate <strong>of</strong> the <strong>in</strong>ternational law firm, HowreySimon Arnold & White, Dist<strong>in</strong>guished Fellow at the Center for Study <strong>of</strong> Public Choiceat George Mason University as well as the university’s Mercatus Center, <strong>and</strong> SeniorFellow (by courtesy) <strong>of</strong> the Hoover Institution. This contribution is based on the author’sexpert report submitted to the US Supreme Court <strong>in</strong> Congressman Ron Paul, et al. v. FederalElection Commission, et al. (2002). Useful comments by William Olson, Parker Normann,<strong>and</strong> Jeff Eisenach are gratefully acknowledged.2 James C. Miller III (1999). Monopoly Politics. Stanford: Hoover Press.3 Much <strong>of</strong> this research is <strong>in</strong> the field <strong>of</strong> public choice.4 For more on the similarities <strong>and</strong> differences between commercial markets <strong>and</strong> politicalmarkets, see Monopoly Politics, Chapters 2–4.5 The follow<strong>in</strong>g discussion replicates po<strong>in</strong>ts made <strong>in</strong> Donald Wittman (1989). WhyDemocracies Produce Efficient Results. Journal <strong>of</strong> Political Economy, 97(4): 1395–424.6 Political parties withdraw their support <strong>of</strong> c<strong>and</strong>idates – especially <strong>in</strong>cumbents – veryrarely.7 Adam Smith (1937). An Inquiry <strong>in</strong>to the Nature <strong>and</strong> Causes <strong>of</strong> the Wealth <strong>of</strong> Nations. New York:Modern Library, p. 128.8 The analogy <strong>in</strong> commercial markets should be evident: more desirable location <strong>and</strong>establishments, superior product/service l<strong>in</strong>e, more effective advertis<strong>in</strong>g, <strong>and</strong> betterreputation.9 There are modest restrictions on use <strong>of</strong> the frank. See Monopoly Politics, pp. 77–8.10 There are also modest restrictions on the use <strong>of</strong> these <strong>in</strong>struments for political purposes.See Monopoly Politics, p. 76.11 When governments jo<strong>in</strong> the “digital revolution,” elected <strong>of</strong>ficials typically comm<strong>and</strong>eerfor themselves the up-front cost (web pages, e-mail, etc.). See C<strong>in</strong>dy Cr<strong>and</strong>all <strong>and</strong> JeffEisenach (1998). The Digital State. Wash<strong>in</strong>gton: Progress & Freedom Foundation.12 National Taxpayers Union <strong>and</strong> Federal Election Commission. The po<strong>in</strong>t made aboutthe <strong>in</strong>cumbent’s spend<strong>in</strong>g on franked mail versus challengers’ campaign spend<strong>in</strong>g wasnoted <strong>in</strong> Steve Symms (1997). Campaign F<strong>in</strong>ance Reform Ga<strong>in</strong>ers. Wash<strong>in</strong>gton Times,13August, p. A14.13 Albert D. Cover <strong>and</strong> Bruce S. Brumberg (1982). Baby Books <strong>and</strong> Ballots: The Impact<strong>of</strong> Congressional Mail on Constituent Op<strong>in</strong>ion. American Political Science Review, 76(2):347–59.14 Norman S. Ornste<strong>in</strong>, Thomas E. Mann, <strong>and</strong> Michael J. Malb<strong>in</strong> (1998). Vital Statistics onCongress, 1997–1998. Wash<strong>in</strong>gton, DC: Congressional Quarterly.15 Yiannakis found that constituent service is especially effective <strong>in</strong> attract<strong>in</strong>g supporters <strong>of</strong>the <strong>in</strong>cumbent’s challenger. See Diana Evans Yiannakis (1981). The Grateful Electorate:Casework <strong>and</strong> Congressional Elections. American Journal <strong>of</strong> Political Science, 25(3): 568–80.Serra <strong>and</strong> Cover found that constituent service creates a positive evaluation <strong>of</strong> the<strong>in</strong>cumbent <strong>and</strong> has the most impact on constituents where only a small portion <strong>of</strong> themidentify with the <strong>in</strong>cumbent’s party. See George Serra <strong>and</strong> Albert D. Cover (1992). TheElectoral Consequences <strong>of</strong> Perquisite Use: The Casework Case. Legislative StudiesQuarterly, 17: 233–46.


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 63Serra <strong>and</strong> Moon found that voters respond to constituent service <strong>and</strong> implied thatconstituent service might be able to <strong>of</strong>fset policy differences between the <strong>in</strong>cumbent <strong>and</strong>his or her constituents. See George Serra <strong>and</strong> David Moon (1994). Casework, IssuePosition, <strong>and</strong> Vot<strong>in</strong>g <strong>in</strong> Congressional Elections: A District Analysis. Journal <strong>of</strong> Politics, 56:200–13.16 Morris Fior<strong>in</strong>a (1981). Some Problems <strong>in</strong> Study<strong>in</strong>g the Effects <strong>of</strong> Resource Allocation onCongressional Elections. American Journal <strong>of</strong> Political Science, 25: 543–67.17 Gerald W. Scully (1995). Congressional Tenure: Myth <strong>and</strong> Reality. Public Policy,203–19.18 Robert M. Ste<strong>in</strong> <strong>and</strong> Kenneth N. Bickers (1994). Congressional Elections <strong>and</strong> the PorkBarrel. Journal <strong>of</strong> Politics, 56: 377–99.19 Kenneth N. Bickers <strong>and</strong> Robert M. Ste<strong>in</strong> (1996). The Electoral Dynamics <strong>of</strong> the FederalPork Barrel. American Journal <strong>of</strong> Political Science, 40(4): 1300–26.20 R<strong>and</strong>all W. Bennett <strong>and</strong> Christ<strong>in</strong>e Loucks (1994). Sav<strong>in</strong>gs <strong>and</strong> Loan <strong>and</strong> F<strong>in</strong>anceIndustry PAC Contributions to Incumbent Members <strong>of</strong> the House Bank<strong>in</strong>g Committee.Public Choice, 79: 83–104.21 Mark W. Cra<strong>in</strong> <strong>and</strong> John T. Sullivan (1997). Committee Characteristics <strong>and</strong> Re-electionMarg<strong>in</strong>s: An Empirical Investigation <strong>of</strong> the U.S. House. Public Choice, 93(3–4): 271–85.22 For example, Loucks found an <strong>in</strong>crease <strong>in</strong> PAC contributions from appo<strong>in</strong>tment to theSenate Bank<strong>in</strong>g Committee. Christ<strong>in</strong>e Loucks (1996). F<strong>in</strong>ance Industry PAC Contributionsto U.S. Senators, 1983–88. Public Choice, 219–29.Kroszner <strong>and</strong> Stratmann found that committee members get more money from PACswith an <strong>in</strong>terest <strong>in</strong> their jurisdictions, <strong>and</strong> the contributions rise with seniority. R<strong>and</strong>allS. Kroszner <strong>and</strong> Thomas Stratmann (1998). Interest Group Competition <strong>and</strong> theOrganization <strong>of</strong> Congress: Theory <strong>and</strong> Evidence from F<strong>in</strong>ancial Services PoliticalAction Committees. American Economic Review, 88(5): 1163–87.Anagnoson found that dur<strong>in</strong>g election years federal agencies speed up their approval<strong>of</strong> grants to the constituents <strong>of</strong> representatives who are on committees with authorityover them. Theodore Anagnoson (1982). Federal Grant Agencies <strong>and</strong> CongressionalElection Campaigns. American Journal <strong>of</strong> Political Science, 26: 547–61.23 Roberts found that the death <strong>of</strong> Senator Scoop Jackson (then a member <strong>of</strong> the SenateArmed Services Committee) depressed the prices <strong>of</strong> stocks <strong>of</strong> companies <strong>in</strong> Jackson’sstate <strong>and</strong> raised the prices <strong>of</strong> stocks <strong>in</strong> the home state <strong>of</strong> his successor. Brian E. Roberts(1990). A Dead Senator Tells No Lies: Seniority <strong>and</strong> the Distribution <strong>of</strong> Federal Benefits.American Journal <strong>of</strong> Political Science, 34(1): 31–58.24 Janet Box-Steffensmeier (1996). A Dynamic Analysis <strong>of</strong> the Role <strong>of</strong> War Chests <strong>in</strong>Campaign Strategy. American Journal <strong>of</strong> Political Science, 352–71.25 F<strong>in</strong>ancial activities <strong>of</strong> house c<strong>and</strong>idates, 1996, FEC (http://www.fedc.gov/1996/dates).26 It is really not necessary to prove motive here. It is the effect <strong>of</strong> the laws <strong>in</strong> limit<strong>in</strong>gcompetition, whatever their <strong>of</strong>ficial or secret rationale.27 For a more thorough exam<strong>in</strong>ation, see Monopoly Politics, esp. Chapter 5.28 Theodore J. Lowi (1996). A Ticket to Democracy. New York Times, 28 December,p. A27.29 James T. Hamilton <strong>and</strong> Helen F. Ladd (1996). Biased Ballots?: The Impact <strong>of</strong> BallotStructure on North Carol<strong>in</strong>a Elections <strong>in</strong> 1992. Public Choice, 87: 259–80.30 David J. Gopoian <strong>and</strong> Darrell M. West (1984). Trad<strong>in</strong>g Security for Seats: StrategicConsiderations <strong>in</strong> the Redistrict<strong>in</strong>g Process. Journal <strong>of</strong> Politics, 46: 1080–96.31 Gary K<strong>in</strong>g (1989). Representation through Legislative Redistrict<strong>in</strong>g: A StochasticModel. American Journal <strong>of</strong> Political Science, 33(4): 787–824; Janet Campagna <strong>and</strong> BernardGr<strong>of</strong>man (1990). Party Control <strong>and</strong> Partisan Bias <strong>in</strong> the 1980s CongressionalRedistrict<strong>in</strong>g. Journal <strong>of</strong> Politics, 52(4): 1242–57; <strong>and</strong> Bruce E. Ca<strong>in</strong> (1985). Assess<strong>in</strong>g thePartisan Effects <strong>of</strong> Redistrict<strong>in</strong>g. American Political Science Review, (79)2: 320–33.32 See Buckley v. Valeo, 424 US 1 (1976).


64 James C. Miller III33 Peter H. Aranson <strong>and</strong> Melv<strong>in</strong> J. H<strong>in</strong>ich (1979). Some Aspects <strong>of</strong> the Political Economy<strong>of</strong> Election Campaign Contribution Laws. Public Choice, 34(5): 435–61.34 Burton A. Abrams <strong>and</strong> Russell F. Settle (1978). The Economic Theory <strong>of</strong> Regulation<strong>and</strong> Public F<strong>in</strong>anc<strong>in</strong>g <strong>of</strong> Presidential Elections. Journal <strong>of</strong> Political Economy, 86(2): 245–57.35 Bruce Bender (1968). An Analysis <strong>of</strong> Congressional Vot<strong>in</strong>g on Legislation Limit<strong>in</strong>gCongressional Expenditures. Journal <strong>of</strong> Political Economy, 1005–21.36 As quoted <strong>in</strong> Aranson <strong>and</strong> H<strong>in</strong>ich, “Some Aspects,” p. 451.37 See, for example, Aranson <strong>and</strong> H<strong>in</strong>ich, “Some Aspects”; Bruce Bender, “An Analysis <strong>of</strong>Congressional Vot<strong>in</strong>g,” pp. 1005–21; Amihai Glazer (1993). On the Incentives toEstablish <strong>and</strong> Play Political Rent-Seek<strong>in</strong>g Games. Public Choice, 75(2): 139–48; Gary C.Jacobson (1985). <strong>Money</strong> <strong>and</strong> Votes Re-considered: Congressional Elections, 1972–82.Public Choice, 47(1): 7–62 <strong>and</strong> (1990). The Effects <strong>of</strong> Campaign Spend<strong>in</strong>g <strong>in</strong> HouseElections: New Evidence for Old Arguments. American Journal <strong>of</strong> Political Science, 34:334–62; Christopher Kenny <strong>and</strong> Michael McBurnett (1992). A Dynamic Model <strong>of</strong> theEffect <strong>of</strong> Campaign Spend<strong>in</strong>g on Congressional Vote Choice. American Journal <strong>of</strong> PoliticalScience, 36(4): 923–37; John R. Lott (1991). Does Additional Campaign Spend<strong>in</strong>g ReallyHurt Incumbents?: The Theoretical Importance <strong>of</strong> Past Investments <strong>in</strong> Political Br<strong>and</strong>Name. Public Choice, 87–92; John L. Mikesell (1987). A Note on Senatorial Mass Mail<strong>in</strong>gExpenditures <strong>and</strong> the Quest for Reelection. Public Choice, 53: 257–65; Dennis C. Mueller(1989). Public Choice II. New York: Cambridge University Press, pp. 209–12; K. FilipPalda <strong>and</strong> Kristian S. Palda (1985). Ceil<strong>in</strong>gs on Campaign Spend<strong>in</strong>g: Hypothesis <strong>and</strong>Partial Test with Canadian Data. Public Choice, 45: 313–31; <strong>and</strong> Thomas J. Scott (1989).Do Incumbent Campaign Expenditures Matter? Journal <strong>of</strong> Politics, 51: 965–76.38 Jeff Milyo (1998). The Electoral Effects <strong>of</strong> Campaign Spend<strong>in</strong>g <strong>in</strong> House Elections. Citizens’Research Foundation, University <strong>of</strong> Southern California, June 1998, p. 27.39 Bradley A. Smith (1997). Why Campaign F<strong>in</strong>ance Reform Never Works. Wall StreetJournal, 19 March, p. A19.40 Under the Act, a newspaper, for example, may make news-story, commentary, <strong>and</strong>editorial (<strong>in</strong>-k<strong>in</strong>d) contributions to a c<strong>and</strong>idate unless the newspaper is owned by thec<strong>and</strong>idate. However, a supporter <strong>of</strong> the c<strong>and</strong>idate may purchase a newspaper <strong>and</strong> runnews-stories, commentaries, <strong>and</strong> editorials on behalf <strong>of</strong> the c<strong>and</strong>idate without restra<strong>in</strong>t.41 Section 103 <strong>of</strong> Title I waives the relevant restra<strong>in</strong>ts when the money is to be used toconstruct build<strong>in</strong>gs to house the political parties.42 See, for example, Larry J. Sabato <strong>and</strong> Glenn R. Simpson (1994). <strong>Money</strong> Talks, VotersListen. Wall Street Journal, 28 December, p. A12.43 Given the <strong>in</strong>credible complexity <strong>of</strong> the campaign laws, challengers justifiably would befearful <strong>of</strong> even <strong>in</strong>nocent mistakes. Consider, for example, the f<strong>in</strong>al regulations <strong>and</strong> associatedexplanation <strong>and</strong> justification the FEC promulgated <strong>in</strong> 9 February 1995 regulat<strong>in</strong>gall expenditures by pr<strong>in</strong>cipal campaign committees designed to prohibit personal use.These regulations run 14 pages, <strong>in</strong> the Federal Register, are far from clear, <strong>and</strong> conveythe notion that it is really impossible to write a clear rule, <strong>and</strong> therefore violations mustbe left to the judgment <strong>of</strong> the FEC. Given that penalties under the BCRA for know<strong>in</strong>g orwillful violations <strong>in</strong>volv<strong>in</strong>g mak<strong>in</strong>g, receiv<strong>in</strong>g, <strong>and</strong> report<strong>in</strong>g contributions or expenditurescan run as high as $25,000 <strong>and</strong> imprisonment <strong>of</strong> up to five years, novice would-bechallengers might opt never to run for <strong>of</strong>fice.44 Because <strong>of</strong> my experience <strong>in</strong> government, I am aware <strong>of</strong> the deference the courts affordCongress. But the <strong>in</strong>stances with which I am aware go to broad policy issues. In these<strong>in</strong>stances, the law is brazen <strong>in</strong> its uneven treatment <strong>of</strong> those compet<strong>in</strong>g for the privilege<strong>of</strong> represent<strong>in</strong>g us: one set <strong>of</strong> rules for <strong>in</strong>cumbents, another (less desirable) set forchallengers.45 See Monopoly Politics, p. 116.46 Various matters trigger the requirement to file as a c<strong>and</strong>idate, such as rais<strong>in</strong>g or spend<strong>in</strong>gover $5,000.


Monopoly politics <strong>and</strong> its unsurpris<strong>in</strong>g effects 6547 Moreover, accord<strong>in</strong>g to the FEC, the treasurer has unlimited personal liability – surelyan impediment, especially for challengers.48 See Monopoly Politics, pp. 96–100.49 It is worth not<strong>in</strong>g that this license requirement gives <strong>in</strong>cumbents another specialadvantage, for it says, <strong>in</strong> effect, that a challenger must give ample, <strong>and</strong> formal, notice toan <strong>in</strong>cumbent that “I want your job.”50 These changes, <strong>of</strong> course, would not remove all forms <strong>of</strong> contrived advantages. SeeMonopoly Politics, esp. Chapter 6.51 See Monopoly Politics, pp. 117–18.


6 Good ideas <strong>and</strong> bad regressionsThe sad state <strong>of</strong> empirical work <strong>in</strong>public choiceSteven B. Caudill *It was the late 1990s. As I walked down the hallway my young colleague, JohnWells, a times-series econometrician, was st<strong>and</strong><strong>in</strong>g <strong>in</strong> his <strong>of</strong>fice doorway mutter<strong>in</strong>gsometh<strong>in</strong>g about an “<strong>in</strong>tervention analysis.” I asked, “John, isn’t an <strong>in</strong>terventionwhen your family <strong>and</strong> close friends get you <strong>in</strong>to a room <strong>and</strong> confront you aboutestimat<strong>in</strong>g bad regressions?”(S.B. Caudill)ForewordWe face an epidemic <strong>of</strong> bad empirical work <strong>in</strong> economics <strong>and</strong> much <strong>of</strong> it can befound <strong>in</strong> the public choice area. My goal is to characterize <strong>and</strong> criticize a cavalierapproach to empirical work that I first noticed <strong>in</strong> papers <strong>in</strong> the areas <strong>of</strong> publicchoice <strong>and</strong> the sociology <strong>of</strong> economics. I <strong>in</strong>clude the latter because much <strong>of</strong> thework <strong>in</strong> the sociology <strong>of</strong> economics is an extension <strong>of</strong> public choice <strong>and</strong> many <strong>of</strong> thesame researchers are <strong>in</strong>volved. If my characterization <strong>of</strong> public choice is “goodideas <strong>and</strong> bad regressions,” then my characterization <strong>of</strong> the sociology <strong>of</strong> economicsis either “worse ideas <strong>and</strong> bad regressions” or “no ideas <strong>and</strong> bad regressions.”There are no theories <strong>in</strong> the sociology <strong>of</strong> economics. Both public choice <strong>and</strong> thesociology <strong>of</strong> economics employ a common approach to empirical research that Ihenceforth refer to as the PC approach.Despite the suggestions <strong>of</strong> my colleagues, I do not plan to “name names” so that,<strong>in</strong> the words <strong>of</strong> my market<strong>in</strong>g colleague, Herbert Rotfeld, “more people will feelguilty.” The lone exception I make is to exam<strong>in</strong>e, <strong>in</strong> detail, the bad regression <strong>in</strong> thepaper by Lab<strong>and</strong> <strong>and</strong> Taylor published <strong>in</strong> Economic Inquiry <strong>in</strong> 1992 entitled, “TheImpact <strong>of</strong> Bad Writ<strong>in</strong>g <strong>in</strong> Economics.” I use this paper <strong>and</strong> identify the authorsbecause the econometrics there<strong>in</strong> has previously been criticized <strong>in</strong> pr<strong>in</strong>t by McCloskey(1992). I merely echo McCloskey’s criticisms to evaluate my characterization <strong>of</strong> abad regression.In this Foreword I wish to <strong>in</strong>dicate why I, <strong>in</strong> particular, am bothered by the PCapproach to empirical work. The explanation is found <strong>in</strong> my background <strong>and</strong> tra<strong>in</strong><strong>in</strong>gas an economist, the general nature <strong>of</strong> PC empirical work, <strong>and</strong> my experienceteach<strong>in</strong>g econometrics courses to PhD students at Auburn University.


Good ideas <strong>and</strong> bad regressions 67I evaluate all empirical research <strong>in</strong> light <strong>of</strong> my tra<strong>in</strong><strong>in</strong>g as an econometrician.My PhD is from the University <strong>of</strong> Florida. There, I studied under the prom<strong>in</strong>enteconometrician, G.S. Maddala, a leader <strong>in</strong> the development <strong>of</strong> limited-dependentvariable models. The importance <strong>of</strong> these limited-dependent variable models <strong>in</strong>economics is <strong>in</strong>dicated, <strong>in</strong> part, by the fact that the Nobel Prize <strong>in</strong> Economicsfor the year 2000 is shared by James J. Heckman <strong>and</strong> Daniel L. McFadden for work<strong>in</strong> this area.As the name suggests, limited-dependent variable means the dependent variableis limited <strong>in</strong> some way. This differs from the usual ord<strong>in</strong>ary least squares, orOLS, assumption <strong>of</strong> normality. The normality assumption implies a dependentvariable that is cont<strong>in</strong>uous <strong>and</strong> has unlimited range. Instead, <strong>in</strong> limited-dependentvariable models, the dependent variable could be dichotomous (such as a yes or novote), ord<strong>in</strong>al (such as low, medium, or high), or an <strong>in</strong>teger (such as number <strong>of</strong>coauthors). In fact, the dependent variable might consist <strong>of</strong> any comb<strong>in</strong>ation <strong>of</strong> theabove. Estimation <strong>of</strong> these models by OLS generally leads to estimators that areunbiased but <strong>in</strong>efficient. That is, there exist more efficient estimators than OLS foruse <strong>in</strong> the presence <strong>of</strong> limited-dependent variables. Limited-dependent variablesoccur quite <strong>of</strong>ten <strong>in</strong> PC data, yet the methods for mak<strong>in</strong>g efficient use <strong>of</strong> this limited<strong>in</strong>formation are almost never applied. By look<strong>in</strong>g only at the dependent variable <strong>in</strong>a PC regression model one can determ<strong>in</strong>e whether a more efficient statisticalprocedure is <strong>in</strong>dicated. These more efficient procedures have been used extensively<strong>in</strong> other areas <strong>of</strong> economics, but are not widely applied <strong>in</strong> public choice <strong>and</strong> thesociology <strong>of</strong> economics.My concern about the state <strong>of</strong> PC research stems partly from my role as aneducator. I have tra<strong>in</strong>ed several <strong>of</strong> the economists presently estimat<strong>in</strong>g “bad regressions”to <strong>in</strong>clude <strong>in</strong> their PC papers. Many <strong>of</strong> the students attracted to the PhDprogram at Auburn University were <strong>in</strong>terested <strong>in</strong> Austrian economics <strong>and</strong> theLudwig von Mises Institute. Most <strong>of</strong> these students, although obligated to takecourses <strong>in</strong> econometrics, had little use for the subject. Those students frequentlyquoted von Mises (1966) that statistics was a method <strong>of</strong> history. In my role as pr<strong>of</strong>essor,I tried to show these Austrian students the usefulness <strong>of</strong> econometricmethods. I encouraged, pleaded, <strong>and</strong> cajoled them <strong>in</strong>to learn<strong>in</strong>g some econometrics.Unfortunately, many <strong>of</strong> these students are today estimat<strong>in</strong>g the same “badregressions” I criticize <strong>in</strong> this paper. By do<strong>in</strong>g so, my former students are demonstrat<strong>in</strong>gjust how useless econometrics is. I feel a little guilt about this matter <strong>and</strong>properly so. Either I should have been a better teacher or I should have left wellenough alone.IntroductionSome years ago, I attended a meet<strong>in</strong>g <strong>of</strong> the Southern Economic Association.There I attended one <strong>of</strong> many public choice sessions. I took my seat <strong>and</strong> listened toa newly-m<strong>in</strong>ted PhD lecture the crowd on the subject <strong>of</strong> the “size <strong>of</strong> state government”or “state government growth.” The lecture was go<strong>in</strong>g very well <strong>and</strong> thenthe speaker came to the discussion <strong>of</strong> his empirical results. The first <strong>in</strong>dependent


68 Steven B. Caudillvariable he discussed was the average altitude <strong>of</strong> the state. The higher the altitude,the more difficult to leave, <strong>and</strong> difficulty leav<strong>in</strong>g implied more monopoly power, orso we were told. One has visions <strong>of</strong> people stuck on mounta<strong>in</strong>s be<strong>in</strong>g taxed to death.An alternative view is that the high altitude would make it easier to leave a state –one could simply coast downhill to lower taxes. My relatives <strong>in</strong> Eastern Kentuckywould probably agree with this higher altitude–less monopoly power effect, but foran entirely different reason. The terra<strong>in</strong> <strong>in</strong> Eastern Kentucky is hilly which, <strong>in</strong> thepast, has made it difficult <strong>and</strong> dangerous for “revenuers” to come around.These comments are not meant to suggest that I took this altitude variableseriously. My reactions were surprise <strong>and</strong> amusement. As I was seated near themiddle <strong>of</strong> the room, I began look<strong>in</strong>g over my left shoulder, then my right shoulderto see whether the audience or the presenter would snicker <strong>and</strong> let me <strong>in</strong> on thejoke. Neither the audience nor the presenter snickered, so I concluded that this wasto be taken as serious economics. I waited <strong>and</strong> hoped someone would call this joke<strong>of</strong>f, but the presenter calmly began discuss<strong>in</strong>g the next explanatory variable, “I also<strong>in</strong>clude the diameter <strong>of</strong> the smallest circle that can be drawn around the state.”This was too much. Is this really empirical research? Sadly, most <strong>of</strong> the audience satbusily writ<strong>in</strong>g the names <strong>of</strong> two new proxy variables to use <strong>in</strong> their regressionmodels, just <strong>in</strong> case their other proxies failed to produce.The empirical research just described is but one example <strong>of</strong> a “bad regression”which is all too typical <strong>of</strong> the approach to empirical research found <strong>in</strong> public choice<strong>and</strong> the sociology <strong>of</strong> economics. Although the empirical research <strong>in</strong> public choice <strong>and</strong>the sociology <strong>of</strong> economics are similar, these areas differ <strong>in</strong> how the research papersare constructed. Public choice is a field <strong>in</strong> economics based on economic theories<strong>and</strong> pr<strong>in</strong>ciples. A typical public choice empirical paper has a theory sectionfollowed by an empirical section. The sociology <strong>of</strong> economics is the study <strong>of</strong>economists – how we write, how we work, how we do what we do. Papers <strong>in</strong> thisarea do not have theory sections, although authors may try to disguise this fact byus<strong>in</strong>g economic language <strong>in</strong> place <strong>of</strong> theory. Without theory, empirical work <strong>in</strong> thesociology <strong>of</strong> economics is reduced to be<strong>in</strong>g descriptive <strong>in</strong> nature.This paper represents an attempt to characterize the PC approach to empiricalresearch <strong>and</strong> to show that “bad regressions” are a consequence <strong>of</strong> this approach.Several solutions to the problem <strong>of</strong> bad regressions are discussed <strong>in</strong>clud<strong>in</strong>g: (1)omitt<strong>in</strong>g the empirical work from the paper; (2) requir<strong>in</strong>g that data sets used <strong>in</strong> thepapers be made publicly available; (3) reward<strong>in</strong>g research work on the construction<strong>of</strong> proxy variables <strong>and</strong> <strong>in</strong>dices; <strong>and</strong> (4) rem<strong>in</strong>d<strong>in</strong>g those <strong>in</strong> the pr<strong>of</strong>ession <strong>in</strong> theirroles as educators <strong>and</strong> referees to dem<strong>and</strong> improvements <strong>in</strong> the quality <strong>of</strong> empiricalwork <strong>and</strong> to stop publish<strong>in</strong>g papers until the quality is improved.Why empirical research?First, let us establish the uses <strong>of</strong> empirical research. Econometricians <strong>of</strong>fer thesethoughts on the goals <strong>of</strong> empirical research:the entire body <strong>of</strong> economic theory can be regarded as a collection <strong>of</strong> relations


Good ideas <strong>and</strong> bad regressions 69among variables. . . . econometrics is concerned with test<strong>in</strong>g the theoreticalpropositions embodied <strong>in</strong> these relations, <strong>and</strong> with estimat<strong>in</strong>g the parameters<strong>in</strong>volved.(Kmenta 1986: 203)Econometrics, the result <strong>of</strong> a certa<strong>in</strong> outlook on the role <strong>of</strong> economics, consists <strong>of</strong>the application <strong>of</strong> mathematical statistics to economic data to lend empiricalsupport to the models constructed by mathematical economics <strong>and</strong> to obta<strong>in</strong>numerical results.(T<strong>in</strong>tner 1968: 74)The method <strong>of</strong> econometric research aims, essentially, at a conjunction <strong>of</strong> economictheory <strong>and</strong> actual measurements, us<strong>in</strong>g theory <strong>and</strong> technique <strong>of</strong> statistical<strong>in</strong>ference as a bridge pier.(Haavelmo 1944: preface)These quotes po<strong>in</strong>t to what most would agree are the two ma<strong>in</strong> goals <strong>of</strong> empiricalresearch: measurement <strong>and</strong> test<strong>in</strong>g. Econometrics can be used to measure conceptslike the elasticity <strong>of</strong> dem<strong>and</strong> or the MPC, <strong>and</strong> can be used to test hypotheses derivedfrom theories <strong>and</strong> econometrics.Holcombe (1989) argues for a third use <strong>of</strong> empirical methods. In Holcombe’sview, regression methods are a lens with which to view the world, sometimesreveal<strong>in</strong>g relationships that are not otherwise obvious. When used <strong>in</strong> this way,econometric methods can lead to the development <strong>of</strong> a new theory. Holcombecites the Phillips curve as an example <strong>of</strong> a theory developed from empiricalobservation.Although I am sympathetic to this use <strong>of</strong> econometric methods, I am notcomfortable with the implications <strong>of</strong> this use for the goal <strong>of</strong> hypothesis test<strong>in</strong>g. Onecannot snoop around the data for a new theory <strong>and</strong> then use the same data set fortest<strong>in</strong>g. If a trade-<strong>of</strong>f between unemployment <strong>and</strong> <strong>in</strong>flation is suggested by the data,one should test the theory us<strong>in</strong>g different data. However, one might use the samedata set for measurement.The empirical research found <strong>in</strong> papers <strong>in</strong> the area <strong>of</strong> public choice, whichusually follows a theory section, is used for hypothesis test<strong>in</strong>g <strong>and</strong> measurement. 1Empirical research <strong>in</strong> the area <strong>of</strong> the sociology <strong>of</strong> economics, which usually doesnot follow a theory section, is conducted to f<strong>in</strong>d a result. This use <strong>of</strong> empiricalresearch is consistent with Holcombe’s view that regression methods provideanother way to view the world. Unfortunately, the empirical results are not used todevelop a new theory which is later tested on new data. The empirical result is theend <strong>of</strong> the story. Empirical work <strong>in</strong> the sociology <strong>of</strong> economics is a search forcorrelations.As I state earlier, I see no harm <strong>in</strong> learn<strong>in</strong>g about the world through a regressionmodel. The problem with the use <strong>of</strong> regression methods to f<strong>in</strong>d theories is thatauthors rarely, if ever, confess to hav<strong>in</strong>g done so. Researchers pretend that theEmpirical Results section <strong>of</strong> the paper is <strong>in</strong>cluded for the goals <strong>of</strong> measurement


70 Steven B. Caudill<strong>and</strong> hypothesis test<strong>in</strong>g. In these data-<strong>in</strong>stigated papers, it is a certa<strong>in</strong>ty that the nullhypotheses will be rejected <strong>in</strong> favor <strong>of</strong> the alternative. After all, the high t-ratios arewhat spawned the paper <strong>in</strong> the first place. If researchers wish to use econometrics toreveal or <strong>in</strong>spire theories, I <strong>in</strong>sist that they confess. For those work<strong>in</strong>g <strong>in</strong> the area <strong>of</strong>public choice who are unwill<strong>in</strong>g to test the data-<strong>in</strong>stigated theories us<strong>in</strong>g differentdata sets, I suggest that the Empirical Results section be moved nearer to the front<strong>of</strong> the paper <strong>and</strong> re-titled “Look What I Found.” Those work<strong>in</strong>g <strong>in</strong> theorychallengedsociology <strong>of</strong> economics should simply title their papers, “Look What IFound.”The PC approach to empirical researchWhat I have called the PC approach is really a method <strong>of</strong> conduct<strong>in</strong>g empiricalresearch which I associate with those work<strong>in</strong>g <strong>in</strong> the public choice area or hav<strong>in</strong>gpublic choice backgrounds, although examples can be found <strong>in</strong> all areas <strong>of</strong> economics.I have not scoured the literature for examples <strong>of</strong> this type <strong>of</strong> research. Myhope is that once the approach has been characterized, the articles will be easilyrecognized.PC empirical research is characterized by the follow<strong>in</strong>g: (1) no structural modelis presented <strong>and</strong> may not exist; (2) many, if not all, <strong>of</strong> the variables <strong>in</strong> the model areproxy variables; (3) the estimation results may be the result <strong>of</strong> a proxy variablesearch; <strong>and</strong> (4) more efficient statistical approaches that are <strong>in</strong>dicated by the data ormodel are not applied. 2 In fact, the list could probably be shortened to three characteristicsbecause, as I show, the fourth characteristic <strong>of</strong> the PC approach is largely aconsequence <strong>of</strong> the first three.1. No structural model. Economists are taught to th<strong>in</strong>k about the world <strong>in</strong> terms<strong>of</strong> constructs like supply <strong>and</strong> dem<strong>and</strong>, production functions, <strong>and</strong> cost functions.Those adopt<strong>in</strong>g the PC approach may mention these constructs but they are neverformalized. No structural model is presented <strong>and</strong> may not exist. Instead, what thereader gets is someth<strong>in</strong>g like a reduced form model, or what my colleague, RogerGarrison, calls a “pro forma reduced form model.” 3Econometricians tell us that when the reduced form model is derived from astructural model, one can still estimate regression coefficients, but <strong>in</strong>terpret<strong>in</strong>g theresults is nearly impossible. All that can be estimated is some function <strong>of</strong> the structuralcoefficients. This is the identification problem <strong>in</strong> econometrics. The situation<strong>in</strong> PC regressions is even worse because there may be noth<strong>in</strong>g to identify. 4 A “pr<strong>of</strong>orma reduced form” is not derived from any structural model, so <strong>in</strong>terpret<strong>in</strong>g theresults is impossible.The absence <strong>of</strong> a structural model leads the researcher <strong>in</strong> the direction <strong>of</strong>data m<strong>in</strong><strong>in</strong>g. This folly occurs because, without a structural model for guidance,researchers are more likely to try a “kitchen s<strong>in</strong>k” approach to empirical research.One cannot appeal to a theory for help <strong>in</strong> determ<strong>in</strong><strong>in</strong>g the number <strong>and</strong> k<strong>in</strong>d <strong>of</strong>explanatory variables to <strong>in</strong>clude <strong>in</strong> the regression model, so many variables are


Good ideas <strong>and</strong> bad regressions 71“tried.” The consequence <strong>of</strong> data m<strong>in</strong><strong>in</strong>g is the dilution <strong>of</strong> reported significancelevels (see Caudill <strong>and</strong> Holcombe 1999).2. Many proxy variables. A proxy variable is a substitute for the variable we wish toexam<strong>in</strong>e. The <strong>in</strong>clusion <strong>of</strong> a s<strong>in</strong>gle proxy variable leads to biased <strong>and</strong> <strong>in</strong>consistentparameter estimates <strong>of</strong> all coefficients <strong>in</strong> the model. In some cases all the variables<strong>in</strong> a PC regression models are proxies. The consequences for estimation are, <strong>in</strong>all likelihood, not good. The problems <strong>of</strong> bias <strong>and</strong> <strong>in</strong>consistency are not likelyremedied by us<strong>in</strong>g more proxy variables.3. Proxy variable searches. Depend<strong>in</strong>g on one’s po<strong>in</strong>t <strong>of</strong> view, a trip <strong>in</strong>to the world <strong>of</strong>proxy variables presents problems or opportunities. Because one does not have<strong>in</strong>formation or data on a particular variable, one might require a proxy. But proxiesmust be acquired or constructed. One can discover, construct, <strong>and</strong> imag<strong>in</strong>e manydifferent proxies for any variable. If one has any data related to the miss<strong>in</strong>g variable,proxies can be constructed by us<strong>in</strong>g differences, ratios <strong>and</strong> other transformations.The problem becomes how to determ<strong>in</strong>e which proxy to use. Of course, the proxyvariable chosen is the one that provides the desired empirical result.What has just been described is a proxy variable specification search (see Leamer1978). The consequence <strong>of</strong> this type <strong>of</strong> specification search is a further dilution <strong>of</strong>the true, as opposed to reported, statistical significance <strong>of</strong> the results.4. Absence <strong>of</strong> advanced econometric methods. Many <strong>of</strong> the advanced econometricmethods, <strong>in</strong>clud<strong>in</strong>g those for estimat<strong>in</strong>g models with limited-dependent variables,are absent from PC regressions. This absence occurs despite the fact that many <strong>of</strong>the econometric models used <strong>in</strong> PC regressions have limited-dependent variables.Estimation <strong>of</strong> these models by OLS leads to unbiased but <strong>in</strong>efficient estimators,but there are a number <strong>of</strong> methods available to estimate regression models moreefficiently than by OLS. These econometric methods, based on the pr<strong>in</strong>ciple <strong>of</strong>maximum likelihood, are detailed <strong>in</strong> textbooks by Greene (2003), Kennedy (1998),<strong>and</strong> Maddala (1983).What could an approach to empirical research characterized by a “pro formareduced form” model conta<strong>in</strong><strong>in</strong>g proxy variables, a proxy variable search, <strong>and</strong><strong>in</strong>efficient statistical methods be expected to yield? Not much. The absence <strong>of</strong> astructural model means that the regression parameters are, at best, jumbles <strong>of</strong>structural parameters, if a structural model exists. The use <strong>of</strong> proxy variables yieldsbiased <strong>and</strong> <strong>in</strong>consistent estimates <strong>of</strong> the parameter “jumbles.” The proxy variablesearch means that the reported levels <strong>of</strong> significance on the coefficient “jumbles”are overstated. We end up with a poorly measured estimate <strong>of</strong> a jumble <strong>of</strong>parameters. 5 In short, the result is a bad regression.A bad regression conta<strong>in</strong>s no useful <strong>in</strong>formation. No <strong>in</strong>formation about theprecise measurement <strong>of</strong> important economic constructs like elasticities is obta<strong>in</strong>ed


72 Steven B. Caudill<strong>and</strong> no <strong>in</strong>formation can be gleaned from the hypothesis tests. Given that thePC approach leads to poor estimates <strong>of</strong> jumbles <strong>of</strong> parameters, the goal <strong>of</strong> measurementis lost immediately. The uselessness <strong>of</strong> the hypothesis tests is more difficult tocharacterize. The <strong>in</strong>formation <strong>in</strong> a hypothesis test should conv<strong>in</strong>ce the unconv<strong>in</strong>ced,or at least cause the unconv<strong>in</strong>ced to pause. 6 If a regression model providesno useful parameter estimates <strong>and</strong> “unconv<strong>in</strong>c<strong>in</strong>g” hypothesis test results, it is a badregression.For public choice empirical research the implications <strong>of</strong> us<strong>in</strong>g the PC approachare that the goals <strong>of</strong> hypothesis test<strong>in</strong>g <strong>and</strong> measurement cannot possibly beachieved. In the sociology <strong>of</strong> economics the PC approach is employed to search forcorrelations. 7Why so many bad regressions?Why are there so many bad regressions <strong>in</strong> the areas <strong>of</strong> public choice <strong>and</strong> thesociology <strong>of</strong> economics? The explanation follows the reasons as to why there are nostructural models, why many proxies are used, <strong>and</strong> why advanced econometricmethods are shunned. I also explore the merits <strong>of</strong> suggest<strong>in</strong>g that empirical researchis as poor as the market will bear, us<strong>in</strong>g an argument similar to that made byLab<strong>and</strong> <strong>and</strong> Taylor (1992). The Lab<strong>and</strong> <strong>and</strong> Taylor justification is explored <strong>and</strong>dismissed.In order to expla<strong>in</strong> the low quality <strong>of</strong> empirical research <strong>in</strong> public choice, one c<strong>and</strong>raw upon the dist<strong>in</strong>ction made by Holcombe (1989) between a theory <strong>and</strong> amodel. Holcombe def<strong>in</strong>es a theory as “a coherent group <strong>of</strong> general propositionsused as pr<strong>in</strong>ciples <strong>of</strong> explanation for a general class <strong>of</strong> phenomena” (see Holcombe1989: 26). Holcombe states that theories expla<strong>in</strong> noth<strong>in</strong>g about the real world.Holcombe says, “theories may be developed <strong>in</strong>to models by mak<strong>in</strong>g assumptionsthat l<strong>in</strong>k the conditions <strong>of</strong> the theory to the conditions <strong>of</strong> the real world.” InHolcombe’s view a model is “a framework for analysis that duplicates somecharacteristics <strong>of</strong> the phenomena be<strong>in</strong>g modeled” (Holcombe 1989: 27). The gapbetween theory <strong>and</strong> model <strong>in</strong> PC research is large. Data are what researchers use tobridge the gap, but data <strong>in</strong> the PC area are not <strong>of</strong> high quality <strong>and</strong> usually bear littleresemblance to the phenomenon be<strong>in</strong>g studied.Part <strong>of</strong> the problem with empirical research <strong>in</strong> public choice is that much <strong>of</strong> theeconomic activity exam<strong>in</strong>ed is non-market. The usual economic data on costs,prices, <strong>in</strong>comes, <strong>in</strong>puts, <strong>and</strong> outputs either do not exist or are poorly measured.As economists, we desire to characterize the world us<strong>in</strong>g familiar <strong>and</strong> rigorouslydef<strong>in</strong>edconcepts like supply <strong>and</strong> dem<strong>and</strong> curves, cost functions, <strong>and</strong> productionfunctions. The poor association <strong>of</strong> available data to costs, prices, <strong>in</strong>comes, <strong>in</strong>puts,<strong>and</strong> outputs <strong>in</strong> the PC area makes the use <strong>of</strong> these familiar constructs problematic.The implication <strong>of</strong> these data problems is that models <strong>in</strong> the public choice areacannot bear close association to theories. The gap between theory <strong>and</strong> model <strong>in</strong> thepublic choice area is much larger than <strong>in</strong> other areas <strong>of</strong> economics. The situation iseven worse <strong>in</strong> the area <strong>of</strong> the sociology <strong>of</strong> economics for there are no theories to


Good ideas <strong>and</strong> bad regressions 73approximate. One cannot expect to f<strong>in</strong>d structural models <strong>in</strong> these papers. Theconsequence is that PC regressions cannot provide useful <strong>in</strong>formation abouthypothesis tests <strong>of</strong> the theories or measurement <strong>of</strong> key parameters. In the end, badregressions are produced.Why do PC researchers shun the use <strong>of</strong> advanced econometric methods? Onepossibility is that the PC researchers are unaware <strong>of</strong> these methods or lack the skillsto apply them to their PC regressions models. This explanation is <strong>in</strong>adequate fortwo reasons: the widespread availability <strong>of</strong> LIMDEP s<strong>of</strong>tware <strong>and</strong> the possibility <strong>of</strong>co-authorship or friendly advice.The LIMDEP s<strong>of</strong>tware makes the application <strong>of</strong> the limited-dependent variablemethods very easy. The program is menu-driven so that all one has to do is checkthe appropriate box <strong>and</strong> then estimate the model. With LIMDEP, estimat<strong>in</strong>g anadvanced econometric model is literally as simple as estimat<strong>in</strong>g an OLS regression.One simply needs to check a different box on the menu.One reason PC researchers may not effectively use s<strong>of</strong>tware like LIMDEP isbecause those work<strong>in</strong>g <strong>in</strong> the PC area may not be aware <strong>of</strong> the appropriate econ o-metric model to apply. The solution to this problem is to acquire a co-author orseek the advice <strong>of</strong> an econometrician. The co-author or the econometrician may beable to po<strong>in</strong>t the PC researcher <strong>in</strong> the direction <strong>of</strong> an efficient statistical procedure.With the availability <strong>of</strong> user-friendly s<strong>of</strong>tware <strong>and</strong> econometric advice, why mightPC researchers still shun advanced econometric methods? The econometricianmay decl<strong>in</strong>e to become <strong>in</strong>volved for two reasons. First, the project might be sowhimsical that the econometrician might worry about a loss <strong>of</strong> reputation if theproject is embraced. Second, the econometrician may simply decide that estimat<strong>in</strong>ga “pro forma reduced form” full <strong>of</strong> proxy variables is not the place for anadvanced econometric method. Advanced econometric methods might not beused because the author decided the audience would not be <strong>in</strong>terested. A readerundisturbed by a “pro forma reduced form” regression model full <strong>of</strong> proxyvariables would not likely care about the omission <strong>of</strong> advanced econometrics.The ultimate consequence is a water<strong>in</strong>g down <strong>of</strong> PC empirical research. Withpoor data there is little po<strong>in</strong>t <strong>in</strong> apply<strong>in</strong>g advanced econometric methods. We havebad on top <strong>of</strong> bad <strong>and</strong> the end result is a bad regression.One might try to justify the state <strong>of</strong> empirical research by us<strong>in</strong>g an argumentalong the l<strong>in</strong>es presented by Lab<strong>and</strong> <strong>and</strong> Taylor (1992) to expla<strong>in</strong> the abundance <strong>of</strong>bad writ<strong>in</strong>g <strong>in</strong> economics. Lab<strong>and</strong> <strong>and</strong> Taylor argue that the writ<strong>in</strong>g <strong>in</strong> economicsis as bad as the market will bear. That is, poorly written papers are be<strong>in</strong>g citedat roughly the same rate as well-written papers, so the market has spoken.Lab<strong>and</strong> <strong>and</strong> Taylor argue that the market is not penaliz<strong>in</strong>g those for writ<strong>in</strong>gpoorly.Can the same be argued for bad regressions? In the reply to Lab<strong>and</strong> <strong>and</strong> Taylor,McCloskey argues that one <strong>of</strong> our duties as teachers is to teach students to be betterwriters. We should educate <strong>in</strong>dividuals to consume <strong>and</strong> produce high-qualitywrit<strong>in</strong>g. If we, as economists, are charged with educat<strong>in</strong>g <strong>in</strong> the area <strong>of</strong> writ<strong>in</strong>g, wehave an even greater responsibility to educate <strong>in</strong> the area <strong>of</strong> econometrics.


74 Steven B. CaudillA bad regressionLet us look <strong>in</strong> detail at one case McCloskey considers to be a bad regression<strong>in</strong>cluded <strong>in</strong> a paper written <strong>in</strong> the area <strong>of</strong> sociology <strong>of</strong> economics. In 1992 <strong>in</strong> thejournal Economic Inquiry, Lab<strong>and</strong> <strong>and</strong> Taylor (henceforth LT), <strong>in</strong> response to anearlier work by McCloskey (1986), use econometrics to determ<strong>in</strong>e whether poorlywritten papers are less valuable than well-written papers. As a measure <strong>of</strong> value, LTuse citations <strong>and</strong> adjusted citations. As explanatory variables they <strong>in</strong>clude thelength <strong>of</strong> the article <strong>and</strong>, as a measure <strong>of</strong> reputation, the number <strong>of</strong> citations to theauthor’s work. The <strong>in</strong>dependent variables <strong>of</strong> <strong>in</strong>terest <strong>in</strong> these regression methodsare several <strong>in</strong>dicators <strong>of</strong> bad writ<strong>in</strong>g suggested by McCloskey such as: (1) words persentence; (2) number <strong>of</strong> footnotes; (3) number <strong>of</strong> footnotes that <strong>in</strong>terrupt sentences;(4) use <strong>of</strong> “bad words” such as “like” <strong>and</strong> “very”; (5) the use <strong>of</strong> “five-dollar” words;(6) the use <strong>of</strong> “is”; (7) the use <strong>of</strong> rhetorical questions; (8) the presence <strong>of</strong> table <strong>of</strong>contents paragraphs; <strong>and</strong> (9) excessive <strong>in</strong>troduction <strong>and</strong> summariz<strong>in</strong>g. Us<strong>in</strong>g thesemeasures <strong>and</strong> their regression models, LT f<strong>in</strong>d no difference <strong>in</strong> “value” or citationcount between poorly-written <strong>and</strong> well-written articles <strong>and</strong> conclude that writ<strong>in</strong>gquality does not matter.In the reply to Lab<strong>and</strong> <strong>and</strong> Taylor, McCloskey criticizes every aspect <strong>of</strong>the paper: the motivation, the “theory,” the writ<strong>in</strong>g, <strong>and</strong> the econometrics. 8In McCloskey’s op<strong>in</strong>ion, the Lab<strong>and</strong> <strong>and</strong> Taylor model is a “bad” regression.McCloskey describes their empirical work as be<strong>in</strong>g “firmly <strong>in</strong> the lower tail <strong>of</strong>modern economics.” I attempt to fit McCloskey’s criticisms <strong>of</strong> the LT paper <strong>in</strong>tomy four-po<strong>in</strong>t characterization <strong>of</strong> the PC approach to empirical research.McCloskey’s first criticism is not specific to the LT paper but is a criticism <strong>of</strong>econometrics as it is currently applied. McCloskey says, “What’s ma<strong>in</strong>ly wrong <strong>in</strong>the use <strong>of</strong> econometrics <strong>in</strong> our pr<strong>of</strong>ession is that it is not used for serious <strong>in</strong>quiry butfor reaffirm<strong>in</strong>g what everyone, especially the authors, already know.” McCloskeychides LT for us<strong>in</strong>g their econometrics to show that “Economists’ writ<strong>in</strong>g variesaccord<strong>in</strong>g to the <strong>in</strong>tended audience” (McCloskey 1992: 693).McCloskey criticizes Lab<strong>and</strong> <strong>and</strong> Taylor for us<strong>in</strong>g a very crude measure <strong>of</strong>writ<strong>in</strong>g quality. LT use the n<strong>in</strong>e easy-to-quantify <strong>in</strong>dicators given by McCloskey,<strong>in</strong>dividually, as proxies for writ<strong>in</strong>g quality. McCloskey argues that a s<strong>in</strong>gle <strong>in</strong>dex <strong>of</strong>writ<strong>in</strong>g quality is needed. As McCloskey po<strong>in</strong>ts out, the approach used by LTassumes that writers display<strong>in</strong>g excellence on one marg<strong>in</strong> would exhibit excellenceon other marg<strong>in</strong>s as well. Writers with high scores on some measures <strong>of</strong> writ<strong>in</strong>gquality might have low scores <strong>in</strong> other areas. This possibility could mean that thesample conta<strong>in</strong>s writ<strong>in</strong>g <strong>of</strong> uniformly poor quality even though scores on <strong>in</strong>dividualmeasures vary. If the writ<strong>in</strong>g is <strong>of</strong> uniformly poor quality, the f<strong>in</strong>d<strong>in</strong>g that all papersare cited about equally is not surpris<strong>in</strong>g. The problem, aga<strong>in</strong>, is that no s<strong>in</strong>glemeasure <strong>of</strong> writ<strong>in</strong>g quality is used <strong>in</strong> the empirical research. In McCloskey’s viewthis is the end <strong>of</strong> the story. The LT <strong>in</strong>strument for measur<strong>in</strong>g quality is no good, sothe project is useless.McCloskey notes that LT admit to hav<strong>in</strong>g an omitted variables problem. Theconsequence <strong>of</strong> omitted variables is <strong>in</strong>consistent estimators. McCloskey then statesthat little can be learned from the statistical failure <strong>of</strong> a misspecified model.


Good ideas <strong>and</strong> bad regressions 75Let us exam<strong>in</strong>e how aspects <strong>of</strong> the LT regression model fit my characterization<strong>of</strong> PC empirical research. We exam<strong>in</strong>e LT for the follow<strong>in</strong>g: (1) absence <strong>of</strong> astructural model; (2) many proxy variables; (3) a proxy variable search; <strong>and</strong> (4)absence <strong>of</strong> advanced econometric methods.1. No structural model. Throughout their paper LT talk about production functions<strong>and</strong> markets. These are familiar concepts to us all, but the actual empirical workbears little resemblance to any <strong>of</strong> these constructs. LT estimate a s<strong>in</strong>gle equationmodel with citations as the dependent variable <strong>and</strong> article length, author citations,<strong>and</strong> several <strong>in</strong>dicators <strong>of</strong> bad writ<strong>in</strong>g as <strong>in</strong>dependent variables. There is no connectionto production, supply, or dem<strong>and</strong>. 9 The result is a “pro forma reduced form”model.Us<strong>in</strong>g the theory–model dist<strong>in</strong>ction discussed by Holcombe, one can see that thegap between production functions, markets, <strong>and</strong> the LT empirical work is large.Although many economic concepts are discussed <strong>in</strong> the LT paper, no structuralmodel is presented. This is a characteristic <strong>of</strong> research <strong>in</strong> the sociology <strong>of</strong>economics.2. Proxy variables. All <strong>of</strong> the variables used <strong>in</strong> the LT regression model are proxies.Citations is a proxy for quality or value. The follow<strong>in</strong>g are all proxies for writ<strong>in</strong>gquality: words per sentence, number <strong>of</strong> footnotes, number <strong>of</strong> footnotes that <strong>in</strong>terruptsentences, use <strong>of</strong> “bad words” such as “like” <strong>and</strong> very,” the use <strong>of</strong> “five-dollar”words, the use <strong>of</strong> “is,” the use <strong>of</strong> rhetorical questions, the presence <strong>of</strong> table <strong>of</strong>contents paragraphs, <strong>and</strong> excessive <strong>in</strong>troduction <strong>and</strong> summariz<strong>in</strong>g.3. Proxy variable searches. LT do not appear to spend much time on a proxy variablesearch, probably because they found a publishable result quickly, but their Table 1does <strong>in</strong>dicate two alternative measures <strong>of</strong> poor writ<strong>in</strong>g: Bad Footnotes <strong>and</strong> Percent BadFootnotes.4. Advanced econometrics. I have stated earlier that advanced econometric methodsare <strong>of</strong>ten not used because the problems associated with estimat<strong>in</strong>g a pro formareduced form conta<strong>in</strong><strong>in</strong>g proxies <strong>and</strong> searched over proxies will discourage othersfrom provid<strong>in</strong>g advice or assistance. I <strong>of</strong>fer a suggestion about how the LT papermight be improved but also freely admit that I, <strong>and</strong> I suspect others, can generatelittle enthusiasm for the undertak<strong>in</strong>g. The nature <strong>of</strong> the dependent variable affordsthe opportunity to apply a limited-dependent variable model. The dependentvariable <strong>in</strong> the LT paper is the number <strong>of</strong> citations to a journal article. As this is an<strong>in</strong>teger, estimation by OLS will lead to unbiased but <strong>in</strong>efficient estimation. What is<strong>of</strong>ten done <strong>in</strong> this case is to estimate a limited-dependent variable model known asa Poisson regression (see Maddala 1983: 51). This model is easy to estimate us<strong>in</strong>gthe LIMDEP s<strong>of</strong>tware.However, the absence <strong>of</strong> a Poisson regression from the LT paper is not the po<strong>in</strong>t.Had this been a paper <strong>in</strong> labor economics or <strong>in</strong>dustrial organization, the referees


76 Steven B. Caudillwould no doubt have <strong>in</strong>sisted that Poisson regression either be used <strong>in</strong>stead <strong>of</strong> OLSor <strong>in</strong> addition to OLS. This is an example <strong>of</strong> the water-down theory. The idea is nottoo important <strong>and</strong> the data are not <strong>of</strong> high quality, so the usual st<strong>and</strong>ard forempirical work does not apply. In the end, we have no structural model, a “pr<strong>of</strong>orma reduced form” model full <strong>of</strong> proxies, <strong>and</strong> no advanced econometric methodsused. In short, we have a bad regression. 10Reduc<strong>in</strong>g the number <strong>of</strong> bad regressionsThere is some hope for reduc<strong>in</strong>g the number <strong>of</strong> bad regressions <strong>in</strong> empiricalresearch. As many <strong>of</strong> the problems with public choice empirical research stem fromthe gap between theory <strong>and</strong> model, some effort to close the gap is helpful. Help forthe sociology <strong>of</strong> economics is another matter because these papers lack a theorysection. A change <strong>in</strong> culture among economists would help improve the quality <strong>of</strong>empirical research. In our roles as teachers, referees, <strong>and</strong> editors, we can bettereducate young economists to consume, produce, <strong>and</strong> appreciate sound empiricalwork. As referees <strong>and</strong> editors we can stop publish<strong>in</strong>g the stuff. I elaborate on thesesuggestions <strong>in</strong> the follow<strong>in</strong>g paragraphs.I <strong>of</strong>fer four suggestions that might help reduce the problem <strong>of</strong> bad regressions <strong>in</strong>the PC area: (1) omit the empirical work from the paper; (2) require that data used<strong>in</strong> the papers be made publicly available; (3) reward/publish work on proxyvariables; <strong>and</strong> (4) rem<strong>in</strong>d those <strong>in</strong> the pr<strong>of</strong>ession <strong>in</strong> their roles as educators <strong>and</strong>referees to dem<strong>and</strong> improvements <strong>in</strong> the quality <strong>of</strong> empirical work. I discuss themerits <strong>of</strong> each <strong>of</strong> these suggestions <strong>in</strong> turn.1. Omit the empirical section. An obvious suggestion is to simply omit the regressionsfrom the paper entirely. The data problems make the <strong>in</strong>terpretation <strong>of</strong> the empiricalresults impossible. The results do not serve the goals <strong>of</strong> measurement <strong>and</strong>estimation <strong>and</strong> should therefore be omitted. This would save author, editor, <strong>and</strong>reader time.The implications <strong>of</strong> this suggestion are very different for papers <strong>in</strong> the areas <strong>of</strong>public choice <strong>and</strong> the sociology <strong>of</strong> economics. Papers <strong>in</strong> the area <strong>of</strong> public choicehave a theory section <strong>and</strong> an empirical section. If the empirical section conta<strong>in</strong><strong>in</strong>gthe bad regressions is elim<strong>in</strong>ated, the paper could possibly survive. Consider thenew PhD student I mentioned <strong>in</strong> the Introduction. Little would have been lost if hispresentation had not made mention <strong>of</strong> the “altitude <strong>of</strong> a state.” Although theempirical section adds noth<strong>in</strong>g, the presence <strong>of</strong> the theory section gives the papersome chance <strong>of</strong> survival.The consequences <strong>of</strong> omitt<strong>in</strong>g bad regressions from sociology <strong>of</strong> economicspapers are fatal. These papers are purely empirical <strong>and</strong> conta<strong>in</strong> no theory section.Without the empirical section, the paper no longer exists. In light <strong>of</strong> this <strong>in</strong>dictmentone might suppose that I argue that these papers should not be written. I do not. Myhope is that papers <strong>in</strong> the sociology <strong>of</strong> economics will no longer be published <strong>in</strong>ma<strong>in</strong>stream economics journals.


Good ideas <strong>and</strong> bad regressions 772. Require data be made publicly available. Another suggestion is to require authors <strong>of</strong>accepted manuscripts to make their data sets publicly available. Although themeasure will do little to close the gap between theory <strong>and</strong> model, it will providesome checks on specification searches <strong>and</strong> proxy variable construction. With easilyaccessible data, others can try different proxies <strong>and</strong> different specifications <strong>in</strong> orderto determ<strong>in</strong>e the fragility <strong>of</strong> published regressions results. The data are still bad, butpublish<strong>in</strong>g the data may reduce the tendency to report a fragile result.There is little reason today for not requir<strong>in</strong>g all datasets be submitted to journalsalong with accepted papers. We live <strong>in</strong> the electronic age where journals have theirown websites <strong>and</strong> many accept electronic submissions. The cost <strong>of</strong> support<strong>in</strong>ga data archive must be low <strong>and</strong> fall<strong>in</strong>g but, at present, only the Journal <strong>of</strong> Bus<strong>in</strong>ess<strong>and</strong> Economics Statistics, the Economic Journal, <strong>and</strong> the Journal <strong>of</strong> Applied Econometricscurrently support data archives.3. Encourage work on proxies. Another suggestion for improvements <strong>in</strong> empiricalresearch <strong>in</strong> the PC area lies <strong>in</strong> encourag<strong>in</strong>g <strong>in</strong>creased effort <strong>in</strong> the production <strong>and</strong>exam<strong>in</strong>ation <strong>of</strong> proxy variables. Bad data beget bad regressions. To have anychance <strong>of</strong> produc<strong>in</strong>g better results, those <strong>in</strong> the PC area need to beg<strong>in</strong> with betterdata to close the gap between model <strong>and</strong> theory. Researchers should be encouraged<strong>and</strong> rewarded for produc<strong>in</strong>g good proxy variables. So far, this research hasbeen neglected <strong>in</strong> public choice <strong>and</strong> other areas <strong>of</strong> economics for two reasons:econo mists are not tra<strong>in</strong>ed to develop proxies <strong>and</strong> <strong>in</strong>dices <strong>and</strong> the work <strong>of</strong> develop<strong>in</strong>gproxy variables is not viewed by the pr<strong>of</strong>ession as “glamorous.”The area <strong>of</strong> public choice needs more studies <strong>of</strong> <strong>in</strong>dex <strong>and</strong> proxy variableconstruction. The good news is that several groups are currently <strong>in</strong>volved <strong>in</strong> theconstruction <strong>of</strong> <strong>in</strong>dices that might be useful to PC empirical researchers. The badnews is that most <strong>of</strong> these <strong>in</strong>dices are not be<strong>in</strong>g published <strong>in</strong> economics journals.Perhaps the most popular are the <strong>in</strong>dices constructed to measure economic freedom<strong>in</strong> a country. Several <strong>in</strong>dices <strong>of</strong> economic freedom exist: the Fraser Institute<strong>in</strong>dex <strong>of</strong> Gwartney et al. (1996), the Freedom House <strong>in</strong>dex <strong>in</strong> the work edited byMessick (1996), <strong>and</strong> the Heritage Foundation–Wall Street Journal <strong>in</strong>dex <strong>of</strong>Johnson et al. (1998).Although produc<strong>in</strong>g proxies is a worthy goal, the problems with bad regressionswill not disappear with better proxies alone. The PC people, by <strong>and</strong> large, do notcare about construct<strong>in</strong>g new proxies <strong>and</strong>, by <strong>and</strong> large, do not care whether theexist<strong>in</strong>g proxies are any good. Proxies simply represent another empirical opportunity.At present, the proxies that have been produced have been accepteduncritically, gobbled up, <strong>and</strong> tossed <strong>in</strong>to the same bad regressions. Construction <strong>of</strong>the <strong>in</strong>dices is the beg<strong>in</strong>n<strong>in</strong>g <strong>of</strong> the process, not the end. Indices should be constructed,dissected, <strong>and</strong> carefully exam<strong>in</strong>ed (see, for example, Caudill et al. 2000).More <strong>and</strong> better proxies can help reduce the <strong>in</strong>cidence <strong>of</strong> bad regressions. Betterproxies will lead to less data m<strong>in</strong><strong>in</strong>g. Better proxies will, perhaps, lead to thedevelopment <strong>of</strong> structural models, <strong>and</strong> better proxies may help get the <strong>in</strong>terest <strong>of</strong>the neighborhood econometrician.


78 Steven B. Caudill4. Education is the best hope. Education will improve the quality <strong>of</strong> empirical research<strong>in</strong> many ways. The best <strong>and</strong> probably only hope for improvement lies with usas educators, referees, <strong>and</strong> journal editors. If we educate <strong>and</strong> enforce st<strong>and</strong>ards,the pr<strong>of</strong>ession will follow along. On this po<strong>in</strong>t I echo McCloskey (1992) about thesolution to the problem <strong>of</strong> poor writ<strong>in</strong>g <strong>in</strong> economics. We all bear some <strong>of</strong> theresponsibility for the <strong>in</strong>cidence <strong>of</strong> bad regressions, <strong>and</strong> as an econometrician, I bearmore than most. We spend so much time <strong>in</strong> econometrics class study<strong>in</strong>g varioustechniques that we neglect the transition from theoretical model, or theory asHolcombe would call it, to empirical model. In this area we are far beh<strong>in</strong>d ourcous<strong>in</strong>s <strong>in</strong> agricultural economics departments.As educators. We do not spend enough time <strong>in</strong> econometrics courses teach<strong>in</strong>gstudents about the transition from structural model to empirical model. To use theanalogy <strong>of</strong> a cook, “We take them <strong>in</strong> the kitchen <strong>and</strong> show them how to use all theappliances but we do not show them how to prepare any meals.” We should do abetter job <strong>of</strong> tra<strong>in</strong><strong>in</strong>g <strong>in</strong> our graduate programs. As econometricians we do imposest<strong>and</strong>ards on students writ<strong>in</strong>g empirical papers for our econometrics classes, but,aga<strong>in</strong>, we tend to focus on the methods used <strong>and</strong> tests performed. Graduatestudents write empirical papers <strong>in</strong> most graduate courses, so a more global solutionis warranted. I suggest that graduate programs adopt a system similar to the oneused at my alma mater, Ohio Wesleyan University, to address, ironically, theproblem <strong>of</strong> bad writ<strong>in</strong>g. At any time dur<strong>in</strong>g a student’s college career, any termpaper written for any course deemed to be poorly written obligated the student toretake the freshmen English Composition course. In economics, I propose that anyempirical paper written for any course be submitted to the econometricians forreview. An unacceptable mark <strong>in</strong> econometrics would obligate the student toretake the econometrics sequence. I do not th<strong>in</strong>k this would result <strong>in</strong> many graduatestudents actually retak<strong>in</strong>g the econometrics courses because the threat, alone,would have the desired effect <strong>of</strong> improv<strong>in</strong>g the quality <strong>of</strong> the empirical research.As referees <strong>and</strong> editors. As reviewers, we are too s<strong>of</strong>t. When review<strong>in</strong>g a paper, I tendto focus more on the method than the data. I have always felt that researchersshould not be held accountable for their data. Data are what they are. We all facedata constra<strong>in</strong>ts. My view was, “Do the best with what you have.” After all, baddata are not the fault <strong>of</strong> the researcher. For this reason I typically try to determ<strong>in</strong>ewhether a researcher has done as well as possible with the data they have. If theyhave done so, I recommend accept, if not, I recommend changes.I now realize that my “don’t blame the author for the data” approach to referee<strong>in</strong>gis wrong. If the data is no good, then the researcher can be held responsible for notchoos<strong>in</strong>g a different topic. If the data is bad, don’t write the paper. Researchers<strong>in</strong> the PC area do not always follow this approach because we, as educators <strong>and</strong>referees, have not always forced them to do so.The problem is that papers conta<strong>in</strong><strong>in</strong>g bad results still get published. If we, as apr<strong>of</strong>ession, want to improve the quality <strong>of</strong> empirical research, we must not publish


Good ideas <strong>and</strong> bad regressions 79papers conta<strong>in</strong><strong>in</strong>g bad regressions. For those papers <strong>in</strong> the public choice area thismeans, with the weak empirical sections tossed aside, the theoretical model must bepublishable on its own merits.On the other h<strong>and</strong>, papers <strong>in</strong> the sociology <strong>of</strong> economics should never be published<strong>in</strong> ma<strong>in</strong>stream economics journals. They are not economics but sociology.If they are to be published, they can be published <strong>in</strong> sociology journals. Perhapsnew journals will come <strong>in</strong>to existence with titles like, Sociology <strong>of</strong> Economists or Journal<strong>of</strong> Rank<strong>in</strong>gs.Let us not forget, journal publication is not the only method <strong>of</strong> provid<strong>in</strong>g<strong>in</strong>formation. Those work<strong>in</strong>g <strong>in</strong> the sociology <strong>of</strong> economics can post these papers ontheir web pages. Journals could do the same. Without publish<strong>in</strong>g <strong>in</strong> a ma<strong>in</strong>streameconomics journal as the reward, McCloskey’s utilitarians would largely ab<strong>and</strong>onthe sociology <strong>of</strong> economics. If we, as a pr<strong>of</strong>ession, rema<strong>in</strong> curious about the subjectmatter <strong>of</strong> the sociology <strong>of</strong> economics, perhaps the American Economic Associationcould use some <strong>of</strong> our dues to hire someone whose job is to keep track <strong>of</strong> all them<strong>in</strong>utiae <strong>in</strong> the sociology <strong>of</strong> economics. This <strong>in</strong>formation could be made publiclyavailable, but not by publish<strong>in</strong>g it <strong>in</strong> the AER.Of all these suggestions, not publish<strong>in</strong>g papers conta<strong>in</strong><strong>in</strong>g bad regressions is thebest solution. If we want to improve the quality <strong>of</strong> empirical research, we shouldsimply stop publish<strong>in</strong>g papers conta<strong>in</strong><strong>in</strong>g bad regressions. This will prove to be thebest <strong>in</strong>structional lesson we, as educators, can deliver. Certa<strong>in</strong>ly, we should educateour students to appreciate <strong>and</strong> produce high-quality empirical research. But publish<strong>in</strong>gis a powerful drug. As long as we publish articles conta<strong>in</strong><strong>in</strong>g bad regressions,they will be written.ConclusionsThis paper characterizes <strong>and</strong> criticizes empirical research <strong>in</strong> the areas <strong>of</strong> publicchoice <strong>and</strong> the sociology <strong>of</strong> economics. Research <strong>in</strong> both areas is characterized bythe follow<strong>in</strong>g: (1) no structural model is presented <strong>and</strong> may not exist; (2) many, if notall, <strong>of</strong> the variables are proxy variables; (3) the estimation results may be the result<strong>of</strong> a proxy variable search; <strong>and</strong> (4) more efficient statistical approaches have notbeen applied. The consequence <strong>of</strong> this approach to research is that many articles <strong>in</strong>these areas <strong>of</strong> economics conta<strong>in</strong> “bad regressions.”Several solutions to the problem <strong>of</strong> bad regressions are discussed, <strong>in</strong>clud<strong>in</strong>g: (1)omitt<strong>in</strong>g the empirical work from the paper; (2) requir<strong>in</strong>g that data used <strong>in</strong> thepapers be made publicly available; (3) reward<strong>in</strong>g work on the construction <strong>of</strong> proxyvariables; <strong>and</strong> (4) rem<strong>in</strong>d<strong>in</strong>g those <strong>in</strong> the pr<strong>of</strong>ession <strong>in</strong> their roles as educators <strong>and</strong>referees to dem<strong>and</strong> improvements <strong>in</strong> the quality <strong>of</strong> empirical work <strong>and</strong> to stoppublish<strong>in</strong>g papers until the quality is improved.The most important suggestion is that we, as a pr<strong>of</strong>ession, stop publish<strong>in</strong>g papersconta<strong>in</strong><strong>in</strong>g bad regressions. This action will lead to an improvement <strong>in</strong> the quality<strong>of</strong> papers <strong>in</strong> the area <strong>of</strong> public choice. I also advocate that economics journals ceasepublication <strong>of</strong> all articles <strong>in</strong> the area <strong>of</strong> the sociology <strong>of</strong> economics, <strong>and</strong> <strong>of</strong>fersuggestions as to other means <strong>of</strong> provid<strong>in</strong>g <strong>in</strong>formation conta<strong>in</strong>ed there<strong>in</strong>.


80 Steven B. CaudillClos<strong>in</strong>g thoughtsI end with some observations <strong>and</strong> speculations about our pr<strong>of</strong>ession <strong>and</strong> the future<strong>of</strong> empirical research. A look at the McCloskey/Lab<strong>and</strong>–Taylor exchange <strong>in</strong> 1992is <strong>in</strong>structive. Lab<strong>and</strong> <strong>and</strong> Taylor wrote an article about bad writ<strong>in</strong>g <strong>in</strong> economicswhich they were able to publish <strong>in</strong> the well-respected journal, Economic Inquiry. I say“well-respected,” but, as Lel<strong>and</strong> <strong>Yeager</strong> has <strong>of</strong>ten rem<strong>in</strong>ded us, <strong>in</strong> these cases onedoes not th<strong>in</strong>k more <strong>of</strong> the paper, one th<strong>in</strong>ks less <strong>of</strong> the journal. Although I amsurprised that Economic Inquiry published the Lab<strong>and</strong>–Taylor paper, I am moresurprised that they published the reply by McCloskey. I do not th<strong>in</strong>k a greatercondemnation <strong>of</strong> a published paper has ever been pr<strong>in</strong>ted.What was the fallout? Very little. Lab<strong>and</strong> is still writ<strong>in</strong>g <strong>and</strong> publish<strong>in</strong>g similarpapers. Economic Inquiry has published another 10–15 articles <strong>in</strong> the sociology <strong>of</strong>economics area. In fact, soon after this paper is published I expect someone willcollect data <strong>and</strong> prove that papers us<strong>in</strong>g only OLS are be<strong>in</strong>g cited no less thanpapers us<strong>in</strong>g more advanced econometric methods.Notes* Regions Bank Pr<strong>of</strong>essor, born 30 years to the day after Lel<strong>and</strong> B. <strong>Yeager</strong>. My ideas onthis subject have been shaped by many long discussions with Lel<strong>and</strong> <strong>Yeager</strong>, R<strong>and</strong>yHolcombe, <strong>and</strong> Roger Garrison. I am grateful to Janice E. Caudill, Roger W. Garrison,Daniel M. Gropper, Valent<strong>in</strong>a Hartarska, R<strong>and</strong>all G. Holcombe, <strong>and</strong> Roger Koppl forseveral helpful comments.1 However, Holcombe does tell the tale <strong>of</strong> a prom<strong>in</strong>ent public choice economist whodeveloped a theory which led to a prediction about the direction <strong>of</strong> an effect. After anexhaustive data-m<strong>in</strong><strong>in</strong>g adventure, no regression model could be produced conta<strong>in</strong><strong>in</strong>g aresult consistent with the prediction <strong>of</strong> the theory. This failure led the economist to redothe theory.2 We have probably all, at some time or other, written empirical research conta<strong>in</strong><strong>in</strong>g some<strong>of</strong> these characteristics. Although do<strong>in</strong>g poor research should never be excused, I amtalk<strong>in</strong>g here about the habitual <strong>of</strong>fenders. For some economists the four characteristicsabove def<strong>in</strong>e a research methodology. It is all they do.3 The term I use to describe the result is a “feel good” regression which <strong>in</strong>dicates that thebenefits accrue to the author <strong>and</strong> not to the audience.4 There is at least one <strong>in</strong>stance <strong>in</strong> empirical research where a model hav<strong>in</strong>g the appearance<strong>of</strong> a “pro forma reduced form” should be estimated. This case is the estimation <strong>of</strong> amodel <strong>of</strong> <strong>in</strong>dividual choice. In these models the dependent variable is a dummy variablerepresent<strong>in</strong>g a choice – possibly an <strong>in</strong>dividual’s vote. If the dependent variable is a vote,an econometric model called a conditional logit model can be estimated (see Maddala1983 or Greene 2003).To estimate a conditional logit model one needs data on the choice an <strong>in</strong>dividualmakes <strong>and</strong> the attributes, <strong>in</strong> each chooser’s perception, <strong>of</strong> each <strong>of</strong> the choices, even those notselected. The conditional logit model has a familiar underly<strong>in</strong>g structure. The regressionfunctions associated with each choice are <strong>in</strong>direct utility functions. The observed choiceis the one that maximizes an <strong>in</strong>dividual’s expected utility. This regression model lookslike what Garrison might call a “pro forma reduced form,” but actually has an underly<strong>in</strong>g<strong>and</strong> familiar structure.The estimation <strong>of</strong> this conditional logit model requires enormous data because onealso needs to know how the chooser feels about the options not chosen. For this reason


Good ideas <strong>and</strong> bad regressions 81the conditional logit model is not <strong>of</strong>ten used <strong>in</strong> economic research. Ironically, the onearea <strong>in</strong> economics where data might be sufficient to estimate such a model is <strong>in</strong> the area<strong>of</strong> vot<strong>in</strong>g/public choice with some <strong>of</strong> the large data sets available.Another model <strong>of</strong> <strong>in</strong>dividual choice that is sometimes found <strong>in</strong> PC research is calledthe logit model. In this model one needs data on the observed choice, only, <strong>and</strong>characteristics <strong>of</strong> the chooser. With only characteristics <strong>of</strong> the chooser, the connection toutility maximization is weak <strong>and</strong> we are led back <strong>in</strong> the direction <strong>of</strong> the “pro formareduced form.” There are many other <strong>in</strong>stances <strong>of</strong> these “pro forma reduced forms” <strong>in</strong>PC research <strong>and</strong> I discuss the conditional logit model <strong>in</strong> detail because that is the onlyplace a “pro forma reduced form” model can be justified.5 One <strong>in</strong>dication <strong>of</strong> the problems <strong>in</strong> PC empirical research is that the terms “structuralmodel,” “reduced form,” <strong>and</strong> “proxy variable,” are <strong>of</strong>ten not mentioned <strong>in</strong> the paper. Inthe absence <strong>of</strong> a structural model one might not recognize that what is be<strong>in</strong>g estimated isthe “pro forma reduced form.” The term, “proxy variable” has been replaced withlanguage like, “As a measure <strong>of</strong> X, we used Y.” The term, “proxy,” <strong>and</strong> discussion <strong>of</strong> theeconometric implications <strong>of</strong> proxy variables are omitted.6 McCloskey (1994) would argue that this is too strict a condition because no one believesempirical research.7 One <strong>in</strong>dication that this type <strong>of</strong> work is be<strong>in</strong>g done by some economists is the existence <strong>of</strong>empirical papers with titles like, “The Determ<strong>in</strong>ants <strong>of</strong> Someth<strong>in</strong>g.” In economics oneshould know the determ<strong>in</strong>ants before estimat<strong>in</strong>g the regression model. This title<strong>in</strong>dicates that a search for correlations is to follow.8 LT use citations as a measure <strong>of</strong> value. I note that, <strong>in</strong> the reply, McCloskey does not citethe LT paper.9 In the reply, McCloskey po<strong>in</strong>ts out that the bad writ<strong>in</strong>g issue can be <strong>in</strong>vestigated by othermeans. To directly address the research question about writ<strong>in</strong>g quality, McCloskeysuggests that LT simply put examples <strong>of</strong> writ<strong>in</strong>g before experts/people to judge.10 On one count I disagree with McCloskey’s assessment <strong>of</strong> the LT paper. McCloskeyrefers to the LT paper as “economics.” In my op<strong>in</strong>ion, the LT paper is not economics butsociology.ReferencesCaudill, S.B. <strong>and</strong> R.G. Holcombe (1999). Specification Search <strong>and</strong> Levels <strong>of</strong> Significance <strong>in</strong>Econometric Models. Eastern Economic Journal, 25: 289–300.Caudill, S.B., F. Zanella <strong>and</strong> F. Mixon (2000). Is Economic Freedom One Dimensional? AFactor Analysis <strong>of</strong> Some Common Measures <strong>of</strong> Economic Freedom. Journal <strong>of</strong> EconomicDevelopment, 75: 27–40.Greene, W.H. (2003). Econometric Analysis, 5th edn. New Jersery: Prentice Hall.Gwartney, J., R. Lawson <strong>and</strong> W. Block (1996). Economic Freedom <strong>of</strong> the World: 1975–1995.Vancouver, BC: Fraser Institute.Haavelmo, T. (1944). The Probability Approach <strong>in</strong> Econometrics. Supplement to Econometrica,12: iii.Holcombe, R.G. (1989). Economic Models <strong>and</strong> Methodology. New York: Greenwood.Johnson, B., K. Holmes <strong>and</strong> M. Kirkpatrick (1998). 1998 Index <strong>of</strong> Economic Freedom.Wash<strong>in</strong>gton, DC: The Heritage Foundation <strong>and</strong> Dow Jones & Company, Inc.Kennedy, P. (1998). A Guide to Econometrics, 4th edn. Cambridge, MA: The MIT Press.Kmenta, J. (1986). Elements <strong>of</strong> Econometrics, 2nd edn. New York: Macmillan.Lab<strong>and</strong>, D.N. <strong>and</strong> C.N. Taylor (1992). The Impact <strong>of</strong> Bad Writ<strong>in</strong>g <strong>in</strong> Economics. EconomicInquiry, 30: 673–88.Leamer, E.E. (1978). Specification Searches. New York: John Wiley & Sons.


82 Steven B. CaudillMaddala, G.S. (1983). Limited-dependent Variable Models <strong>in</strong> Econometrics. Cambridge: CambridgeUniversity Press.McCloskey, D.N. (1986). The Writ<strong>in</strong>g <strong>of</strong> Economics. New York: Macmillan.McCloskey, D.N. (1992). Writ<strong>in</strong>g as a Responsibility <strong>of</strong> Science: A Reply to Lab<strong>and</strong> <strong>and</strong>Taylor. Economic Inquiry, 30: 689–95.McCloskey, D.N. (1994). Why Don’t Economists Believe Empirical F<strong>in</strong>d<strong>in</strong>gs? EasternEconomic Journal, 20(3): 479–81.Messick, R. (ed.) (1996). World Survey <strong>of</strong> Economic Freedom 1995–1996: A Freedom House Study.New Brunswick, NJ: Transaction.T<strong>in</strong>tner, G. (1968). Methodology <strong>of</strong> Mathematical Economics <strong>and</strong> Econometrics. Chicago, IL: TheUniversity <strong>of</strong> Chicago Press.von Mises, L. (1966). Human Action, 3rd edn. Chicago, IL: Henry Regnery.


7 Pluralism, formalism, <strong>and</strong>American economics *Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erEconomics evolves <strong>in</strong> fits <strong>and</strong> starts as it struggles to come to an underst<strong>and</strong><strong>in</strong>g <strong>of</strong>the economy <strong>and</strong> to provide some guidance for policy. In this evolution there hasbeen an ongo<strong>in</strong>g debate between “formalists,” those economists who believe thatthe study <strong>of</strong> economics should consist <strong>of</strong> a highly formal analysis <strong>of</strong> the economy,<strong>and</strong> “nonformalists,” who believe that a less formal, process-oriented analysis <strong>of</strong>the economy, <strong>in</strong>clud<strong>in</strong>g relevant historical <strong>and</strong> <strong>in</strong>stitutional elements, is the moreappropriate model for economic analysis. Although Lel<strong>and</strong> <strong>Yeager</strong> falls <strong>in</strong>to thenonformalist category, he is unusual <strong>in</strong> that he also falls <strong>in</strong>to the committed pluralistcategory, <strong>and</strong> he is always consider<strong>in</strong>g <strong>and</strong> <strong>in</strong>tegrat<strong>in</strong>g subtle ideas developed fromformalist models <strong>in</strong>to his work. His wide-rang<strong>in</strong>g scholarship has enabled him to<strong>in</strong>tegrate a sense <strong>of</strong> history <strong>and</strong> <strong>in</strong>stitutions <strong>in</strong>to his analysis, <strong>and</strong> while he has consistentlyavoided any mathematical presentation <strong>of</strong> his ideas, the ideas he addressesare those addressed more by formalists than nonformalists.Although <strong>Yeager</strong>’s analysis is nonformal, it is, nevertheless, highly rigorous; hisviews are always well thought out <strong>and</strong> supported by impeccable logic. But, exceptamong his ardent admirers, his work has not had the impact that its cogencydeserves. The reason lies <strong>in</strong> part <strong>in</strong> the very attributes <strong>of</strong> his work that give it itsstrengths. It is iconoclastic – logical unto itself but unbend<strong>in</strong>g <strong>in</strong> its dedication to theexposition <strong>of</strong> the <strong>in</strong>stitutional realities <strong>of</strong> the time. Be it <strong>in</strong> his <strong>in</strong>terest <strong>in</strong> Interl<strong>in</strong>gua,his theory <strong>of</strong> money, his consideration <strong>of</strong> the role <strong>of</strong> ethics, or <strong>in</strong> his consideration <strong>of</strong>what Austrian economics is all about, one can be sure that Lel<strong>and</strong>’s work will provideenormous <strong>in</strong>sight but also that it likely will be out <strong>of</strong> step with the ma<strong>in</strong>streampr<strong>of</strong>ession’s th<strong>in</strong>k<strong>in</strong>g. He could have expressed his ideas <strong>in</strong> a formalistic manner,but he found that approach a less than optimal way <strong>of</strong> express<strong>in</strong>g them, because itwould not allow him to po<strong>in</strong>t out the subtleties <strong>of</strong> the argument that went beyondthe math. Thus, his work was rich <strong>in</strong> <strong>in</strong>stitutional detail that was impossible to<strong>in</strong>clude with<strong>in</strong> a formalist presentation <strong>of</strong> those ideas, but at the same time wasconcerned with the ideas that the formalists were concerned with, not the ideas thatthe nonformalists focused on.Recently there have been a number <strong>of</strong> considerations <strong>of</strong> formalism, pluralism,<strong>and</strong> their relationship to the evolution <strong>of</strong> economic thought over the last 100 years. 1In Morgan <strong>and</strong> Rutherford there seems to be a sense that formalism is bad <strong>and</strong> thatnonformalism is <strong>in</strong>herently pluralistic <strong>and</strong> good, <strong>and</strong> that, <strong>in</strong> an ideal pluralistically


84 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>ercommitted world, be<strong>in</strong>g out <strong>of</strong> step with the ma<strong>in</strong>stream should be a strength. In apr<strong>of</strong>ession devoted to a pluralist methodology, researchers would turn to those whoare out <strong>of</strong> step for applicable solutions, because the <strong>in</strong>sights one might ga<strong>in</strong> fromthem would likely be higher than from other sources. Lel<strong>and</strong> <strong>Yeager</strong> certa<strong>in</strong>lywould be considered pluralistic <strong>and</strong> open; <strong>in</strong> his work he has demonstrated a will<strong>in</strong>gnessto give every view consideration, <strong>and</strong> he has always dealt seriously withthose that he felt met his st<strong>and</strong>ard <strong>of</strong> <strong>in</strong>sightfulness, regardless <strong>of</strong> whether theyadvanced an “<strong>in</strong>” theory or not. He follows a self-described libert<strong>in</strong>e approach tomethodology. 2 His argumentation dem<strong>and</strong>s rigor but is almost impervious to ideologicalpositions – he criticizes ma<strong>in</strong>stream, Austrian, <strong>and</strong> radical economists withequal vigor.<strong>Yeager</strong> is <strong>in</strong> a small m<strong>in</strong>ority <strong>in</strong> follow<strong>in</strong>g this pluralistic approach on either side<strong>of</strong> the formalist/nonformalist divide. Commitment to a pluralistic approach is nota characteristic <strong>of</strong> the pr<strong>of</strong>ession – <strong>and</strong>, <strong>in</strong> our view, his commitment to pluralismhas played an important role <strong>in</strong> reduc<strong>in</strong>g his work’s <strong>in</strong>fluence. 3 Our argument isthat a pluralist methodology, such as that practiced by Lel<strong>and</strong>, <strong>and</strong> that supportedby Morgan <strong>and</strong> Rutherford, is not a systemically stable methodology. This presentsa problem for researchers committed to a pluralist methodology: How does oneexist <strong>in</strong> a world that is not committed to pluralism? We see this question as a<strong>Yeager</strong>esque question; for Lel<strong>and</strong> there is no ideal world, there is only the world welive <strong>in</strong>. And <strong>in</strong> this world the periods <strong>of</strong> pluralism that we observe generally have notcome about because researchers have made a commitment to pluralism, but<strong>in</strong>stead because various oppos<strong>in</strong>g methodological groups have found themselves <strong>of</strong>roughly equal strength. The reality is that if you fall outside the methodologicalma<strong>in</strong>stream <strong>of</strong> your time, your work will get less consideration than it otherwisewould. It follows that, other th<strong>in</strong>gs be<strong>in</strong>g equal, methodological libert<strong>in</strong>es such as<strong>Yeager</strong> will have less success than methodologically committed <strong>in</strong>dividuals. Ourargument is not that this situation is good – <strong>in</strong> this paper we take <strong>Yeager</strong>’s commitmentto what is, rather than to what should be, seriously, <strong>and</strong> simply say that this isthe way it is: a commitment to pluralism is not an evolutionarily stable strategy.We raise these issues because they relate to how one might underst<strong>and</strong> thehistory <strong>of</strong> the pr<strong>of</strong>ession over the past century. Specifically, Morgan <strong>and</strong> Rutherford,hav<strong>in</strong>g considered that history, have described how the formalist revolutionwiped out the pluralism that existed <strong>in</strong> the early 1900s. In their story what they termneoclassical economics overcame a pluralistic <strong>in</strong>stitutionalist approach here <strong>in</strong> theUS, with the result that modern economics is far less pluralistic than it was earlier. 4They seem to lament both the formalization <strong>of</strong> economics <strong>and</strong> the loss <strong>of</strong> pluralismthat occurred <strong>in</strong> the <strong>in</strong>terwar period. We f<strong>in</strong>d that story unsatisfy<strong>in</strong>g. We see thepluralism that existed then as a byproduct <strong>of</strong> other forces. It was simply a tem porarypart <strong>of</strong> a dynamic process <strong>in</strong> which the formalist <strong>and</strong> nonformalist methodologicalpositions were <strong>of</strong> somewhat equal strength. None <strong>of</strong> the players <strong>in</strong> the <strong>in</strong>terwarperiod was so dom<strong>in</strong>ant that others were excluded from academic appo<strong>in</strong>tments atimportant graduate programs, from space <strong>in</strong> the major journals, from representation<strong>in</strong> the power structure <strong>of</strong> the American Economics Association, or fromresearch support. As we will show, our approach provides a different view <strong>of</strong> the


Pluralism, formalism, <strong>and</strong> American economics 85formalist revolution over the last 100 years from that found <strong>in</strong> previous studies.Ours is a process-oriented view <strong>of</strong> the pr<strong>of</strong>ession <strong>in</strong> which ideas compete given the<strong>in</strong>stitutional realities <strong>of</strong> the pr<strong>of</strong>ession. Those that succeed are those that meet the<strong>in</strong>stitutional requirements <strong>of</strong> survival. The “truth” or “appropriateness” <strong>of</strong> the ideais only one <strong>of</strong> many decid<strong>in</strong>g factors <strong>of</strong> the success <strong>of</strong> an idea. 5The alternative story we tell is one <strong>in</strong> which pluralism has occurred by default, asthe pr<strong>of</strong>ession has swung from a nonformalist to formalist methodology, as one sideor the other ga<strong>in</strong>ed prom<strong>in</strong>ence while hold<strong>in</strong>g an unpluralistic methodology.Formalism <strong>and</strong> nonformalism are both disequilibrium situations which, over thebroad course <strong>of</strong> the history <strong>of</strong> economics, have swung like a pendulum from oneside to another <strong>and</strong> will likely cont<strong>in</strong>ue to sw<strong>in</strong>g <strong>in</strong>def<strong>in</strong>itely <strong>in</strong> the future. Given thispendulistic sw<strong>in</strong>g, our argument is that, when viewed <strong>in</strong> its historical context, thelast 100 years is best seen not as a movement away from pluralism, but simply aspart <strong>of</strong> the sw<strong>in</strong>g <strong>of</strong> the pendulum.In our “process” view, a pluralist methodology <strong>in</strong> which <strong>in</strong>dividuals are activelycommitted to pluralism has seldom been the nature <strong>of</strong> the equilibrium; it is simplya state <strong>in</strong> the evolutionary process <strong>in</strong> which compet<strong>in</strong>g sides are <strong>of</strong> relatively equalstrength. Thus, <strong>in</strong> our view the unpluralistic formalism that emerged <strong>in</strong> the latterhalf <strong>of</strong> the twentieth century was a temporary state, one that, <strong>in</strong> our view, is alreadychang<strong>in</strong>g. Today the formalism <strong>of</strong> that period is comb<strong>in</strong><strong>in</strong>g with the <strong>in</strong>formal work<strong>of</strong> earlier times, creat<strong>in</strong>g a new type <strong>of</strong> economics that is <strong>in</strong>ductive, highly mathematical,<strong>and</strong> <strong>in</strong>stitutional. 6 This paper, however, is concerned with the ascendancy<strong>of</strong> pure formalism, not its current demise, although we will briefly discuss thatdemise <strong>in</strong> our conclud<strong>in</strong>g comments.The sw<strong>in</strong>g<strong>in</strong>g pendulumThe ongo<strong>in</strong>g debate between formalists <strong>and</strong> nonformalists can be seen <strong>in</strong> theapproaches <strong>of</strong> the major economists <strong>of</strong> classical economics. Smith was a nonformalist,Ricardo a formalist. Mill moderated Ricardo’s formalism, while post-Millian economists diverged as to which track to take. In the late 1800s the battlebetween the two approaches peaked <strong>in</strong> the famous Methodenstreit that pittedthe German historical school aga<strong>in</strong>st the newly emerg<strong>in</strong>g marg<strong>in</strong>alists. ThisMethodenstreit set the backdrop for the rise <strong>of</strong> the American economics pr<strong>of</strong>ession,<strong>and</strong>, with that rise, the shift <strong>of</strong> the center <strong>of</strong> world economics from Europe to theUnited States.At the beg<strong>in</strong>n<strong>in</strong>g <strong>of</strong> the twentieth century, the debate considered by Morgan <strong>and</strong>Rutherford was between the <strong>in</strong>stitutionalist nonformalists <strong>and</strong> the neoclassical formalistswho <strong>in</strong>corporated the newly emerg<strong>in</strong>g marg<strong>in</strong>alist ideas as the centerpiece<strong>of</strong> their approach to economics. The <strong>in</strong>itial debate, however, was nowhere near asstark as it might have been, because at the time the primary st<strong>and</strong>ard-bearers <strong>of</strong> theformalist views were, <strong>in</strong> large part, Marshallians. From a formalist perspective, thisperiod was hardly pluralistic. In fact, as Blaug notes <strong>in</strong> 1930, “it is doubtful thatthere were more than a half-dozen economists <strong>in</strong> the world who had ever read Walras,much less understood him” (Blaug 2003: 150).


86 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erMarshall’s approach to economics was itself a compromise approach, us<strong>in</strong>gformalist techniques but then moderat<strong>in</strong>g them with history <strong>and</strong> <strong>in</strong>stitutions atevery po<strong>in</strong>t. Marshall’s approach was essentially a straddle between the Germanhistorical school <strong>and</strong> the marg<strong>in</strong>alist formalists. Thus, contrary to what is implied <strong>in</strong>the Morgan <strong>and</strong> Rutherford volume, from the perspective <strong>of</strong> a formalist, the 1930swere hardly pluralistic. What would at that time be called the superformalists, suchas Edgeworth <strong>and</strong> Walras, were <strong>in</strong> a small m<strong>in</strong>ority <strong>in</strong> the US dur<strong>in</strong>g the <strong>in</strong>terwarperiod. 7Why this history is importantThe long history <strong>of</strong> battles between the two sides is important because <strong>of</strong> the perspectiveit adds to the transformation <strong>of</strong> economics that has occurred s<strong>in</strong>ce the1930s. It strongly suggests that whatever pluralism existed <strong>in</strong> the <strong>in</strong>terwar period wasa tenuous pluralism exist<strong>in</strong>g because neither side had elim<strong>in</strong>ated the other, not apluralism grounded <strong>in</strong> pluralistic methodological foundations. The history <strong>of</strong> thedevelopment <strong>of</strong> the economics pr<strong>of</strong>ession <strong>in</strong> the US is one that abounds with<strong>in</strong>trigue, hostility, <strong>and</strong> warfare between advocates <strong>of</strong> the different views (Barber1988). Given this lack <strong>of</strong> a pluralistic methodological foundation, the transfor mationaway from pluralism that occurred <strong>in</strong> the post World War II era is about as surpris<strong>in</strong>gas the tipp<strong>in</strong>g over <strong>of</strong> a co<strong>in</strong> st<strong>and</strong><strong>in</strong>g on its edge. The relevant question is not:Why did the co<strong>in</strong> tip? It is: Why did the co<strong>in</strong> l<strong>and</strong> on the side that it did? Specifically,why did superformalism become the center <strong>of</strong> the American econ omics pr<strong>of</strong>ession?This question is even more <strong>in</strong>terest<strong>in</strong>g given the start<strong>in</strong>g po<strong>in</strong>t <strong>of</strong> the debatebetween the formalists <strong>and</strong> nonformalists. True formalists had a m<strong>in</strong>imal presence<strong>in</strong> the US at the beg<strong>in</strong>n<strong>in</strong>g <strong>of</strong> the <strong>in</strong>terwar period. Thus, to underst<strong>and</strong> the history<strong>of</strong> the pr<strong>of</strong>ession, one must underst<strong>and</strong> how this small group emerged from WorldWar II as the strongest group <strong>and</strong> how the <strong>in</strong>stitutionalists <strong>and</strong> Marshallians, whichwere strong at the turn <strong>of</strong> the century, eroded. In our view, two <strong>in</strong>terrelated issuesexpla<strong>in</strong> these events: the failure <strong>of</strong> the <strong>in</strong>stitutionalist’s research <strong>and</strong> pedagogicalprogram to meet the <strong>in</strong>stitutional requirements <strong>of</strong> an ongo<strong>in</strong>g research programwith<strong>in</strong> the US <strong>in</strong>stitutional environment, <strong>and</strong> the <strong>in</strong>stability <strong>of</strong> the Marshallianstraddle. We will argue that the transformation was essentially bipartite. First, itwas a victory <strong>of</strong> the coalition <strong>of</strong> formalists <strong>and</strong> Marshallians over the <strong>in</strong>stitutionalists.Second, it was a victory <strong>of</strong> the formalists over Marshallians.The playersLet us beg<strong>in</strong> by briefly consider<strong>in</strong>g who the players were <strong>in</strong> the early 1900s <strong>and</strong> <strong>in</strong>the <strong>in</strong>terwar period. Those players can be divided <strong>in</strong>to three loose groups thatrepresented divisions similar to those that existed <strong>in</strong> Europe at the time. The largestgroup was the <strong>in</strong>stitutionalists. This group represented the German <strong>and</strong> Englishhistorical–<strong>in</strong>stitutional approach to economics as a discipl<strong>in</strong>e <strong>and</strong> conta<strong>in</strong>ed anumber <strong>of</strong> German tra<strong>in</strong>ed PhDs. However, the pr<strong>in</strong>cipal <strong>in</strong>tellectual force <strong>in</strong> thisgroup came from American-tra<strong>in</strong>ed Veblen, Commons, <strong>and</strong> Mitchell.


Pluralism, formalism, <strong>and</strong> American economics 87The second group was what we will call formalists. This was the smallest group.Its roots were not <strong>in</strong> Smith, but rather <strong>in</strong> Cournot, Jevons, Walras, <strong>and</strong> Edgeworth.This group was <strong>in</strong>fluenced by contemporaries – the English economists, Edgeworth,Bowley, <strong>and</strong> Wicksteed, <strong>and</strong> the Swede, Wicksell. Simon Newcomb was amember <strong>of</strong> the group, but the tower<strong>in</strong>g American figure <strong>in</strong> the early years <strong>of</strong> thetwentieth century was Irv<strong>in</strong>g Fisher.The third group was a sw<strong>in</strong>g group between the two. It probably best goes underthe name Marshallian, because its methodology <strong>and</strong> approach closely followedAlfred Marshall. Marshall had masterfully built an economic eng<strong>in</strong>e <strong>of</strong> analysisthat tried to straddle the <strong>in</strong>stitutionalist <strong>and</strong> pure formalist schools. It argued for atype <strong>of</strong> pluralism <strong>in</strong> which no rigid l<strong>in</strong>es were drawn on almost any issue <strong>of</strong> scope,method, or content, <strong>and</strong> all were welcome under the big tent. 8In this development a dist<strong>in</strong>ct Austrian school did not exist; it was simply part <strong>of</strong>the Marshallianism that characterized the period. By 1900, the beg<strong>in</strong>n<strong>in</strong>g <strong>of</strong> thetime frame we are mostly concerned with, the exist<strong>in</strong>g ma<strong>in</strong> contributions <strong>of</strong> thosewho later became called “Austrians,” <strong>in</strong> the m<strong>in</strong>ds <strong>of</strong> most economists <strong>of</strong> the time,had already been <strong>in</strong>corporated <strong>in</strong>to the Marshallian views <strong>of</strong> the time, views thatcame to be called neoclassical economics. 9The victory <strong>of</strong> the coalition <strong>of</strong> formalists <strong>and</strong>Marshallians over the <strong>in</strong>stitutionalistsIn the early part <strong>of</strong> the twentieth century, <strong>in</strong>stitutionalists were the most powerfulgroup. Thus, the first part <strong>of</strong> the story is their loss <strong>of</strong> power. That loss was <strong>in</strong> manyways due to the <strong>in</strong>stitutionalists’ failure to meet the <strong>in</strong>stitutional requirements <strong>of</strong> anongo<strong>in</strong>g research program with<strong>in</strong> the economics pr<strong>of</strong>ession’s <strong>in</strong>stitutional structure.To see this we need to look more closely at the three groups <strong>of</strong> <strong>in</strong>stitutionalistswho, though never united <strong>in</strong> a coherent research program, came to be l<strong>in</strong>ked toone another primarily by their opposition to theory, whether it be formalist, orMarshallian. Thus the glue that held <strong>in</strong>stitutionalists together was not a positiveglue, but a negative glue.To give you an idea <strong>of</strong> their opposition to Marshallian neoclassicism, considerVeblen’s mockery <strong>of</strong> the assumption <strong>of</strong> rationality <strong>in</strong> his essay “Why Economics IsNot an Evolutionary Science”:The psychological <strong>and</strong> anthropological preconceptions <strong>of</strong> the economists havebeen those that were accepted by the psychological <strong>and</strong> social sciences somegenerations ago. The hedonistic conception <strong>of</strong> man is that <strong>of</strong> a lightn<strong>in</strong>g calculator<strong>of</strong> pleasure <strong>and</strong> pa<strong>in</strong>s, who oscillates like a homogeneous globule <strong>of</strong> desire<strong>of</strong> happ<strong>in</strong>ess under the impulse <strong>of</strong> stimuli that shift him about the area, but leavehim <strong>in</strong>tact. He has neither antecedent nor consequent.(Veblen 1919: 73–4)Wesley Claire Mitchell, <strong>in</strong> a letter to J.M. Clarke, made even more bit<strong>in</strong>gcomments about the formalists. In expla<strong>in</strong><strong>in</strong>g why he could not take neoclassical


88 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>ertheory seriously, he compares the gr<strong>and</strong> theorist to a great-aunt with whom heargued when he was young. In argu<strong>in</strong>g with that great-aunt, who “was the best <strong>of</strong>the Baptists, <strong>and</strong> knew exactly how the Lord had planned the world,” he foundwhen he presented her with logical difficulties that her simple scheme could noth<strong>and</strong>le, she always “slipped back <strong>in</strong>to the logical scheme, <strong>and</strong> bl<strong>in</strong>ked the facts,”just as the gr<strong>and</strong> theorists do. For Mitchell, develop<strong>in</strong>g gr<strong>and</strong> theories was child’splay. He states, “Give me premises <strong>and</strong> I would sp<strong>in</strong> speculations by the yard”(Mitchell as cited <strong>in</strong> Clarke 1936: 410–11).While all <strong>in</strong>stitutionalists agreed on the problems <strong>of</strong> neoclassical economics, theydid not agree on what should replace it. This meant that <strong>in</strong>stitutionalism went <strong>in</strong>three disparate directions. The sons <strong>and</strong> daughters <strong>of</strong> W.C. Mitchell never became<strong>in</strong>stitutionalized <strong>in</strong> any academy <strong>in</strong> the sense that there was a graduate educationprogram <strong>in</strong> economics founded on the research philosophy <strong>of</strong> Mitchell. TheNational Bureau <strong>of</strong> Economic Research <strong>and</strong> other agencies <strong>in</strong>itially pursued hisempirical approach, but with the development <strong>of</strong> econometrics that supposedly<strong>of</strong>fered a way <strong>of</strong> <strong>in</strong>tegrat<strong>in</strong>g theory <strong>and</strong> measurement, Mitchell’s empiricism diedout. The reasons this change from Mitchell’s empiricism to econometrics occurred– <strong>and</strong> assessments <strong>of</strong> it are complicated – are only now beg<strong>in</strong>n<strong>in</strong>g to be understood.But it is clear that the <strong>in</strong>itial belief that econometrics <strong>of</strong>fered a way <strong>of</strong> <strong>in</strong>tegrat<strong>in</strong>gtheory <strong>and</strong> empirical work that tested theories was an important element <strong>of</strong> the fall<strong>of</strong> Mitchell’s br<strong>and</strong> <strong>of</strong> <strong>in</strong>stitutionalism <strong>and</strong> <strong>in</strong> the transition. In this transitionKeynes’ General Theory played a significant role, provid<strong>in</strong>g the needed push to boththe collection <strong>of</strong> macroeconomic data <strong>and</strong> the build<strong>in</strong>g <strong>of</strong> macroeconomic econometricmodels <strong>and</strong> thus precipitated the demise <strong>of</strong> Mitchell’s approach.The Veblenese part <strong>of</strong> <strong>in</strong>stitutionalism was, <strong>in</strong> large part, unique to Veblen.Mitchell rejected it, <strong>and</strong> while almost all will agree that Veblen’s approach washighly <strong>in</strong>sightful, it <strong>of</strong>fered little that ord<strong>in</strong>ary students could build upon. Veblen’sapproach was carried on largely <strong>in</strong> the work <strong>of</strong> Clarence Ayres <strong>and</strong> his students. Inretrospect it appears to have been a non-viable research program, with PhDsreceiv<strong>in</strong>g tra<strong>in</strong><strong>in</strong>g <strong>in</strong> what was wrong with Marshall <strong>and</strong> more formal economicsbut with few tools to br<strong>in</strong>g to a positive research agenda. The Ayresians never wereable to ga<strong>in</strong> editorial control <strong>of</strong> a major economics journal, <strong>and</strong> they <strong>of</strong>ten squabbledwith editors <strong>of</strong> journals publish<strong>in</strong>g <strong>in</strong> the historical-<strong>in</strong>stitutional tradition.The criticism that the Ayresians had no analytical framework or research programled Ayres to write “The Coord<strong>in</strong>ates <strong>of</strong> Institutionalism” (1951), which had littleimpact on the pr<strong>of</strong>ession. Veblenian–Ayresian <strong>in</strong>stitutionalism was fad<strong>in</strong>g <strong>in</strong> postWord War II America. 10While there were a few Aust<strong>in</strong> satellites attempted, they never took hold. Oneimportant aspect <strong>of</strong> underst<strong>and</strong><strong>in</strong>g the demise <strong>of</strong> Veblen–Ayres <strong>in</strong>stitutionalism isthe recognition that over time a communication barrier developed between theseeconomists <strong>and</strong> the rest <strong>of</strong> the pr<strong>of</strong>ession. They <strong>and</strong> the emerg<strong>in</strong>g formalists did notread each other’s writ<strong>in</strong>gs, <strong>and</strong> both were like visitors <strong>in</strong> a foreign country with nolanguage skills. The same divide existed for Austrian economists as they developed<strong>in</strong>to a separate group: their basic framework was so different from that <strong>of</strong> theformalists that they could not communicate with them. 11


Pluralism, formalism, <strong>and</strong> American economics 89What happened to the Commons-Wiscons<strong>in</strong> part <strong>of</strong> the historical-<strong>in</strong>stitutionalcamp is complex <strong>and</strong> subtle. 12 Here was a progressive research program withpossibly an element more important than the tools: a view that government <strong>and</strong><strong>in</strong>tellectuals should work together to help solve some <strong>of</strong> the social problems createdby the <strong>in</strong>dustrial society. The union between the state government at Madison <strong>and</strong>the academicians produced a long list <strong>of</strong> social legislation. The depression <strong>of</strong> the1930s found a cadre <strong>of</strong> academicians ready to go to Wash<strong>in</strong>gton DC to apply theWiscons<strong>in</strong> model <strong>of</strong> government–academy cooperation. It is not by chance thatone <strong>of</strong> the foremost advocates <strong>of</strong> Keynesianism <strong>in</strong> the United States, Alv<strong>in</strong> Hansen,was a Wiscons<strong>in</strong> PhD who brought the Wiscons<strong>in</strong> model to Harvard <strong>in</strong> its fiscalpolicy sem<strong>in</strong>ar <strong>and</strong> began a Harvard–Wash<strong>in</strong>gton DC nexus which rema<strong>in</strong>s today.The demise <strong>of</strong> Wiscons<strong>in</strong> economics is <strong>in</strong> large part expla<strong>in</strong>ed by its failure toproduce pr<strong>of</strong>essors who would produce more pr<strong>of</strong>essors. The cha<strong>in</strong>-letter process<strong>of</strong> the modern ma<strong>in</strong>stream, whereby graduate pr<strong>of</strong>essors beget students whobecome pr<strong>of</strong>essors <strong>and</strong> beget more students ad <strong>in</strong>f<strong>in</strong>itum, assures cont<strong>in</strong>uity <strong>and</strong>ascendancy, at least until major paradigmatic changes occur. But s<strong>in</strong>ce the Wiscons<strong>in</strong>PhDs went primarily to government, undergraduate education, <strong>and</strong> bus<strong>in</strong>ess,no major satellites produc<strong>in</strong>g PhDs <strong>of</strong> their philosophy were established. Part <strong>of</strong> thedemise is explicable by the fact that the ideological position <strong>of</strong> Wiscons<strong>in</strong>ites aboutthe faults <strong>of</strong> society <strong>and</strong> the role <strong>of</strong> government became accepted, co-opted, <strong>and</strong>preempted by other graduate programs. As it played out <strong>in</strong> the Roosevelt adm<strong>in</strong>istration,the rest <strong>of</strong> the economics pr<strong>of</strong>ession would not go as far as the CommonsWiscons<strong>in</strong>ites <strong>in</strong> chang<strong>in</strong>g the <strong>in</strong>stitutional structure, but they were will<strong>in</strong>g to go farenough to create a society <strong>in</strong> the 1960s very different from that <strong>of</strong> the 1920s.The <strong>in</strong>stitutional cause <strong>of</strong> <strong>in</strong>stitutionalists’ demiseThe l<strong>in</strong>k between the demise <strong>of</strong> the three br<strong>and</strong>s <strong>of</strong> <strong>in</strong>stitutionalism was the failure<strong>of</strong> each to meet the <strong>in</strong>stitutional requirements for survival. Institutionalist economistswere seen as anti-theoretical <strong>and</strong> anti-mathematical. Neoclassical economistswere seen as theoretical. Mathematical neoclassical economists portrayed economicsas a predictive science that <strong>in</strong>volved specify<strong>in</strong>g a theory <strong>and</strong> empirically test<strong>in</strong>gthat theory. Such a method created large numbers <strong>of</strong> small jobs, enough to keep anacademic neoclassical army <strong>of</strong> students busy. Institutionalism, however, presentedeconomics as a policy-driven comb<strong>in</strong>ation <strong>of</strong> the study <strong>of</strong> <strong>in</strong>stitutions <strong>and</strong> <strong>of</strong> empiricalfacts about the economy, neither <strong>of</strong> which required a formal theory or def<strong>in</strong>itive– <strong>and</strong> labor <strong>in</strong>tensive – empirical test<strong>in</strong>g. Given those choices, it is quite clearwhich view would succeed <strong>in</strong>stitutionally – <strong>and</strong> it was not the <strong>in</strong>stitutionalist view.Whether one believes that a gr<strong>and</strong> theory is true <strong>in</strong> some fundamental sense isirrelevant. Even if you do not believe a theory, it can still be useful <strong>in</strong> the metaphysicalsense <strong>of</strong> organiz<strong>in</strong>g one’s th<strong>in</strong>k<strong>in</strong>g. Students <strong>and</strong>, <strong>in</strong>deed, almost everyonerequires such an organizational scheme. Neoclassical economics <strong>of</strong>fered one, butonly Veblen’s br<strong>and</strong> <strong>of</strong> <strong>in</strong>stitutional economics <strong>of</strong>fered broadly <strong>in</strong>clusive theory,<strong>and</strong> it was highly nonformal <strong>and</strong> <strong>in</strong>def<strong>in</strong>ite. One reason such formal theoriesare needed is that, while Mitchell might have been able to twist his great-aunt’s


90 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erarguments every which way, most students cannot perform these k<strong>in</strong>ds <strong>of</strong> mentalgymnastics: they need an organiz<strong>in</strong>g structure for their study. Most people needa simple structure to organize complex pr<strong>in</strong>ciples <strong>in</strong> their m<strong>in</strong>ds. Neoclassicaleconomics <strong>of</strong>fered such a simple organiz<strong>in</strong>g pr<strong>in</strong>ciple; <strong>in</strong>stitutional economicsdid not. The lure <strong>of</strong> neoclassical economics mimics the lure <strong>of</strong> religion <strong>in</strong> be<strong>in</strong>g arelatively simple way <strong>of</strong> organiz<strong>in</strong>g one’s underst<strong>and</strong><strong>in</strong>g <strong>of</strong> an otherwise almosthopeless chaos.This need for a formal organiz<strong>in</strong>g theory was strengthened by the structure <strong>of</strong>US higher educational <strong>in</strong>stitutions that typically emphasized a broad-based educationalsystem <strong>in</strong> which large numbers <strong>of</strong> students were enrolled <strong>in</strong> economicscourses. In practical terms, that necessitated the use <strong>of</strong> multiple-choice tests. The<strong>in</strong>stitutionalist approach to economics with no accompany<strong>in</strong>g formal theory didnot fit well <strong>in</strong>to that system. There are only so many times that “it depends” can begiven as an answer.In the eyes <strong>of</strong> the <strong>in</strong>stitutionalists, the simple neoclassical models did not comeclose to correspond<strong>in</strong>g to reality. They recoiled at the disparity between the simplemodel <strong>and</strong> the observed reality. Students who shared an <strong>in</strong>stitutionalist sensibilitytypically either ab<strong>and</strong>oned the study <strong>of</strong> economics or were weeded out, s<strong>in</strong>ce theywere unable to br<strong>in</strong>g themselves to provide the simplistic answers to the complexquestions the educational system required <strong>of</strong> them. Those who appreciated thesimplicity <strong>of</strong> the neoclassical models did well on exams <strong>and</strong> went on to create morecomplicated versions <strong>of</strong> them: they became modern economists.What we are argu<strong>in</strong>g is that hav<strong>in</strong>g a branch <strong>of</strong> economics work<strong>in</strong>g on a formalgr<strong>and</strong> theory was a requirement <strong>of</strong> survival <strong>in</strong> the US educational environment.Lack<strong>in</strong>g a gr<strong>and</strong> theory reducible to simple textbook models, the <strong>in</strong>stitutionalists’complex economic worldview was <strong>in</strong>compatible with the pedagogical <strong>in</strong>stitutionsthrough which economic ideas were propagated. Their decision simply to not discussformal theoriz<strong>in</strong>g rendered them <strong>in</strong>capable <strong>of</strong> compet<strong>in</strong>g <strong>in</strong> the metaphysicalgr<strong>and</strong> theory realm, whereas the neoclassical worldview succeeded <strong>in</strong> provid<strong>in</strong>g asystem whereby students could organize their th<strong>in</strong>k<strong>in</strong>g about the economy. Oncethe simplicity <strong>of</strong> that worldview was built <strong>in</strong>, moreover, it was not questioned, <strong>and</strong>it soon became the norm by which economists approached their work. Little considerationwas afforded the implications <strong>of</strong> the <strong>in</strong>stitutionalists’ complexity leap <strong>of</strong>faith, while more <strong>and</strong> more elaborate theoriz<strong>in</strong>g was developed on the simplicityleap <strong>of</strong> faith.An ongo<strong>in</strong>g research program needs to excite students, <strong>and</strong> provide dissertation<strong>and</strong> article topics for them to work on. These dissertations <strong>and</strong> articles must lead tojobs at other universities, produc<strong>in</strong>g future PhDs so that the research program canreplicate itself. All three branches <strong>of</strong> <strong>in</strong>stitutionalists failed to do these th<strong>in</strong>gs,although for different reasons. Commons’ students went on to government; so <strong>in</strong> asense it planted no seed corn. Mitchell gave students no organiz<strong>in</strong>g pr<strong>in</strong>ciples.While his m<strong>in</strong>d was large enough to sp<strong>in</strong> out millions <strong>of</strong> theories, <strong>and</strong> organizeempirical work, most students were not up to the task <strong>of</strong> follow<strong>in</strong>g his lead. Theygravitated <strong>in</strong>stead to the clarity <strong>of</strong> neoclassical theory <strong>and</strong> econometrics, even if itdid not fit reality. Veblen required students to be as <strong>in</strong>sightful <strong>and</strong> as good an


Pluralism, formalism, <strong>and</strong> American economics 91expositor as he; most weren’t. Thus, <strong>in</strong>stitutionalism failed <strong>in</strong>stitutionally, <strong>and</strong> itsdemise was sped up by the enormous growth <strong>of</strong> universities, requir<strong>in</strong>g large numbers<strong>of</strong> new PhDs dur<strong>in</strong>g the post World War II era.The victory <strong>of</strong> formalists over MarshalliansThe above section expla<strong>in</strong>s our view <strong>of</strong> why <strong>in</strong>stitutionalism lost the battle withMarshallian economics. Had that been the end <strong>of</strong> the story, the pluralism <strong>of</strong>Marshallian economics would typify post World War II American economics. Butthat was not the case. Instead, soon after World War II, Marshallian economicsbegan to fade, <strong>and</strong> with it, the methodological pluralism that characterized it. Bythe early 1960s Marshallian economics was totally overwhelmed by a formalisteconomics clothed <strong>in</strong> a methodological straight jacket.To underst<strong>and</strong> why this second transformation occurred, we need to look morecarefully at Marshallian economics. One can view Marshall’s economics as anattempt to prevent either side <strong>of</strong> the long-cont<strong>in</strong>u<strong>in</strong>g battle between formalists <strong>and</strong>nonformalists from w<strong>in</strong>n<strong>in</strong>g. Marshall argues that what is needed is the broadest <strong>of</strong>scopes, methods, <strong>and</strong> content with some problems <strong>and</strong> issues more satisfactorilypursued by less rigid, more historical–<strong>in</strong>stitutional approaches, <strong>and</strong> other problems<strong>and</strong> issues by more formal abstract analysis. It all depends said Marshall. This “itdepends” answer irritated both <strong>of</strong> the other groups. Marshall irritated the would-beformalists <strong>in</strong> his Appendix B <strong>of</strong> his Pr<strong>in</strong>ciples (Marshall 1961) prais<strong>in</strong>g Adam Smithas a model <strong>of</strong> method; <strong>in</strong> Appendix C, “The Scope <strong>and</strong> Method <strong>of</strong> Economics,”<strong>and</strong> Appendix D, “The Uses <strong>of</strong> Abstract Reason<strong>in</strong>g <strong>in</strong> Economics,” where he commendedthe methodology <strong>of</strong> the German historical school; <strong>in</strong> his widely circulatedletter to Bowley deprecat<strong>in</strong>g the role <strong>of</strong> mathematics <strong>and</strong> abstract reason<strong>in</strong>g <strong>in</strong>economics; <strong>in</strong> his refusal to give precise def<strong>in</strong>itions <strong>of</strong> economics, factors <strong>of</strong> production,or the representative firm; <strong>and</strong> <strong>in</strong> his Pr<strong>in</strong>ciples <strong>in</strong> which he preaches that“a man is likely to be a better economist if he trusts to his common sense, <strong>and</strong> practical<strong>in</strong>st<strong>in</strong>cts . . .” (1961: 368). The <strong>in</strong>stitutionalists were similarly irritated withMarshall’s attempt to take what he regarded as someth<strong>in</strong>g from all sides. Theysaw him as essentially accept<strong>in</strong>g neoclassical theory <strong>and</strong> then slightly modify<strong>in</strong>g itsapplication.Be<strong>in</strong>g the pluralist he was, Marshall was extremely hesitant to draw policy conclusionsfrom economic theory. He believed that policy issues required normative<strong>and</strong> <strong>in</strong>stitutional judgments that had to be added back to any logical–deductivetheoretical model before policy conclusions could be drawn. Policy conclusions didnot follow from theory alone.Marshall’s hesitation to associate policy arguments with economic theory hasbeen noted by Hirsch <strong>and</strong> De Marchi. They po<strong>in</strong>t out that for Marshall the analysis<strong>of</strong> direct <strong>in</strong>centive effects was only a start<strong>in</strong>g po<strong>in</strong>t <strong>of</strong> his analysis <strong>of</strong> taxes (Hirsch<strong>and</strong> De Marchi 1990: 161). Another example they give is Marshall’s consideration<strong>of</strong> the question <strong>of</strong> import duties. In that consideration Marshall lists a variety <strong>of</strong>specific questions that need to be answered before one can come to a policy conclusion.They write:


92 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erMarshall operates not as a theorist who sets up his assumptions <strong>and</strong> then“reasons out” (to some general conclusions for hypothetical categories <strong>of</strong> cases),but as one who actually has to give advice, or to make the decision <strong>in</strong> favor <strong>of</strong> one tax overanother, or for no tax at all [emphasis supplied]. He cautions frequently aga<strong>in</strong>stmak<strong>in</strong>g direct application <strong>of</strong> the results <strong>of</strong> simple first-round impact analysis. Aprefatory note <strong>in</strong> his Memor<strong>and</strong>um, for example, po<strong>in</strong>ts out that “the <strong>in</strong>cidence<strong>of</strong> import duties is extremely complex” <strong>and</strong> he adds: “the <strong>in</strong>direct are <strong>of</strong>tenmuch more important than the direct effects.”. .. Marshall also warns thatalthough the exposition to follow is concerned chiefly with “proximate causes<strong>and</strong> their effects” a student should actually be “endeavor<strong>in</strong>g to probe to thecauses <strong>of</strong> causes.”. ..(Hirsch <strong>and</strong> De Marchi 1990: 162)Despite the fact that Marshall worked assiduously not to fall <strong>in</strong>to any particularmethodological or policy position, his partial formalization gave a suggestion <strong>of</strong>scientific aura to the results <strong>of</strong> models. Marshall’s concept <strong>of</strong> consumer surplusseemed to make it possible to draw policy results from analytic models. We can seethis <strong>in</strong> Pigou’s proposal to subsidize <strong>in</strong>dustries, <strong>and</strong> <strong>in</strong> the development <strong>of</strong> costbenefitanalysis, <strong>and</strong> the enormous focus <strong>of</strong> the economics pr<strong>of</strong>ession on efficiency<strong>and</strong> waste to the exclusion <strong>of</strong> other issues such as the <strong>in</strong>ability <strong>of</strong> government toimplement proposals, or the <strong>in</strong>formation transfer role <strong>of</strong> prices. Thus, when therewas a debate about market socialism, it concerned technical issues, <strong>and</strong> the subtlety<strong>of</strong> Hayek’s arguments aga<strong>in</strong>st socialism was lost until rediscovered <strong>in</strong> the 1980s.The <strong>in</strong>stability <strong>of</strong> Marshall’s straddleWhat we are argu<strong>in</strong>g is that, while Marshall’s pluralist methodological approachworked for him, just as it worked for Lel<strong>and</strong>, it was not transferable. In the h<strong>and</strong>s<strong>of</strong> a less committed pluralist, such as Abba Lerner, or Milton Friedman, theMarshallian approach provoked reactions aga<strong>in</strong>st it that underm<strong>in</strong>ed pluralism <strong>in</strong>the post World War II era. Marshall’s strength was his ability to do formal theory<strong>and</strong> simultaneously to recognize the limitations <strong>of</strong> his formal model. But many <strong>of</strong>his followers did not; they drew policy conclusions from the theory, which set up aproblem for other researchers – to show how, analytically, those conclusions didnot necessarily flow from theory, or that they were based on a particular assumption.Thus, Marshall’s partial formalization was unstable; it set <strong>in</strong> motion a cha<strong>in</strong><strong>of</strong> formalizations, each one demonstrat<strong>in</strong>g that the previous formalization was<strong>in</strong>complete – <strong>and</strong> <strong>in</strong>clusive – with regard to policy.Perhaps the most obvious partial formalization that Marshallian economicsbrought <strong>in</strong>to the pr<strong>of</strong>ession was the elevation <strong>of</strong> the partial equilibrium supply–dem<strong>and</strong> diagram to center stage. This elevation created an almost totem-likemodel that shaped students’ vision <strong>and</strong> underst<strong>and</strong><strong>in</strong>g <strong>of</strong> economics. With<strong>in</strong> thissupply–dem<strong>and</strong> view, economics issues weren’t complex: they were simple, <strong>and</strong>could be answered <strong>in</strong> reference to the supply <strong>and</strong> dem<strong>and</strong> diagram. Institutionsweren’t important: they were simply frictions that slowed the forces <strong>of</strong> supply <strong>and</strong>


Pluralism, formalism, <strong>and</strong> American economics 93dem<strong>and</strong>. The market existed: it drove the economy to a desirable equilibrium, <strong>and</strong>any restriction on the market was bad.Marshall’s vision <strong>of</strong> economics was far more complex than this, but that complexitydid not come through the supply <strong>and</strong> dem<strong>and</strong> diagrams. As those diagramsbecame <strong>in</strong>stitutionalized, Marshall’s broader pluralism was lost. Thus, it wasFriedman who picked up the mantle <strong>of</strong> Marshallian economics <strong>in</strong> the US, <strong>and</strong> heused it to push a laissez-faire policy agenda. 13 In Friedman’s h<strong>and</strong>s, Marshallianeconomics led to laissez-faire policy conclusions, just as <strong>in</strong> Lerner’s <strong>and</strong> Pigou’sh<strong>and</strong>s it led to activist policy conclusions.In the 1930s the supply–dem<strong>and</strong> diagram was exp<strong>and</strong>ed upon <strong>and</strong> exp<strong>and</strong>edupon. It was <strong>in</strong> the 1930s that the st<strong>and</strong>ard monopoly concepts were created, <strong>and</strong>many <strong>of</strong> the geometric tools that are now st<strong>and</strong>ard <strong>in</strong> <strong>in</strong>troductory <strong>and</strong> <strong>in</strong>termediatemicroeconomics were <strong>in</strong>troduced. This geometricization <strong>of</strong> economicsstarted a shift with<strong>in</strong> Marshallian economics – towards less focus on historical <strong>and</strong><strong>in</strong>stitutional detail <strong>and</strong> more on formalization.An example <strong>of</strong> Marshallianism <strong>in</strong> America is the theory <strong>of</strong> monopolistic competition<strong>of</strong> E.H. Chamberl<strong>in</strong>. Chamberl<strong>in</strong> had neither Marshall’s mathematicsaptitudes nor broad <strong>in</strong>terests <strong>in</strong> historical materials. The theory <strong>of</strong> monopolisticcompetition is <strong>in</strong> Marshall, although never formalized. Chamberl<strong>in</strong>’s formali zation<strong>of</strong> it used a comb<strong>in</strong>ation <strong>of</strong> words <strong>and</strong> graphs. The result was someth<strong>in</strong>g <strong>of</strong> amuddle, but one that could be taught neatly to undergraduates. It was <strong>in</strong>conclusive,<strong>and</strong> it was unclear how it related to a theory <strong>of</strong> oligopoly, which was, observationally,much more prevalent <strong>in</strong> the economy.The reality was that markets between pure competition <strong>and</strong> pure monopolyrequired a mathematics that could deal with the mutual <strong>in</strong>terdependence <strong>of</strong> actors,<strong>and</strong> that was beyond the mathematics <strong>of</strong> the time. The Marshallians formalizedthe presentation sufficiently to make nice neat geometric models that providedexcellent teach<strong>in</strong>g tools for students, but <strong>in</strong> do<strong>in</strong>g so it naturally led to moreformalization. The pedagogical use <strong>of</strong> these models elevated their policy conclusionsfrom logical games to formal policy arguments.The formalization <strong>of</strong> economics allowed by geometricization, no matter howcomplicated the diagram, was highly limited – it reduced everyth<strong>in</strong>g to two, or atmost three, dimensions. This limitation <strong>in</strong>vited mathematically oriented economiststo correct the errors, which led to publications, advancement <strong>in</strong> the academicpr<strong>of</strong>ession, <strong>and</strong> the propagation <strong>of</strong> further formalism to clear up the problems <strong>of</strong>the last level <strong>of</strong> formalization.The limitations <strong>of</strong> partial equilibrium analysis were recognized early on, <strong>and</strong> <strong>in</strong>the 1930s the work <strong>of</strong> Abraham Wald <strong>and</strong> John von Neuman on equilibrium conditions<strong>of</strong> static <strong>and</strong> dynamic models turned the heads <strong>of</strong> mathematically tra<strong>in</strong>edeconomists towards general equilibrium theory. As Samuelson cogently noted,“To a person <strong>of</strong> analytical ability, perceptive enough to realize that mathematicalequipment was a powerful sword <strong>in</strong> economics, the world <strong>of</strong> economics was his orher oyster <strong>in</strong> 1935” (Samuelson 1964: 315). Thus, beg<strong>in</strong>n<strong>in</strong>g <strong>in</strong> the 1940s, economicsbegan consider<strong>in</strong>g issues <strong>in</strong> a formal mathematical manner nicely describedby Blaug.


94 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erThe movement was first toward a calculus formulation <strong>of</strong> general equilibrium<strong>and</strong> then toward set theoretic formulation <strong>of</strong> general equilibrium <strong>in</strong> which theexistence <strong>of</strong> equilibrium was a key issue. Our difference with Blaug is that we seethis work develop<strong>in</strong>g because <strong>of</strong> the Marshallian straddle, which led to a comb<strong>in</strong><strong>in</strong>g<strong>of</strong> theory <strong>and</strong> policy that made it look as if results were be<strong>in</strong>g pulled from economictheory that, <strong>in</strong> fact, could not be pulled from them. The formal work <strong>in</strong> generalequilibrium theory caught on because it showed the limitations <strong>of</strong> theoriz<strong>in</strong>g, not itsstrengths. It showed the enormously strong assumptions that were necessary to drawout any actual <strong>in</strong>formation from the theory much more than it showed the power <strong>of</strong>the theory to expla<strong>in</strong> real world events.As <strong>of</strong>ten happens when someth<strong>in</strong>g develops <strong>in</strong> reaction to someth<strong>in</strong>g else, it sets<strong>in</strong> motion a set <strong>of</strong> forces that sw<strong>in</strong>g the pendulum too far <strong>in</strong> the opposite direction,<strong>and</strong> that happened <strong>in</strong> the 1960s <strong>and</strong> 1970s. Microeconomics became the formalistgame that Rosenberg (1992) has described, mov<strong>in</strong>g to higher <strong>and</strong> higher levels <strong>of</strong>abstraction. Initially macroeconomics was immune to this movement; but <strong>in</strong> the1970s the push to carry out the logic <strong>of</strong> macroeconomics <strong>in</strong> the Walrasian uniqueequilibrium led to the new classical revolution.Formal general equilibrium theory, as contrasted to Marshallian partial equilibriumtheory, could not be studied or applied without considerable tra<strong>in</strong><strong>in</strong>g <strong>in</strong>mathematics. When that tra<strong>in</strong><strong>in</strong>g was added to the graduate school curriculum, theformalists’ victory began to fall <strong>in</strong>to place. Sometime <strong>in</strong> the 1950s, the economist’stool box required for holy ano<strong>in</strong>tment began chang<strong>in</strong>g. The two foreign languagesrequirement was replaced by mathematics–quantitative pr<strong>of</strong>iciency, <strong>and</strong> economichistory <strong>and</strong> the history <strong>of</strong> economic thought went the way <strong>of</strong> the dodo bird. As thathappened, the curricula <strong>of</strong> graduate economic programs changed, the editors <strong>and</strong>content <strong>of</strong> the major journals changed, <strong>and</strong> the types <strong>of</strong> <strong>in</strong>dividuals who werebecom<strong>in</strong>g economists changed. All <strong>of</strong> these forces f<strong>in</strong>ally prevailed <strong>in</strong> the 1960s, atleast temporarily. By the 1970s, if you wanted to be considered a theorist, you hadto play by formalist’s rules: the formalist pendulum sw<strong>in</strong>g was at its peak.Some f<strong>in</strong>al comments <strong>and</strong> some thoughts about thefutureLet us conclude by briefly summariz<strong>in</strong>g our argument. The evolution <strong>of</strong> the economicspr<strong>of</strong>ession can best be seen as a pendulum sw<strong>in</strong>g<strong>in</strong>g between formalism <strong>and</strong><strong>in</strong>tuitive approaches. The nature <strong>of</strong> the sw<strong>in</strong>g<strong>in</strong>g pendulum can best be understood<strong>in</strong> reference to the <strong>in</strong>stitutional structure <strong>of</strong> the pr<strong>of</strong>ession <strong>and</strong> the chang<strong>in</strong>ganalytic <strong>and</strong> comput<strong>in</strong>g technologies <strong>of</strong> the time. Pluralism is highly unlikely toexist at any given time because researchers favor<strong>in</strong>g either an <strong>in</strong>tuitive or a formalapproach have a commitment to pluralism. Hence, when pluralism does exist, itwill be simply as a temporary state <strong>in</strong> which various sides are at a po<strong>in</strong>t whereneither has won out. Thus, <strong>in</strong> our view, dur<strong>in</strong>g the 1930s there was no pluralism <strong>in</strong>the sense <strong>of</strong> a pr<strong>of</strong>ession committed to a pluralist methodology, there was simply atemporary position <strong>in</strong> the sw<strong>in</strong>g <strong>of</strong> the pendulum <strong>in</strong> which compet<strong>in</strong>g sides were <strong>of</strong>relatively equal strength.


Pluralism, formalism, <strong>and</strong> American economics 95Formalism started w<strong>in</strong>n<strong>in</strong>g out <strong>in</strong> the 1930s because <strong>of</strong> the failure <strong>of</strong> non formalistschools to meet the <strong>in</strong>stitutional requirements for survival. It tried to become toopolicy-oriented, <strong>and</strong> seemed to be argu<strong>in</strong>g that one could draw out policy conclusionsfrom positive economics. Formalist writ<strong>in</strong>g del<strong>in</strong>eated the problems with thatposition, but <strong>in</strong> the process created a set <strong>of</strong> <strong>in</strong>stitutions that kept the pendulumsw<strong>in</strong>g<strong>in</strong>g toward formalism. Analytic <strong>and</strong> comput<strong>in</strong>g power also changed dur<strong>in</strong>gthis time period, caus<strong>in</strong>g applied work to become more technical – <strong>and</strong> moreuseful. It is important not to confuse the formalism <strong>of</strong> Hilbertian general equilibriumtheory that Blaug is describ<strong>in</strong>g as formalism with the highly technicalapplied mathematics <strong>and</strong> econometrics that characterize much <strong>of</strong> the modernapplied work <strong>in</strong> economics. That work is technical but nonformal. This <strong>in</strong>crease <strong>in</strong>the technical nature <strong>of</strong> economic analysis is not an <strong>in</strong>crease <strong>in</strong> formalism; it issimply a reflection <strong>of</strong> a change <strong>in</strong> technology. Whereas Marshall had to rely onobservations, today we can rely much more on technical data analysis. Vectorautoregression is highly technical, but it is not formal theoriz<strong>in</strong>g. Similarly, much <strong>of</strong>modern applied mathematics is nonformal: researchers are not concerned withpro<strong>of</strong>s but rather with pull<strong>in</strong>g <strong>in</strong>formation out <strong>of</strong> data.Turn<strong>in</strong>g to the implications <strong>of</strong> our argument for the future, we see the follow<strong>in</strong>g:The pr<strong>of</strong>ession is now <strong>in</strong> a period <strong>of</strong> change. The formalism described by Blaug is onthe wane, as developments <strong>in</strong> computer technology have made analytic theory lessuseful. Today, <strong>in</strong>stead <strong>of</strong> writ<strong>in</strong>g a general solution to an abstract problem, it is easierto provide a solution for a specific problem. As that happens, the pr<strong>of</strong>ession ismov<strong>in</strong>g from pure mathematics to applied mathematics (We<strong>in</strong>traub 2002). Thesame is true <strong>in</strong> statistical studies. With the development <strong>of</strong> computers, statis tical patternssuch as those searched for by Mitchell can now be found, <strong>and</strong> consequentlyco<strong>in</strong>tegration <strong>and</strong> vector autoregression techniques which pull <strong>in</strong>formation fromdata with m<strong>in</strong>imal theory are flourish<strong>in</strong>g, <strong>and</strong> they are replac<strong>in</strong>g the need for theory.Similarly, agent based model<strong>in</strong>g is allow<strong>in</strong>g economists to analyze models withheterodox agents <strong>and</strong> <strong>in</strong>complete <strong>in</strong>formation that previously were beyond consideration.All these methods are mathematical but not formal. They are essen tiallytools <strong>of</strong> <strong>in</strong>ductive rather than deductive analysis, <strong>and</strong> they are likely to characterizethe economics <strong>of</strong> the future. We believe this because each <strong>of</strong> these new developmentsis article-laden, which will meet the <strong>in</strong>stitutional requirements <strong>of</strong> survival forthe economists who study them. As they become entrenched <strong>in</strong> decision-mak<strong>in</strong>gpositions <strong>in</strong> the pr<strong>of</strong>ession, the formalism <strong>of</strong> the 1950s, such as that found <strong>in</strong> generalequilibrium analysis, will further fade, <strong>and</strong> that solid <strong>in</strong>ductive analysis comb<strong>in</strong>edwith a sharp <strong>in</strong>tuition <strong>and</strong> a rigor <strong>of</strong> the sort that characterized Lel<strong>and</strong> <strong>Yeager</strong>’swork will be mak<strong>in</strong>g a comeback, albeit <strong>in</strong> a quite different form.Notes* An earlier version <strong>of</strong> this paper was presented at a History <strong>of</strong> Political Economyconference at Duke, April, 1997.1 For other views <strong>of</strong> the reorientation <strong>of</strong> economics, mostly complementary <strong>and</strong> compatiblewith ours, see Blaug (1998, 2002, 2003); Niehans (1990); <strong>and</strong> Samuels (1998). Quitedifferent conclusions are reached by Morgan <strong>and</strong> Rutherford (1998), <strong>and</strong> Yonay (1998).


96 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erWhile this paper focuses on the changes that took place <strong>in</strong> American economics dur<strong>in</strong>gthe twentieth century, the importance <strong>of</strong> American graduate education <strong>in</strong> economicsstrongly suggests important ramifications for the development <strong>of</strong> non-American economicthought.2 As he po<strong>in</strong>ts out, by this he does not mean that “anyth<strong>in</strong>g goes, or that whatever onecomes up with is automatically valid.” He is simply say<strong>in</strong>g that one should “let peoplework with whatever method works for them, <strong>and</strong> fits with their talents <strong>and</strong> <strong>in</strong>cl<strong>in</strong>ations,”Austrian Economic Newsletter (1988).3 Our argument is not that he was wrong <strong>in</strong> hold<strong>in</strong>g his views; only that hold<strong>in</strong>g thoseviews reduced his <strong>in</strong>fluence.4 There are many dimensions <strong>of</strong> pluralism. There can be pluralism <strong>in</strong> policy proposals,where the pr<strong>of</strong>ession comes to multiple ma<strong>in</strong>stream positions on policy. We have notseen a significant post World War II decl<strong>in</strong>e <strong>in</strong> policy pluralism. Where we believe therehas been a decl<strong>in</strong>e <strong>in</strong> pluralism is <strong>in</strong> methodological pluralism. There is less diversity <strong>of</strong>approach today than there was <strong>in</strong> the 1930s. It is that aspect <strong>of</strong> pluralism that we focus on<strong>in</strong> this paper.5 For a further development <strong>of</strong> this idea, see Col<strong>and</strong>er (1991).6 This view <strong>of</strong> economics is developed <strong>in</strong> Col<strong>and</strong>er (forthcom<strong>in</strong>g) <strong>and</strong> Col<strong>and</strong>er et al.(2005).7 S<strong>in</strong>ce this debate between the formalists <strong>and</strong> the nonformalists plays such a central role<strong>in</strong> the transformation <strong>of</strong> American economics, it needs to be clarified. It is not a debatebetween those who favor mathematics <strong>and</strong> those who don’t. It is a debate about theworldview that <strong>in</strong>dividuals have concern<strong>in</strong>g the complexity <strong>of</strong> the economy, <strong>and</strong> theusefulness <strong>of</strong> formaliz<strong>in</strong>g discussions <strong>of</strong> the economy with the mathematical tools thatexist at the time. Nonformalists believe that the mathematical tools available at the timeare <strong>in</strong>sufficient to capture the complexity <strong>of</strong> the economy, whereas formalists believe thatthose tools are sufficient.What this means is that as mathematical tools change, people’s view <strong>of</strong> the usefulness<strong>of</strong> a formal approach may change. For example, with the recent developments <strong>in</strong> mathematicssuch as chaos <strong>and</strong> catastrophe theory, <strong>and</strong> with the <strong>in</strong>crease <strong>in</strong> the ability <strong>of</strong>computers to h<strong>and</strong>le difficult problems, views <strong>of</strong> whether formalism is useful can be quitedifferent today than they were <strong>in</strong> the 1930s when the tools <strong>in</strong>volved relatively simpledifferential calculus, <strong>and</strong> almost no developed statistical analysis.8 We see Lel<strong>and</strong>’s methodology as similar to Marshall’s. In many ways Lel<strong>and</strong> was theconsummate Marshallian straddler.9 Austrian economics developed as a separate school only later <strong>in</strong> the 1970s as a group <strong>of</strong>economists worked hard to organize themselves <strong>in</strong>to a separate school.10 As an example, consider the path <strong>of</strong> one <strong>of</strong> the authors. He, together with three otherTexas economics PhD c<strong>and</strong>idates from the University <strong>of</strong> Texas at Aust<strong>in</strong>, transferred tothe PhD program at Harvard dur<strong>in</strong>g the middle 1950s.11 This doesn’t mean that their ideas weren’t correct or better than the emerg<strong>in</strong>g ideas; itsimply means their ideas no longer were compatible with the <strong>in</strong>stitutional structure <strong>of</strong> theemerg<strong>in</strong>g shape <strong>of</strong> the economics pr<strong>of</strong>ession’s <strong>in</strong>stitutions.12 Lampman’s Economists at Wiscons<strong>in</strong> 1892–1992 (1993) may trigger research that willproduce clearer <strong>in</strong>sights <strong>in</strong>to what happened to the Wiscons<strong>in</strong> school.13 See Col<strong>and</strong>er (1995) for further discussion.Bibliography <strong>and</strong> referencesAustrian Economic Newsletter (1988). A Conversation with Lel<strong>and</strong> B. <strong>Yeager</strong>. Austrian EconomicNewsletter, 12(3).Ayres, Clarence E. (1951). The Co-ord<strong>in</strong>ates <strong>of</strong> Institutionalism. American Economic Review,XLI(May): 47–55.


Pluralism, formalism, <strong>and</strong> American economics 97Barber, William J. (ed.) (1988). Break<strong>in</strong>g the Academic Mold. Middletown, CT: WesleyanUniversity Press.Biddle, Jeff (1998). Institutional Economics: A Case <strong>of</strong> Reproductive Failure? In M.S.Morgan <strong>and</strong> M. Rutherford (eds.) From Interwar Pluralism to Postwar Neoclassicism. Durham,NC: Duke University Press.Blaug, Mark (1998). The Formalist Revolution or What Happened to Orthodox EconomicsAfter World War II. Discussion Paper <strong>in</strong> Economics, University <strong>of</strong> Exeter.Blaug, Mark (2002). The Formalist Revolution <strong>in</strong> the 1950s. Dist<strong>in</strong>guished Guest Lecturer,History <strong>of</strong> Economics Society conference at Davis, California, July.Blaug, Mark (2003). The Formalist Revolution <strong>of</strong> the 1950s. Journal <strong>of</strong> the History <strong>of</strong> EconomicThought, 25(2): 145–56.Bodk<strong>in</strong>, Ronald, Lawrence Kle<strong>in</strong> <strong>and</strong> Kanta Marway (1991). A History <strong>of</strong> MacroeconometricModel Build<strong>in</strong>g. Brookfield, VT: Elgar.Clarke, J.M. (1936). Preface to Social Economics. New York: Farrar <strong>and</strong> R<strong>in</strong>ehart.Col<strong>and</strong>er, David (1991). Why Aren’t Economists as Important as Garbagemen? Armonk, NY:Sharpe Publish<strong>in</strong>g.Col<strong>and</strong>er, David (1995). Is Milton Friedman an Artist or Scientist? Journal <strong>of</strong> EconomicMethodology.Col<strong>and</strong>er, David (forthcom<strong>in</strong>g). Complexity <strong>and</strong> the Future <strong>of</strong> Economics. Cambridge Journal<strong>of</strong> Economics.Col<strong>and</strong>er, David, Ric Holt <strong>and</strong> Barkley Rosser (2005). The Chang<strong>in</strong>g Face <strong>of</strong> Economics. AnnArbor, MI: University <strong>of</strong> Michigan Press.Dorfman, Joseph (1949 <strong>and</strong> 1959). The Economic M<strong>in</strong>d <strong>in</strong> American Civilization. Vols. 3 <strong>and</strong> 4.New York: Vik<strong>in</strong>g Press.Epste<strong>in</strong>, Roy J. (1987). A History <strong>of</strong> Econometrics. Chicago, IL: University <strong>of</strong> Ill<strong>in</strong>ois at ChicagoPress.Friedman, Milton (1953). <strong>Essays</strong> <strong>in</strong> Positive Economics. Chicago, IL: University <strong>of</strong> ChicagoPress.Hirsch, Abraham <strong>and</strong> Neil De Marchi (1990). Milton Friedman Economics <strong>in</strong> Theory <strong>and</strong> Practice.Ann Arbor, MI: University <strong>of</strong> Michigan Press.Lampman, Robert J. (1993). Economists at Wiscons<strong>in</strong> 1892–1992. Madison, WI: Department<strong>of</strong> Economics, University <strong>of</strong> Wiscons<strong>in</strong>–Madison.L<strong>and</strong>reth, Harry <strong>and</strong> David C. Col<strong>and</strong>er (1997). The Formalist Revolution <strong>in</strong> AmericanEconomics. History <strong>of</strong> Political Economy Conference, Duke University, April.Marshall, Alfred (1997). Pr<strong>in</strong>ciples <strong>of</strong> Economics, 9th edn. London: Macmillan.Morgan, Mary S. <strong>and</strong> Malcolm Rutherford (1998). American Economics: The Character <strong>of</strong>the Transformation. In From Interwar Pluralism to Postwar Neoclassicism. Durham, NC: DukeUniversity Press.Niehans, Jurg (1990). A History <strong>of</strong> Economic Theory. Baltimore, MD: Johns Hopk<strong>in</strong>s.Rosenberg, Alex<strong>and</strong>er (1992). Economics: Mathematic Politics or Science <strong>of</strong> Dim<strong>in</strong>ish<strong>in</strong>g Returns?Chicago, IL: University <strong>of</strong> Chicago Press.Samuels, Warren (1998). The Transformation <strong>of</strong> American Economics: From InterwarPluralism to Postwar Neoclassicism: An Interpretive Review <strong>of</strong> a Conference. Research <strong>in</strong>the History <strong>of</strong> Economic Thought <strong>and</strong> Methodology. Vol. 16. Amsterdam: Elsevier.Samuelson, Paul A. (1964). The General Theory: 1946. In Robert Lekachman (ed.) Keynes’General Theory: Reports <strong>of</strong> Three Decades. New York: St. Mart<strong>in</strong>’s Press.Samuelson, Paul A. (1972). Maximum Pr<strong>in</strong>ciples <strong>in</strong> Analytical Economics. Nobel MemorialLecture. The Collected Scientific Papers <strong>of</strong> Paul A. Samuelson. Vol. III, 2–17. Cambridge, MA:MIT Press.


98 Harry L<strong>and</strong>reth <strong>and</strong> David C. Col<strong>and</strong>erSchumpeter, Joseph A. (1954). History <strong>of</strong> Economic Analysis. New York: Oxford UniversityPress.Veblen, Thorste<strong>in</strong> (1919). The Place <strong>of</strong> Science <strong>in</strong> Modern Civilization. New York: B.W. Huebsh.We<strong>in</strong>traub, E. Roy (2002). How Economics Became a Mathematical Science. Durham, NC: DukeUniversity Press.Yonay, Yuval P. (1998). The Struggle Over the Soul <strong>of</strong> Economics. Pr<strong>in</strong>ceton, NJ: Pr<strong>in</strong>cetonUniversity Press.


8 Lel<strong>and</strong>’s favorite economists *Jürgen G. BackhausIn a private conversation, when I <strong>in</strong>vited Lel<strong>and</strong> to come to Maastricht <strong>and</strong> give alecture on Walter Eucken on the occasion <strong>of</strong> his 100th birthday, Lel<strong>and</strong> agreedimmediately because, as he said, Walter Eucken was his favorite economist. 1Although Walter Eucken (1891–1950) kept a strong <strong>in</strong>fluence on post-World WarII German economics literature, this <strong>in</strong>fluence was tongue-tied <strong>and</strong> almost exclusivelyrestricted to the German language area, <strong>in</strong> both scholarship <strong>and</strong> policy application.This is despite the fact that some <strong>of</strong> his work has been available <strong>in</strong> English(Eucken 1950, 1951). Ten years ago, however, a first book-length appreciation<strong>of</strong> Eucken’s work appeared <strong>in</strong> English as a special issue <strong>of</strong> the Journal <strong>of</strong> EconomicStudies <strong>and</strong>, 50 years after his death, at least three books <strong>in</strong> German have appeared<strong>in</strong> appreciation <strong>of</strong> Walter Eucken’s work.This essay essentially makes three contributions. First, the recent literature onWalter Eucken is briefly reviewed. Second, Eucken’s constitutive pr<strong>in</strong>ciples <strong>of</strong>market economy, a central focus <strong>of</strong> his work, are discussed from the po<strong>in</strong>t <strong>of</strong> view <strong>of</strong>their philosophical orig<strong>in</strong>. Third, the issue <strong>of</strong> hedonic price <strong>in</strong>dices is discussedfrom the po<strong>in</strong>t <strong>of</strong> view <strong>of</strong> ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g price-stability, Eucken’s central concern.In this sense, I try to respond to some <strong>of</strong> Lel<strong>and</strong>’s most fundamental concerns <strong>in</strong>scholarship. These are the orig<strong>in</strong> <strong>and</strong> mean<strong>in</strong>g <strong>of</strong> concepts <strong>in</strong> economics <strong>and</strong> theprecision <strong>of</strong> language. Hence, section II emphasizes the orig<strong>in</strong> <strong>and</strong> mean<strong>in</strong>g, whilesection III focuses on the precision with which economic phenomena are to beexpressed.I Recent appreciation <strong>of</strong> Eucken’s workThe first <strong>of</strong> the four publications reviewed here appeared <strong>in</strong> 1994 <strong>in</strong> the Journal <strong>of</strong>Economic Studies (21:4) under the guest-editorship <strong>of</strong> Gerrit Meijer. The title <strong>of</strong> thisvolume is appropriately: The Intellectual Roots <strong>of</strong> Market Economies: Walter Eucken’sContribution to Economics. This volume has six essays <strong>in</strong> addition to the guest editor’s<strong>in</strong>troduction focus<strong>in</strong>g on the <strong>in</strong>tellectual roots <strong>of</strong> the market economy notable <strong>in</strong>Walter Eucken’s work. He<strong>in</strong>z Grossekettler has an extremely thorough article “OnDesign<strong>in</strong>g an Institutional Infrastructure for Economies: The Freiburg LegacyAfter 50 Years.” S<strong>in</strong>ce the article was presented at a conference <strong>in</strong> Maastricht <strong>in</strong>1991, it could still have had an <strong>in</strong>fluence on theory construction with respect to all


100 Jürgen G. Backhausthe economies <strong>in</strong> transition after 1989, notably the East-German one. On page 11,you f<strong>in</strong>d a family tree <strong>of</strong> the Ordo-liberals (<strong>in</strong> the broader sense) which I reproduce<strong>in</strong> Figure 8.1. It strikes me as an excellent didactical tool.The guest editor himself follows with an article on Walter Eucken’s contributionto economics <strong>in</strong> an <strong>in</strong>ternational perspective. Of course, the purpose is to overcomethe “splendid isolation” <strong>in</strong> which the Ordo school had existed <strong>in</strong> German academia<strong>and</strong> thereby curtailed its <strong>in</strong>ternational <strong>in</strong>fluence. Eucken’s daughter, Irene Oswalt-Eucken, emphasizes neglected aspects <strong>of</strong> Walter Eucken’s work, notably freedom<strong>and</strong> economic power. Methodological aspects <strong>of</strong> Eucken’s work are taken up byCarsten Hermann-Pillath, <strong>and</strong> f<strong>in</strong>ally Lel<strong>and</strong> <strong>Yeager</strong> has the exposition on capital<strong>and</strong> <strong>in</strong>terest mentioned above. There is a bibliography <strong>of</strong> Walter Eucken’s work,probably the first one <strong>in</strong> English, compiled from Wendula Gräf<strong>in</strong> von Kl<strong>in</strong>ckowstroem’sbibliography. This volume <strong>of</strong> just 80 pages is an excellent <strong>in</strong>troduction<strong>in</strong>to Walter Eucken’s work for an English-language scholar.In 2000, two books on Walter Eucken were prepared <strong>in</strong> Freiburg, where hetaught from 1927 until his death <strong>in</strong> 1950 (<strong>in</strong> London while lectur<strong>in</strong>g there). The firstbook, Walter Eucken <strong>and</strong> his Œuvre, was published under the auspices <strong>of</strong> the WalterEucken Institute at the University <strong>of</strong> Freiburg (Gehrken 2000). This valuable bookhas a somewhat uneven architecture. The bulk <strong>of</strong> the work, about two-thirds, is athorough <strong>in</strong>tellectual biography <strong>of</strong> Walter Eucken authored by Wendula Gräf<strong>in</strong>von Kl<strong>in</strong>ckowstroem. She <strong>in</strong>cludes not only an extensive bibliography, but also aseries <strong>of</strong> pictures. This long, book-length essay is preceded by a tabulated curriculumvitae <strong>of</strong> Walter Eucken. After an <strong>in</strong>troduction, there is a 50 page article onWalter Eucken’s conception <strong>of</strong> Ordo theory by Lüder Gehrken <strong>and</strong> AndreasRenner. From this essay, we get an underst<strong>and</strong><strong>in</strong>g <strong>of</strong> Walter Eucken’s method <strong>of</strong>ga<strong>in</strong><strong>in</strong>g scholarly <strong>in</strong>sight. He conceived the scholar as st<strong>and</strong><strong>in</strong>g outside society <strong>and</strong>,by necessity, hav<strong>in</strong>g to ask radical questions. “Ask<strong>in</strong>g radical questions is the trademark<strong>of</strong> the scholar” (p. 9). The purpose <strong>of</strong> ask<strong>in</strong>g these radical questions, however,is nevertheless the same as it was with the empirically m<strong>in</strong>ded scholars who usedhistorical methods. It was Eucken’s belief that he had overcome the historicalschool by accomplish<strong>in</strong>g his concept <strong>of</strong> an Ordo theory. As Kl<strong>in</strong>ckowstroem po<strong>in</strong>tsout, f<strong>in</strong>d<strong>in</strong>g an answer to the social question became the purpose <strong>of</strong> the last 18 years<strong>of</strong> his scholarly life, to wit “how can a modern <strong>in</strong>dustrialized economy <strong>and</strong> societybe given a human <strong>and</strong> functional order?” (p. 71).The wide array <strong>of</strong> topics Walter Eucken is still able to <strong>in</strong>spire has been docu -mented <strong>in</strong> a Festschrift for Walter Eucken 50 years after his death (Külp <strong>and</strong>Vanberg 2003). The book has four parts with a total <strong>of</strong> 24 chapters. The first part isentitled “Economic Policy as Policy with Respect to an Economic Order.” GeroldBlümle <strong>and</strong> Nils Goldschmidt deal with the normative foundations <strong>of</strong> Ordo-liberalthought. Likewise, Otto Schlecht, who for many years <strong>in</strong> Germany was responsiblefor translat<strong>in</strong>g Ordo-liberal pr<strong>in</strong>ciples <strong>in</strong>to economic policy as state secretary <strong>in</strong> thefederal m<strong>in</strong>istry <strong>of</strong> economics, discusses the ethical formations <strong>in</strong> Eucken’s work.Werner Zohlnhöfer takes an evolutionary view on Ordo-liberalism <strong>and</strong> the socialmarket economy. Walter Hamm, long-time co-editor <strong>of</strong> the liberal daily newspaperFrankfurter Allgeme<strong>in</strong>e Zeitung, takes one element <strong>of</strong> Ordo-liberal pr<strong>in</strong>ciples, the


Figure 8.1 The “Genealogical Table.”


102 Jürgen G. Backhauspredictability <strong>of</strong> economic policy, <strong>and</strong> expla<strong>in</strong>s what can be deduced from this pr<strong>in</strong>ciple<strong>and</strong> what can not. In its first two decades before the accession <strong>of</strong> Brita<strong>in</strong> to theEuropean Union, Ordo-liberal pr<strong>in</strong>ciples played an important role <strong>in</strong> EuropeanUnion policies. It is therefore important that François Bilger discusses both ideas<strong>and</strong> <strong>in</strong>terests <strong>in</strong> the development <strong>of</strong> the European economic order.Ordo-economic pr<strong>in</strong>ciples tend to evoke the strongest controversies whenapplied to labor market <strong>and</strong> social policy. This is the topic <strong>of</strong> Part II <strong>of</strong> this book.Five quarters <strong>of</strong> a century ago, German economists started to pose the “socialquestion” <strong>in</strong> an unmistakenly different way from how other economists <strong>in</strong> France,Brita<strong>in</strong>, or Italy predom<strong>in</strong>antly did at the same time (Backhaus <strong>in</strong> press). BernhardKülp turns to Walter Eucken’s position with respect to the social question. UlrichWitt discusses the social market economy, Germany’s specific “answer” to thesocial question, which he is position<strong>in</strong>g between notions <strong>of</strong> rent-seek<strong>in</strong>g <strong>and</strong> socialcontract respectively. Whether, from Eucken’s po<strong>in</strong>t <strong>of</strong> view, there can be marketorder <strong>in</strong> the labor market is the topic <strong>of</strong> Volker Rieble’s contribution. A specificexample <strong>of</strong> German labor market legislation ostensibly try<strong>in</strong>g to provide for alevel play<strong>in</strong>g field concerns the so-called Worker Transfer Act (Arbeitnehmer-Entsendegesetz), which basically subjects workers employed by foreign companiesoperat<strong>in</strong>g <strong>in</strong> Germany, such as a British construction company do<strong>in</strong>g work ona Berl<strong>in</strong> construction site, to the same conditions that would apply to Germanworkers. Thus, a British electric contractor who has won a bid on a Berl<strong>in</strong> constructionsite has to subject his electricians to German work<strong>in</strong>g <strong>and</strong> pay conditions, thusrobb<strong>in</strong>g him <strong>of</strong> an important competitive advantage. Manfred Löwisch takes thisexample <strong>and</strong> uses Eucken’s approach for a thorough criticism. This example,whether one agrees with the results <strong>of</strong> the analysis or not, shows how topicalEucken’s work can be <strong>and</strong> how usefully it can be employed <strong>in</strong> the context <strong>of</strong> law <strong>and</strong>economic analysis. The <strong>in</strong>tegration <strong>of</strong> the German health <strong>in</strong>dustry, public, not forpr<strong>of</strong>it, <strong>and</strong> private, <strong>in</strong>to the European market is the topic <strong>of</strong> an analysis by EckhardKnappe <strong>and</strong> Hans-Joachim Jubelius, who aga<strong>in</strong> take an Ordo-economic approach.Norbert Berthold, who can always be found <strong>in</strong> the front l<strong>in</strong>es <strong>of</strong> current politicaldebate hold<strong>in</strong>g up the Ordo-economic flag, discusses options for social securityreform.At the heart <strong>of</strong> Ordo-economic pr<strong>in</strong>ciples is the notion that it is one <strong>of</strong> theprimary (if not the primary) purposes <strong>of</strong> a state to provide for <strong>and</strong> guarantee the<strong>in</strong>stitutions which the market requires for its proper operation. Any policy <strong>in</strong>itiativeshould withst<strong>and</strong> the test <strong>of</strong> whether it is compatible with the pr<strong>in</strong>ciples <strong>of</strong> a marketeconomy. Hence, Part III <strong>of</strong> the book is devoted to the issue <strong>of</strong> the role <strong>of</strong> the statewith respect to competition. Hans Otto Lenel therefore takes up the central concept<strong>of</strong> private economic power. Christian Watr<strong>in</strong> compares the view <strong>of</strong> the purposes <strong>of</strong>the state <strong>of</strong> Walter Eucken on the one h<strong>and</strong> <strong>and</strong> Friedrich von Hayek on the other.Erich Streissler deals with free f<strong>in</strong>ancial markets from Eucken’s po<strong>in</strong>t <strong>of</strong> view. HansWillgerodt wonders whether state systems <strong>of</strong> control or system <strong>of</strong> self-control arethe better remedy aga<strong>in</strong>st currency crises. Bernd Schauenberg takes up corruptionas a problem for economic organizations as such, but the economic order as awhole as well. Here we see how close Eucken’s approach can come to current issues


Lel<strong>and</strong>’s favorite economists 103<strong>of</strong> governance. Günter Knieps deals with competition <strong>in</strong> networks, <strong>and</strong> HelmutGröner <strong>and</strong> Gerhard Sauer take up the more specific case <strong>of</strong> municipal electricitysupply <strong>in</strong> Germany, which they discuss from an Ordo-theoretic po<strong>in</strong>t <strong>of</strong> view.Part IV takes up basic issues <strong>of</strong> Ordo-economic theory. Manfred Streit <strong>and</strong>Michael Wohlgemuth aga<strong>in</strong> compare Walter Eucken <strong>and</strong> Friedrich von Hayek.Franz Schober takes up knowledge <strong>in</strong> economic organizations <strong>and</strong> <strong>in</strong> <strong>in</strong>formationtechnology. Peter Oberender <strong>and</strong> Claudius Christl wonder whether WalterEucken’s Ordo-economic approach can be seen as a precursor <strong>of</strong> the new <strong>in</strong>stitutionaleconomics. Alan Peacock looks at civil justice from an economic <strong>and</strong>competitive po<strong>in</strong>t <strong>of</strong> view. Thomas Gehrig discusses the political economy <strong>of</strong>technical progress, <strong>and</strong> Victor Vanberg f<strong>in</strong>ally returns to the problem <strong>of</strong> Ordoeconomics<strong>and</strong> ethics, with which the volume had started out.The essays collected <strong>in</strong> this well-produced book <strong>of</strong> more than 600 pages can byno means be seen as an un-reflected eulogy <strong>of</strong> Eucken. Despite the basic assumptionthe authors share that Eucken is a tower<strong>in</strong>g figure <strong>in</strong> the history <strong>of</strong> economics notjust <strong>in</strong> Germany <strong>and</strong> needs to be taken seriously, the 50 years that have passed s<strong>in</strong>cehis death have also seen an unprecedented rise <strong>of</strong> economics as a social science.In their conclud<strong>in</strong>g section entitled “What rema<strong>in</strong>s?” Gerold Blümle <strong>and</strong> NilsGoldschmidt draw up a balance sheet as this: Methodologically, Eucken’s approach,based on phenomenology, can no longer be ma<strong>in</strong>ta<strong>in</strong>ed <strong>in</strong> a modern discourse <strong>in</strong>the philosophy <strong>of</strong> science. The strong bonds to Husserl necessarily wither, s<strong>in</strong>ceHusserl’s philosophy was basically “an ontology rooted <strong>in</strong> idealism,” <strong>and</strong> <strong>in</strong> thisway an “absolutism <strong>in</strong> transition” (Külp <strong>and</strong> Vanberg 2003: 39). For the benefit <strong>of</strong>the German-speak<strong>in</strong>g reader, I reproduce the orig<strong>in</strong>al. 2 Ethics: If the roots <strong>of</strong>economic theory can no longer be seen <strong>in</strong> “eternal truths,” economic ethics can nolonger be stated <strong>in</strong> absolute terms. If we discard the metaphysical legitimacy <strong>of</strong>pr<strong>in</strong>ciples <strong>of</strong> economic order, we can no longer take a moral position from an economicpo<strong>in</strong>t <strong>of</strong> view. 3 And f<strong>in</strong>ally: “If we want to formulate an economic theory <strong>in</strong> thetradition <strong>of</strong> Eucken, we have to arrive at the distressful but necessary <strong>in</strong>sight alreadyformulated by Schumpeter: ‘Instead <strong>of</strong> gett<strong>in</strong>g sharp contours for discipl<strong>in</strong>es <strong>and</strong>different approaches, we have to resign ourselves to the <strong>in</strong>sight that everyth<strong>in</strong>gblends <strong>in</strong>to each other.’” 4The remarkable dissertation by Nils Goldschmidt (2002) entitled “Development<strong>and</strong> Legacy <strong>of</strong> Ordo-Liberal Thought” is completely devoted to Walter Eucken,<strong>and</strong> was published with the new <strong>and</strong> enterpris<strong>in</strong>g LIT publishers <strong>in</strong> Münster. Thestudy has, <strong>in</strong> pr<strong>in</strong>ciple, four parts <strong>in</strong> addition to the Introduction <strong>and</strong> Conclusion.Part I is devoted to the notion <strong>of</strong> a cultural economics, which is relevant for thepurposes <strong>of</strong> this review only <strong>in</strong> that it puts economic reason<strong>in</strong>g <strong>in</strong>to a broadercontext (Storch 1823–24). Part II is devoted to Walter Eucken’s methodologicalapproach. Part III discusses the ethical basis <strong>and</strong> mov<strong>in</strong>g force <strong>in</strong> Walter Eucken’swork. This is go<strong>in</strong>g to be relevant <strong>in</strong> the course <strong>of</strong> this essay. In particular, Eucken’sdeep roots <strong>in</strong> Christianity, as they translate <strong>in</strong>to economic reason<strong>in</strong>g, need to befurther discussed. Part IV discusses essentially the roots <strong>of</strong> the Ordo-school <strong>in</strong>Schmoller, Wagner, Dietzel, <strong>and</strong> Schumacher. One should emphasize that almostone-fifth <strong>of</strong> the entire book documents the sources covered. This is an extremely


104 Jürgen G. Backhauscareful review <strong>of</strong> the sources. For the purpose at h<strong>and</strong>, however, I focus on whereEucken derived his notion <strong>of</strong> an order <strong>in</strong> economic life.In pr<strong>in</strong>ciple, one could th<strong>in</strong>k that Eucken followed Max Weber <strong>and</strong> postulatedan ideal type <strong>of</strong> an economic order. However, as Goldschmidt po<strong>in</strong>ts out, he was atpa<strong>in</strong>s to distance himself from Weber, whose ideal type he considered a Utopia(p. 51). Rather, as Goldschmidt emphasizes <strong>in</strong> Chapter 4, Eucken sought scholarlyunderst<strong>and</strong><strong>in</strong>g through (religious) belief (p. 121). In this, he explicitly refers back tohis father Rudolf Eucken. 5 The economic order Eucken sought had to be, at thesame time, an order <strong>in</strong> which one could lead one’s life accord<strong>in</strong>g to ethical pr<strong>in</strong>ciples<strong>and</strong> deeply rooted <strong>in</strong> Christian (Lutheran) belief (p. 121). The Ordo-pr<strong>in</strong>ciples hefound can be represented <strong>in</strong> what looks like a wheel <strong>of</strong> the basic pr<strong>in</strong>ciples <strong>of</strong> marketeconomy (p. 133). I herewith reproduce an English adaptation <strong>of</strong> the wheel (seeFigure 8.2).The follow<strong>in</strong>g section is devoted to a further discussion <strong>of</strong> the wheel <strong>and</strong> to anattempt to probe its <strong>in</strong>tellectual orig<strong>in</strong>s.It strikes me as surpris<strong>in</strong>g that the cornerstone <strong>of</strong> Ordo-liberalism should begrounded <strong>in</strong> Lutheran-protestant thought. Lel<strong>and</strong> himself, <strong>in</strong> an arcane footnote,refers to Friedrich Nietzsche but does not underp<strong>in</strong> my argument by what he writes(<strong>Yeager</strong> 2001: 229). Is it not really surpris<strong>in</strong>g that Lel<strong>and</strong>, the agnostic, shouldsubscribe to an economic theory ladled out <strong>of</strong> the founta<strong>in</strong> <strong>of</strong> Christianity? Perhapswe are not too <strong>of</strong>f the mark. In logic we learn ex falso quod libet. From a false statementanyth<strong>in</strong>g can be deduced, even truth. We are not talk<strong>in</strong>g about explicitly falsestatements though; the problem is rather that we are confronted with the teach<strong>in</strong>gs<strong>of</strong> an economist who felt that his economic <strong>in</strong>sight had to parallel his religiousbeliefs. Can a Turkish immigrant to the European Union who opens a grocerystore <strong>in</strong> a metropolitan city conform to these pr<strong>in</strong>ciples, although he has never beentaught these protestant <strong>in</strong>sights? 6S<strong>in</strong>ce Eucken’s pr<strong>in</strong>ciples, which make em<strong>in</strong>ent economic sense, have no crediblefoundation <strong>in</strong> empiric evidence, 7 but s<strong>in</strong>ce, on the other h<strong>and</strong>, they make pla<strong>in</strong>Economicpolicy to ensurepropertyPrimacy <strong>of</strong> astable currencyRegulationaga<strong>in</strong>stanti-competitivebehaviorPredictability<strong>of</strong> economicpolicyLiabilityPrimary pr<strong>in</strong>ciple:functional price-basedcompetitionOpenmarketsPrivatepropertyReliableeconomicstatisticsFreedom<strong>of</strong> contractControl <strong>of</strong>monopoliesFigure 8.2 Eucken’s Wheel.


Lel<strong>and</strong>’s favorite economists 105economic sense, the natural question arises <strong>of</strong> whether they can f<strong>in</strong>d reason <strong>in</strong>other, perhaps philosophers’, reason<strong>in</strong>gs. In a different context, we have found thatFriedrich Nietzsche might have been a source <strong>of</strong> <strong>in</strong>spiration. 8 Is it possible or isit conceivable that Friedrich Nietzsche <strong>in</strong>fluenced Eucken’s view <strong>of</strong> the world?The question cannot be readily answered. On the one h<strong>and</strong>, both Nietzsche <strong>and</strong>Eucken’s father, Rudolf Eucken, were em<strong>in</strong>ent literary figures. Next to everyth<strong>in</strong>gthat Nietzsche had published, <strong>in</strong> particular Morgenröte, must have been householditems at d<strong>in</strong>ner table conversations <strong>in</strong> Jena (at Eucken’s table). It is therefore not farfetchedto wonder whether we can f<strong>in</strong>d the basic ideas <strong>of</strong> Eucken’s Ordo-notions <strong>in</strong>Nietzsche’s writ<strong>in</strong>gs. As the reader will soon discover, we can very well f<strong>in</strong>d the gist<strong>of</strong> the ideas <strong>in</strong> Nietzsche’s works, but Eucken did make a very good attempt to translatethe basic ideas <strong>in</strong>to economic practice, to the extent that he was aware <strong>of</strong> it. 9As far as I can see, most but not all what Eucken suggests <strong>in</strong> his wheel is wellconta<strong>in</strong>ed <strong>in</strong> Nietzsche, but I could have done the same for Justi. What is importantis not the orig<strong>in</strong>al <strong>in</strong>sight <strong>of</strong> the basic <strong>in</strong>gredients <strong>of</strong> a market economy. What isimportant, <strong>and</strong> that has to do with his religious dedication, is to have understoodwhat such a market economy requires, <strong>and</strong> that it takes determ<strong>in</strong>ation to make ithappen. Hav<strong>in</strong>g witnessed several generations enslaved <strong>in</strong> state socialism, whowould cast the first stone aga<strong>in</strong>st a scholar who honestly believes that his economic<strong>in</strong>sight comes from the scripture?Clearly, Nietzsche is another scholar who fell apart because he could not reconcilescripture <strong>and</strong> evidence, <strong>and</strong> nevertheless came to rather similar conclusions.Although the conclusions cannot be tested, s<strong>in</strong>ce they are basic propositions, theyearn credence if different tra<strong>in</strong>s <strong>of</strong> thought lead to the same basic pr<strong>in</strong>ciples. It is forthis reason that we now turn to Friedrich Nietzsche.II Sources <strong>of</strong> <strong>in</strong>sightS<strong>in</strong>ce we are now somewhat stunned as to where Eucken got his <strong>in</strong>sights from, let uslook at a somewhat unlikely source.Friedrich Nietzsche (1844–1900) is certa<strong>in</strong>ly not known as a pr<strong>of</strong>ound writer <strong>in</strong>economics. Contemporary writ<strong>in</strong>gs do not quote him as hav<strong>in</strong>g contributed toeconomics at all. However, a closer look shows that Friedrich Nietzsche had deep<strong>in</strong>sights <strong>in</strong>to why <strong>and</strong> how man can be a homo economicus. This part has three basicpieces. The first piece gives essential quotes from his now available work. Thesecond piece gives a sketch <strong>of</strong> basic <strong>in</strong>stitutions <strong>of</strong> the market economy. The thirdpiece connects the two <strong>in</strong> show<strong>in</strong>g that Nietzsche, <strong>in</strong>deed, had pr<strong>of</strong>ound <strong>in</strong>sightsthat go way beyond other classical th<strong>in</strong>kers <strong>in</strong> economics. In this sense, <strong>and</strong> <strong>in</strong> thissense only, Nietzsche can be claimed to be an important th<strong>in</strong>ker <strong>in</strong> the history <strong>of</strong>economic thought.A)Friedrich Nietzsche (1844–1900) is probably the most important philosopher <strong>of</strong> then<strong>in</strong>eteenth century. S<strong>in</strong>ce philosophy is the mother <strong>of</strong> the social sciences, it would


106 Jürgen G. Backhausbe curious <strong>in</strong>deed if Nietzsche did not have important th<strong>in</strong>gs to say about economics.Economics, after all, is a social science. However, the consensus <strong>in</strong> theeconomics pr<strong>of</strong>ession today is that Nietzsche had little to add to economic analysis.In this sense, Nietzsche is probably silent on economics. He did not contribute to<strong>in</strong>creas<strong>in</strong>g the availability <strong>of</strong> tools available to economists today. Yet, at a differentlevel, he had important th<strong>in</strong>gs to say, <strong>and</strong> <strong>in</strong> this essay devoted to Lel<strong>and</strong> <strong>Yeager</strong>, Itry to show that Nietzsche <strong>in</strong>deed had important economic <strong>in</strong>sights.B)In his “Gay Science” section 377, Nietzsche all <strong>of</strong> a sudden br<strong>in</strong>gs up the word <strong>of</strong>honor. It is the culm<strong>in</strong>ation <strong>of</strong> this section, 10 <strong>in</strong>serted <strong>in</strong>to a longer sentence <strong>and</strong>ended with an exclamation mark. In this section, Nietzsche talks about his vision <strong>of</strong>a civil society. Its <strong>in</strong>tellectual leaders, those who preferred to live on the mounta<strong>in</strong>s,have left their roots beh<strong>in</strong>d, have outgrown nationalism <strong>and</strong> racism, have leftChristianity beh<strong>in</strong>d but are not at all without ideals: “<strong>in</strong> one word we are – <strong>and</strong>this shall be our word <strong>of</strong> honor! – good Europeans, the heirs <strong>of</strong> Europe, the rich,overburdened, but at the same time manifold bound heirs <strong>of</strong> millennia <strong>of</strong> Europeanspirit <strong>and</strong> as such grown beyond Christianity . .. .” This word <strong>of</strong> honor to seal thetrue European spirit is needed, because, as he later po<strong>in</strong>ts out, the quest for aEuropean civil society is based on belief itself.The notion <strong>of</strong> a word <strong>of</strong> honor is not <strong>in</strong>cidental. It has actually been a centralidea <strong>in</strong> his Genealogy <strong>of</strong> Morals written five years later. 11 Man is def<strong>in</strong>ed as that animalwhich can make <strong>and</strong> keep promises. He sees this as the basic <strong>and</strong> most importantmoral achievement atta<strong>in</strong>ed by mank<strong>in</strong>d, an achievement that is even more surpris<strong>in</strong>g<strong>in</strong> that man also has a strong tendency to forget. This <strong>in</strong>sight is at the heart<strong>of</strong> the concept <strong>of</strong> cognitive dissonance. By be<strong>in</strong>g able to make believable promises,man is creat<strong>in</strong>g a l<strong>in</strong>k between the present <strong>and</strong> the future through a process <strong>of</strong>division <strong>of</strong> labor. The promise entails an exchange which is not constra<strong>in</strong>ed to takeplace simultaneously <strong>and</strong> at the same time; this form <strong>of</strong> barter we can also observe<strong>in</strong> animal societies. Instead, the promise allows for an exchange <strong>of</strong> goods or service<strong>in</strong> the present <strong>in</strong> return for equivalent goods or services <strong>in</strong> the future. This is thebasis for such economic activities as sav<strong>in</strong>g, <strong>in</strong>vestment, credit, <strong>and</strong> bequest. If anyone <strong>of</strong> these <strong>in</strong>stitutions is lack<strong>in</strong>g, economic progress can hardly take place.Under current conditions <strong>of</strong> economies undergo<strong>in</strong>g processes <strong>of</strong> transition,Nietzsche’s <strong>in</strong>sight appears to be particularly powerful. In order to make this clear,let us take a look at the basic <strong>in</strong>stitutions characteriz<strong>in</strong>g a market economy. Theseare the <strong>in</strong>stitutions signaled by Eucken.C)“The division <strong>of</strong> labour is limited by the extent <strong>of</strong> the market.” This basic dictumsharply expressed by Adam Smith (1776) focuses our attention on those factorswhich are responsible for limit<strong>in</strong>g the extent <strong>of</strong> the market, thereby limit<strong>in</strong>g depth<strong>and</strong> breadth <strong>of</strong> the division <strong>of</strong> labor <strong>in</strong> the economy <strong>and</strong>, by implication, thecreation <strong>of</strong> wealth.


Lel<strong>and</strong>’s favorite economists 107One 12 can identify eight basic <strong>in</strong>stitutions which must be present <strong>and</strong> workable <strong>in</strong>order for any market economy to function well, irrespective <strong>of</strong> the specific style <strong>of</strong>that economy. Hence, these <strong>in</strong>stitutions must be present <strong>in</strong> an unfettered freemarket economy, <strong>in</strong> a socialist market economy, <strong>in</strong> a cooperative market economy,<strong>in</strong> a market economy with syndicalist elements or variously <strong>in</strong> one with strong statemarket participation. All these forms – <strong>and</strong> many more – are potentially feasible, providedthese basic <strong>in</strong>stitutions are firmly <strong>in</strong> place <strong>and</strong> can fulfill their functions well.If these <strong>in</strong>stitutions are weakened <strong>and</strong> impaired, such as when property rights arebe<strong>in</strong>g diluted, this market will work with high transaction costs <strong>and</strong> only to theextent that the ga<strong>in</strong>s from market exchange outweigh those transaction costs.Basic rightsFreedom <strong>of</strong> contractFrom an economic po<strong>in</strong>t <strong>of</strong> view, freedom <strong>of</strong> contract is an important guaranteebecause it ensures as a necessary condition that all the <strong>in</strong>formation available <strong>in</strong>a society enters economically relevant decisions <strong>and</strong> all the resources available <strong>in</strong> asociety will be put to their most efficient use. This implies that every <strong>in</strong>fr<strong>in</strong>gement <strong>of</strong>freedom <strong>of</strong> contract has to be judged <strong>in</strong> terms <strong>of</strong> the losses imposed on society dueto ignorance <strong>and</strong> wasted resources. From an economic po<strong>in</strong>t <strong>of</strong> view, it is notsufficient to weigh freedom <strong>of</strong> contract aga<strong>in</strong>st some other guarantee such as thepr<strong>in</strong>ciple <strong>of</strong> equality as such, without pay<strong>in</strong>g attention to the full consequences <strong>of</strong>the trade-<strong>of</strong>f. If, for <strong>in</strong>stance, it is observed that <strong>in</strong> a certa<strong>in</strong> society members <strong>of</strong> am<strong>in</strong>ority are not represented <strong>in</strong> a particular pr<strong>of</strong>ession accord<strong>in</strong>g to their numericshare <strong>in</strong> that society, from an economic po<strong>in</strong>t <strong>of</strong> view it is not justified to pit theobserved end-state <strong>in</strong>equality aga<strong>in</strong>st the guarantee <strong>of</strong> freedom <strong>of</strong> contract, s<strong>in</strong>ce arational choice <strong>in</strong> the <strong>in</strong>terest <strong>of</strong> all parties concerned may have led to the unequaloutcome. An economic analysis would have to <strong>in</strong>quire <strong>in</strong>to the reasons for theobserved <strong>in</strong>equality, <strong>and</strong> it would lay the foundation for assess<strong>in</strong>g the trade-<strong>of</strong>fbetween the social (opportunity) costs <strong>of</strong> constra<strong>in</strong><strong>in</strong>g freedom <strong>of</strong> contract on theone h<strong>and</strong>, <strong>and</strong> the ga<strong>in</strong>s <strong>in</strong> terms <strong>of</strong> economic equality on the other. Based onthe <strong>in</strong>quiry <strong>in</strong>to the causes <strong>of</strong> the observed <strong>in</strong>equalities, an alternative strategy toimprove the chances <strong>of</strong> the m<strong>in</strong>ority <strong>in</strong> question can <strong>in</strong> all likelihood be derived. Itis at this <strong>in</strong>stance that the economic analysis <strong>of</strong> constitu tional guarantees can haveimplications for constitutional law. Many constitutions require that basic rights canonly be curtailed if less onerous measures are not available. To the extent thateconomic analysis can yield the design <strong>of</strong> such less onerous measures, it changes theconstitutionality <strong>of</strong> particular policies.Private propertyThe guarantee <strong>of</strong> private property is <strong>of</strong>ten thought to be the most important withrespect to the means <strong>of</strong> production. Aga<strong>in</strong>, from an economic po<strong>in</strong>t <strong>of</strong> view, theguarantee goes far beyond the protection <strong>of</strong> people’s possessions <strong>of</strong> goods <strong>and</strong>services. The reason for this wider scope is fairly straightforward. In economics,


108 Jürgen G. Backhausproperty rights def<strong>in</strong>e <strong>and</strong> circumscribe alternatives for mean<strong>in</strong>gful actions. Hence,the mere property title to some commodity, such as l<strong>and</strong>, is mean<strong>in</strong>gless if it doesnot imply discretionary alternatives <strong>and</strong> options that can be exercised.In particular, the guarantee <strong>of</strong> private property rights implies the right to exerciseprivate property prerogatives with<strong>in</strong> workable <strong>in</strong>stitutions. The guarantee isviolated if, for <strong>in</strong>stance, the contrac tual forms <strong>in</strong> which a property right can beexercised are unworkable or impractical, thereby destroy <strong>in</strong>g the value <strong>of</strong> theproperty right or seriously reduc<strong>in</strong>g it. The <strong>in</strong>stitutions <strong>in</strong> which private propertyrights can be exercised have to provide for the possibility that the four st<strong>and</strong>ardoptions <strong>of</strong> economic conduct 13 rema<strong>in</strong> open. These options <strong>in</strong>clude:1 exit, the right to end an economic relationship;2 voice, the option to mean<strong>in</strong>gfully improve upon a relations hip by chang<strong>in</strong>g itthrough negotiations;3 loyalty, the ability to foster the growth <strong>of</strong> trust <strong>and</strong> goodwill <strong>in</strong> a relationshipeven <strong>in</strong> the face <strong>of</strong> serious problems; <strong>and</strong>4 avoidance, the option to ignore a particular relationship altogether withoutfac<strong>in</strong>g sanctions.This option is extremely important for Nietzsche <strong>and</strong> those who followed him.Look at the Widerst<strong>and</strong> literature, <strong>and</strong> most recently Helge Peukert (2004), whodiscusses the different economic concepts, but also their motivations, based <strong>in</strong>Christian <strong>and</strong> other thought.LiabilityThe two basic rights <strong>of</strong> freedom <strong>of</strong> contract <strong>and</strong> private property need to be complementedby the <strong>in</strong>stitution <strong>of</strong> liability <strong>in</strong> order to be mean<strong>in</strong>gful at all. The faithfulobservance <strong>of</strong> contractual terms requires the protection <strong>of</strong> a shield <strong>of</strong> liability forfailure <strong>of</strong> liv<strong>in</strong>g up to contractual terms just as much as the respective privateproperty rights require the need to make the <strong>in</strong>truder liable. Although this pr<strong>in</strong>cipleis straightforward, from an economic po<strong>in</strong>t <strong>of</strong> view the implications can be farreach<strong>in</strong>g. In particular, liability can only be assigned if the agent to be held liablewas <strong>in</strong>deed <strong>in</strong> control <strong>of</strong> events that led to the liability. If this is not the case, theclaim has to be followed through all the way to those who were either <strong>in</strong> control orcreated the situation that made control impossible. If, for <strong>in</strong>stance, a patient suffersa serious <strong>in</strong>jury because a doctor did not adm<strong>in</strong>ister the necessary treatment, whichhe failed to do because, <strong>in</strong> order to adm<strong>in</strong>ister the treatment, accord<strong>in</strong>g to stateregulations he needed the written consent <strong>of</strong> two colleagues whom he could notreach because they were tied up <strong>in</strong> meet<strong>in</strong>gs, this doctor is not liable for the <strong>in</strong>juryimposed on the patient; nor is the full damage to rema<strong>in</strong> with the patient; rather,the pr<strong>in</strong>ciple <strong>of</strong> synchroniz<strong>in</strong>g control <strong>and</strong> liability requires to make those jo<strong>in</strong>tly<strong>and</strong> severally liable who contributed to pass<strong>in</strong>g the regulations caus<strong>in</strong>g the problem– ty<strong>in</strong>g up doctors <strong>in</strong> meet<strong>in</strong>gs <strong>and</strong> requir<strong>in</strong>g written consent to engage <strong>in</strong> pr<strong>of</strong>essionalactivities – <strong>in</strong> the first place. 14


Lel<strong>and</strong>’s favorite economists 109Stable legal environmentThe follow<strong>in</strong>g three basic guarantees are more or less ancillary to the first three, theclassical threesome <strong>of</strong> economic basic rights. Constancy <strong>and</strong> predictability <strong>of</strong> economicpolicy is required <strong>in</strong> order to be able to enter contracts cover<strong>in</strong>g not only thepresent but also the future. The same is true with respect to the exercise <strong>of</strong> propertyrights with consequences <strong>in</strong> the future, notably <strong>in</strong>vestment decisions. For privateproperty rights, however, the predictability <strong>of</strong> economic policy is crucial because itaffects the adjustment costs necessarily borne by the private sector <strong>and</strong> fall<strong>in</strong>g ontoproperty, conceivably reduc<strong>in</strong>g its value. This requirement does not affect therange <strong>and</strong> doma<strong>in</strong> <strong>of</strong> economic policy, but only the time horizon with<strong>in</strong> which itcan be carried out. The more predictable economic policies are, the smaller theadjustment costs. The corollary statement requires that the more drastic a policychange, the longer its implementation has to be delayed <strong>and</strong> the more carefully theprecise contours <strong>of</strong> the new policy have to be expla<strong>in</strong>ed <strong>in</strong> order to allow for smoothadjustments <strong>in</strong> the private sector. A policy may be unconstitutional simply becausethe legislature did not take the requisite care <strong>in</strong> spell<strong>in</strong>g it out <strong>in</strong> time <strong>and</strong> provid<strong>in</strong>gfor reasonable adjustment periods before implementation.Stable currencyContractual relationships that are entered <strong>in</strong>to for longer periods <strong>of</strong> time typicallyrequire for some k<strong>in</strong>d <strong>of</strong> payment to be made by one or the other party. Thebenefits from contractual relationships can be seriously impaired if there is nocommon language <strong>in</strong> which to express the duties <strong>of</strong> the different parties. Theproblem is most serious <strong>in</strong> the case <strong>of</strong> payments, if there is no stable unit <strong>in</strong> which toexpress the size <strong>of</strong> payments to be made <strong>and</strong> received. The more uncerta<strong>in</strong>ty thereis, the smaller can be the ga<strong>in</strong>s from trade <strong>and</strong> consequently the smaller is thepotential for economic progress <strong>in</strong> that society. This is why, from an economicpo<strong>in</strong>t <strong>of</strong> view, the guarantee <strong>of</strong> a stable currency is important as an ancillary right.Aga<strong>in</strong>, what is really required is not one particular monetary policy, but rather an<strong>in</strong>stitutional arrangement which stabilizes the unit <strong>of</strong> account. It should be notedhere that this requirement does not prescri be any particular monetary policy for acentral bank, such as a European Central Bank, nor does it require only onecurrency to circulate <strong>in</strong> a particular market. Lead<strong>in</strong>g monetary theorists haveshown that a variety <strong>of</strong> currencies circulat<strong>in</strong>g may not only be compatible with thepr<strong>in</strong>ciple <strong>of</strong> keep<strong>in</strong>g the unit <strong>of</strong> account stable, it may even be <strong>in</strong> the <strong>in</strong>terest <strong>of</strong>enforc<strong>in</strong>g this pr<strong>in</strong>ciple. 15Open marketsF<strong>in</strong>ally, access to markets has to rema<strong>in</strong> open <strong>in</strong> order to allow for other basichuman rights to be exercised <strong>in</strong> a mean<strong>in</strong>gful way. This is obvious for the right <strong>of</strong>freedom <strong>of</strong> contract, but also extends <strong>in</strong>to such classical basic rights as the freedom<strong>of</strong> the press, freedom <strong>of</strong> political expression, freedom <strong>of</strong> exercis<strong>in</strong>g the religion <strong>of</strong>


110 Jürgen G. Backhausone’s choice, freedom <strong>of</strong> exercis<strong>in</strong>g the pr<strong>of</strong>ession <strong>of</strong> one’s choice, the academicprivileges <strong>of</strong> freedom <strong>of</strong> <strong>in</strong>struction <strong>and</strong> research, etc. The problem is, by the way,most serious if a particular government or some private agents suppress theexistence <strong>of</strong> a market altogether. The guarantee <strong>of</strong> freedom <strong>of</strong> access to marketsobviously <strong>in</strong>cludes the guarantee to have such markets established, which does notpredeterm<strong>in</strong>e the shape such markets take, as long as they provide for an openforum to communicate <strong>and</strong> exchange, which is what a market basically is about(Schwartze 1990).Procedural guaranteesBasic rights <strong>and</strong> procedural guarantees are equally important, s<strong>in</strong>ce basic rightscan only be exercised if certa<strong>in</strong> procedural guarantees are observed. The importance<strong>of</strong> procedural guarantees is not reflected <strong>in</strong> the amount <strong>of</strong> space they receive<strong>in</strong> this essay, due to space limitations. Essentially, there are two types <strong>of</strong> proceduralguarantees: guarantees regulat<strong>in</strong>g the relationship between public bodies <strong>and</strong>guarantees regulat<strong>in</strong>g the relationship between public bodies <strong>and</strong> citizens.The relationship between public bodiesThe procedural pr<strong>in</strong>ciples regulat<strong>in</strong>g the relationships between public bodies consist<strong>of</strong> at least three groups. They <strong>in</strong>clude all those rules regulat<strong>in</strong>g the doma<strong>in</strong>s <strong>of</strong>competence <strong>of</strong> the various public bodies with respect to each other, <strong>in</strong>clud<strong>in</strong>g theareas <strong>of</strong> cooperation, mutual consent, or hierarchical control. A second groupconsists <strong>of</strong> pr<strong>in</strong>ciples <strong>of</strong> budget<strong>in</strong>g such as the pr<strong>in</strong>ciples <strong>of</strong> timel<strong>in</strong>ess, completeness<strong>of</strong> budgets, etc. A third <strong>in</strong>volves pr<strong>in</strong>ciples <strong>of</strong> legislation. One is that legislationalways has to be <strong>of</strong> a general character, <strong>and</strong> that acts are <strong>in</strong>valid if they address onecase only. Another economically relevant pr<strong>in</strong>ciple <strong>in</strong>volves the requirement thatlegislation which has turned out to be faulty, unjust, or seriously impractical, <strong>and</strong>thereby has turned out to be <strong>in</strong> violation <strong>of</strong> basic rights, needs to be corrected.The relationships between public bodies <strong>and</strong> citizensThe second set <strong>of</strong> procedural rules typically found <strong>in</strong> constitutions <strong>in</strong>volves thequestion <strong>of</strong> how the private citizen or other legal entity relates to public bodies. Intothis category fall two sets <strong>of</strong> rules. One set aga<strong>in</strong> governs the separation <strong>of</strong> thedoma<strong>in</strong>s <strong>of</strong> competence. A typical example is the separation <strong>of</strong> church <strong>and</strong> state.But here, aga<strong>in</strong>, forms <strong>of</strong> cooperation, <strong>of</strong> mutual consent, or <strong>of</strong> hierarchical order<strong>in</strong>gsare clearly available. The second set <strong>of</strong> rules, generally described by theextremely comprehensive term <strong>of</strong> due process, lays down the rules <strong>of</strong> the gamebetween public bodies <strong>and</strong> private citizens or legal entities. These <strong>in</strong>clude <strong>in</strong>formationrights, notification rights, <strong>and</strong> the right to have access to courts <strong>and</strong> bodies<strong>of</strong> appeal <strong>in</strong> mean<strong>in</strong>gful ways that go beyond merely procedural ceremonies withoutcontent, s<strong>in</strong>ce the important benchmark is the effectiveness <strong>of</strong> these procedures<strong>in</strong> safeguard<strong>in</strong>g the six basic economic rights outl<strong>in</strong>ed above.


Lel<strong>and</strong>’s favorite economists 111A prelim<strong>in</strong>ary summaryIn the preced<strong>in</strong>g analysis, we have identified constitutional guarantees with respectto basic rights on the one h<strong>and</strong> <strong>and</strong> procedural rules on the other. There are threebasic rights the guarantee <strong>of</strong> which has to be considered as central from an economicpo<strong>in</strong>t <strong>of</strong> view. These guarantees protect the right <strong>of</strong> freedom <strong>of</strong> contract, the<strong>in</strong>stitution <strong>of</strong> liability <strong>in</strong> the sense that those responsible for actions or a lack there<strong>of</strong>can be held responsible for the effects <strong>of</strong> their activities or the lack there<strong>of</strong>; <strong>and</strong> the<strong>in</strong>stitution <strong>of</strong> private property <strong>in</strong> the sense that clearly specified <strong>and</strong> mean<strong>in</strong>gfulalternatives become available for economic agents to dispose with goods <strong>and</strong>services. These basic economic rights are supported by three ancillary economicrights, guarantee<strong>in</strong>g a stable legal environment, a stable currency provid<strong>in</strong>g for acommon language <strong>of</strong> contractual relationships, <strong>and</strong> open markets which <strong>in</strong>cludethe right to establish such markets <strong>in</strong> areas where they do not exist.Procedural guarantees cover either the relationship between public bodies, orthe relationship between public bodies <strong>and</strong> private citizens or other legal entities.The pr<strong>in</strong>ciple <strong>of</strong> due process requires <strong>in</strong> this context that citizens <strong>and</strong> legal personshave access to courts <strong>and</strong> bodies <strong>of</strong> appeal <strong>in</strong> mean<strong>in</strong>gful ways, barr<strong>in</strong>g purelyceremonial procedures.The economic analysis <strong>of</strong> constitutional rights can, obviously, not substitute forconstitutional jurisprudence. But economic analysis can substantially enhance thesharpness <strong>of</strong> jurisprudential analysis by spell<strong>in</strong>g out the consequences <strong>of</strong> particularconstitutional provisions (or the lack there<strong>of</strong>) <strong>and</strong> the systematic <strong>in</strong>terconnectionsbetween basic legal <strong>in</strong>stitutions such as property, contract, <strong>and</strong> liability, as wellas legal procedures. In this sense, the economic analysis can be <strong>in</strong>tegrated <strong>in</strong>tojurisprudential analysis <strong>and</strong> by be<strong>in</strong>g embodied <strong>in</strong>to the <strong>in</strong>terpretation <strong>of</strong> constitutionalprovisions, economic analysis can become an <strong>in</strong>tegral part <strong>of</strong> constitutionalscholarship.To the <strong>in</strong>advertent, s<strong>in</strong>ce Lel<strong>and</strong> likes to have the precise language beforeh<strong>and</strong>,here is the orig<strong>in</strong>al:Insertion IFriedrich Nietzsche: Die fröhliche WissenschaftAbschnitt 377Wir Heimatlosen. – Es fehlt unter den Europäern von heute nicht an solchen,die e<strong>in</strong> Recht haben, sich <strong>in</strong> e<strong>in</strong>em abhebenden und ehrenden S<strong>in</strong>neHeimatlose zu nennen, – ihnen gerade sei me<strong>in</strong>e geheime Weisheit und gayascienza ausdrücklich ans Herz gelegt! Denn ihr Los ist hart, ihre H<strong>of</strong>fnungungewiß, es ist e<strong>in</strong> Kunststück, ihnen e<strong>in</strong>en Trost zu erf<strong>in</strong>den, – aber was hilftes! Wir K<strong>in</strong>der der Zukunft, wie vermöchten wir <strong>in</strong> diesem Heute zu Hausese<strong>in</strong>! Wir s<strong>in</strong>d allen Idealen abgünstig, auf welche h<strong>in</strong> e<strong>in</strong>er sich sogar <strong>in</strong>dieser zerbrechlichen, zerbrochenen Übergangszeit noch heimisch fühlen


112 Jürgen G. Backhauskönnte; was aber deren “Realitäten” betrifft, so glauben wir nicht daran, daßsie Dauer haben. Das Eis, das heute noch trägt, ist schon sehr dünn geworden:der Tauw<strong>in</strong>d weht, wir selbst, wir Heimatlosen, s<strong>in</strong>d etwas, das Eis und<strong>and</strong>ere allzudünne “Realitäten” aufbricht . . . Wir “konservieren” nichts, wirwollen auch <strong>in</strong> ke<strong>in</strong>e Vergangenheit zurück, wir s<strong>in</strong>d durchaus nicht“liberal”, wir arbeiten nicht für den “Fortschritt”, wir brauchen unser Ohrnicht erst gegen die Zukunfts-Sirenen des Marktes zu verstopfen – das, wassie s<strong>in</strong>gen “gleiche Rechte”, “freie Gesellschaft”, “ke<strong>in</strong>e Herren mehr undke<strong>in</strong>e Knechte”, das lockt uns nicht! – wir halten es schlechterd<strong>in</strong>gs nicht fürwünschenswert, daß das Reich der Gerechtigkeit und E<strong>in</strong>tracht auf Erdengegründet werde (weil es unter allen Umständen das Reich der tiefstenVermittelmäßigung und Ch<strong>in</strong>eserei se<strong>in</strong> würde), wir freuen uns an allen, diegleich uns die Gefahr, den Krieg, das Abenteuer lieben, die sich nichtabf<strong>in</strong>den, e<strong>in</strong>fangen, versöhnen und verschneiden lassen, wir rechnen unsselbst unter die Eroberer, wir denken über die Notwendigkeit neuerOrdnungen nach, auch e<strong>in</strong>er neuen Sklaverei – denn zu jeder Verstärkungund Erhöhung des Typus “Mensch” gehört auch e<strong>in</strong>e neue Art Versklavungh<strong>in</strong>zu – nicht wahr? Mit alledem müssen wir schlecht <strong>in</strong> e<strong>in</strong>em Zeitalter zuHause se<strong>in</strong>, welches die Ehre <strong>in</strong> Anspruch zu nehmen liebt, das menschlichste,mildeste, rechtlichste Zeitalter zu heißen, das die Sonne bisher gesehen hat.Schlimm genug, daß wir gerade bei diesen schönen Worten um so häßlichereH<strong>in</strong>tergedanken haben! Daß wir dar<strong>in</strong> nur den Ausdruck – auch dieMaskerade – der tiefen Schwächung, der Ermüdung, des Alters, derabs<strong>in</strong>kenden Kraft sehen! Was kann uns daran gelegen se<strong>in</strong>, mit was fürFlittern e<strong>in</strong> Kranker se<strong>in</strong>e Schwäche aufputzt! Mag er sie als se<strong>in</strong>e Tugend zurSchau tragen – es unterliegt ja ke<strong>in</strong>em Zweifel, daß die Schwäche mild, achso mild, so rechtlich, so un<strong>of</strong>fensiv, so “menschlich” macht! – Die “Religiondes Mitleidens”, zu der man uns überreden möchte, o wir kennen diehysterischen Männle<strong>in</strong> und Weible<strong>in</strong> genug, welche heute gerade dieseReligion zum Schleier und Aufputz nötig haben! Wir s<strong>in</strong>d ke<strong>in</strong>eHumanitarier; wir würden uns nie erlauben wagen, von unserer “Liebe zurMenschheit” zu reden – dazu ist unsere<strong>in</strong>s nicht Schauspieler genug! Odernicht Sa<strong>in</strong>t-Simonist genug, nicht Franzose genug! Man muß schon mite<strong>in</strong>em gallischen Übermaß erotischer Reizbarkeit und verliebter Ungeduldbehaftet se<strong>in</strong>, um sich <strong>in</strong> ehrlicher Weise sogar noch der Menschheit mitse<strong>in</strong>er Brunst zu nähern . . . Der Menschheit! Gab es je noch e<strong>in</strong> scheußlicheresaltes Weib unter allen alten Weibern? (-es müßte denn etwa “die Wahrheit”se<strong>in</strong>: e<strong>in</strong>e Frage für Philosophen). Ne<strong>in</strong>, wir lieben die Menschheit nicht;<strong>and</strong>ererseits s<strong>in</strong>d wir aber auch lange nicht “deutsch” genug, wie heute dasWort “deutsch” gang und gäbe ist, um dem Nationalismus und demRassenhaß das Wort zu reden, um an der nationalen Herzenskrätze undBlutvergiftung Freude haben zu können, derenthalben sich jetzt <strong>in</strong> EuropaVolk gegen Volk wie mit Quarantänen abgrenzt, absperrt. Dazu s<strong>in</strong>d wir zuunbefangen, zu boshaft, zu verwöhnt, auch zu gut unterrichtet, zu “gereist”:wir ziehen es bei weitem vor, auf Bergen zu leben, abseits, “unzeitgemäß”, <strong>in</strong>


Lel<strong>and</strong>’s favorite economists 113vergangenen oder kommenden Jahrhunderten, nur damit wir uns die stilleWut ersparen, zu der wir uns verurteilt wüßten als Augenzeugen e<strong>in</strong>erPolitik, die den deutschen Geist öde macht, <strong>in</strong>dem sie ihn eitel macht, undkle<strong>in</strong>e Politik außerdem ist: – hat sie nicht nötig, damit ihre eigene Schöpfungnicht s<strong>of</strong>ort wieder ause<strong>in</strong><strong>and</strong>er fällt, sie zwischen zwei Todhasse zupflanzen? muß sie nicht die Verewigung der Kle<strong>in</strong>staaterei Europas wollen?. . . Wir Heimatlosen, wir s<strong>in</strong>d der Rasse und Abkunft nach zu vielfach undgemischt, als “moderne Menschen”, und folglich wenig versucht, an jenerverlogenen Rassen-Selbstbewunderung und Unzucht teilzunehmen, welchesich heute <strong>in</strong> Deutschl<strong>and</strong> als Zeichen deutscher Ges<strong>in</strong>nung zur Schau trägtund die bei dem Volke des “historischen S<strong>in</strong>ns” zwiefach falsch undunanständig anmutet. Wir s<strong>in</strong>d, mit e<strong>in</strong>em Worte – und es soll unserEhrenwort se<strong>in</strong>! – gut Europäer, die Erben Europas, die reichen,überhäuften, aber auch überreich verpflichteten Erben von Jahrtausendendes europäischen Geistes: als solche auch dem Christentum entwachsen undabhold, und gerade, weil wir aus ihm gewachsen s<strong>in</strong>d, weil unsere VorfahrenChristen von rücksichtsloser Rechtschaffenheit des Christentums waren, dieihrem Glauben willig Gut und Blut, St<strong>and</strong> und Vaterl<strong>and</strong> zum Opfergebracht haben. Wir – tun desgleichen. W<strong>of</strong>ür doch? Für unserenUnglauben? Für jede Art Unglauben? Ne<strong>in</strong>, das wißt ihr besser, me<strong>in</strong>eFreunde! Das verborgene Ja <strong>in</strong> euch ist stärker als alle Ne<strong>in</strong>s und Vielleichts,an denen ihr mit eurer Zeit krank seid; und wenn ihr aufs Meer müßt, ihrAusw<strong>and</strong>erer, so zw<strong>in</strong>gt dazu auch euch – e<strong>in</strong> Glaube!(Nietzsche 1988)We who are homeless – Among Europeans today there is nolack <strong>of</strong> those who are entitled to call themselves homeless<strong>in</strong> a dist<strong>in</strong>ctive <strong>and</strong> honorable sense: it is to them that Iespecially commend my secret wisdom <strong>and</strong> gaya scienza.For their fate is hard, their hopes are uncerta<strong>in</strong>; it is quite afeat to devise some comfort for them – but to what avail?We children <strong>of</strong> the future, how could we be at home <strong>in</strong> thistoday? We feel disfavor for all ideals that might lead one t<strong>of</strong>eel at home even <strong>in</strong> this fragile, broken time <strong>of</strong> transition; asfor its “realities,” we do not believe that they will last. The icethat still supports people today has become very th<strong>in</strong>; thew<strong>in</strong>d that br<strong>in</strong>gs the thaw is blow<strong>in</strong>g; we ourselves who arehomeless constitute a force that breaks open ice <strong>and</strong> otherall too th<strong>in</strong> “realities.”We “conserve” noth<strong>in</strong>g; neither do we want to return toany past periods; we are not by any means “liberal”; we donot work for “progress”; we do not need to plug up our earsaga<strong>in</strong>st the sirens who <strong>in</strong> the market place s<strong>in</strong>g <strong>of</strong> the future:their song about “equal rights,” “a free society,” “no moreThis open<strong>in</strong>gspeaks to hisbasic dislike <strong>of</strong>the economy assuch. But heturns aroundrather quickly.


114 Jürgen G. Backhausmasters <strong>and</strong> no servants” has no allure for us. We simply donot consider it desirable that a realm <strong>of</strong> justice <strong>and</strong> concordshould be established on earth (because it would certa<strong>in</strong>ly bethe lighted with all who love), as we do, danger, war, <strong>and</strong>adventures, who refuse to compromise, to be captured,reconciled, <strong>and</strong> castrated; we count ourselves among conquerors;we th<strong>in</strong>k about the necessity for new orders, also fora new slavery – for every strengthen<strong>in</strong>g <strong>and</strong> enhancement <strong>of</strong>the human type also <strong>in</strong>volves a new k<strong>in</strong>d <strong>of</strong> enslavement.Is it not clear that with all this we are bound to feel ill at ease<strong>in</strong> an age that likes to claim the dist<strong>in</strong>ction <strong>of</strong> be<strong>in</strong>g the mosthumane, the mildest, <strong>and</strong> the most righteous age that thesun has ever seen? It is bad enough that precisely when wehear these beautiful words we have the ugliest suspicions.What we f<strong>in</strong>d <strong>in</strong> them is merely an expression – <strong>and</strong> a masquerade– <strong>of</strong> a pr<strong>of</strong>ound weaken<strong>in</strong>g, <strong>of</strong> wear<strong>in</strong>ess, <strong>of</strong> old age,<strong>of</strong> decl<strong>in</strong><strong>in</strong>g energies. What can it matter to us whatt<strong>in</strong>sel the sick may use to cover up their weakness? Let themparade it as their virtue; after all, there is no doubt that weaknessmakes one mild, oh so mild, so righteous, so <strong>in</strong><strong>of</strong>fensive,so “humane!”The “religion <strong>of</strong> pity” to which one would like to convertus – oh, we know the hysterical little male <strong>and</strong> females wellenough who today need precisely this religion as a veil <strong>and</strong>make-up. We are no humani tarians; we should never dareto permit ourselves to speak <strong>of</strong> our “love <strong>of</strong> humanity”; ourk<strong>in</strong>d is not actor enough for that. Or not Sa<strong>in</strong>t-Simonistenough, not French enough. One really has to be afflictedwith a Gallic excess <strong>of</strong> erotic irritability <strong>and</strong> enamoredimpatience to approach <strong>in</strong> all honesty the whole <strong>of</strong> humanitywith one’s lust!Humanity! Has there ever been a more hideous oldwoman among all old women – (unless it were “truth”: aquestion for philosophers)? No, we do not love humanity;but on the other h<strong>and</strong> we are not nearly “German” enough,<strong>in</strong> the sense <strong>in</strong> which the word “German” is constantlybe<strong>in</strong>g used nowadays, to advocate nationalism <strong>and</strong> racehatred <strong>and</strong> to be able to take pleasure <strong>in</strong> the national scabies<strong>of</strong> the heart <strong>and</strong> blood poison<strong>in</strong>g that now leads the nations<strong>of</strong> Europe to delimit <strong>and</strong> barricade themselves aga<strong>in</strong>st eachother as if it were a matter <strong>of</strong> quarant<strong>in</strong>e. For that we are tooopen-m<strong>in</strong>ded, too malicious, too spoiled, also too well<strong>in</strong>formed, too “traveled”: we far prefer to live on mounta<strong>in</strong>s,apart, “untimely,” <strong>in</strong> past or future centuries, merely <strong>in</strong>order to keep ourselves from experienc<strong>in</strong>g the silent rage toHere, Nietzschetakes up centralaspects <strong>of</strong> freemarketeconomics, still<strong>in</strong> a criticalposture,however.When hetalks about“enslavement”,he is at whatnow we callconsumerism.(It is tell<strong>in</strong>g thatVance Packard,who promotedthese ideas,never mentionedNietzsche <strong>in</strong> hisdiatribes.)


Lel<strong>and</strong>’s favorite economists 115which we know we should be condemned as eyewitnesses <strong>of</strong>politics that are desolat<strong>in</strong>g the German spirit by mak<strong>in</strong>g itva<strong>in</strong> <strong>and</strong> that is, moreover, petty politics: to keep its owncreation from immediately fall<strong>in</strong>g apart aga<strong>in</strong>, is it notf<strong>in</strong>d<strong>in</strong>g it necessary to plant it between two deadly hatreds?must it not desire the eternalization <strong>of</strong> the European system<strong>of</strong> a lot <strong>of</strong> petty states?We who are homeless are too manifold <strong>and</strong> mixedracially <strong>and</strong> <strong>in</strong> our descent, be<strong>in</strong>g “modern men,” <strong>and</strong> consequentlydo not feel tempted to participate <strong>in</strong> the men -dacious racial self-admiration <strong>and</strong> racial <strong>in</strong>decency thatparades <strong>in</strong> Germany today as a sign <strong>of</strong> a German way <strong>of</strong>th<strong>in</strong>k<strong>in</strong>g <strong>and</strong> that is doubly false <strong>and</strong> obscene among thepeople <strong>of</strong> the “historical sense.” We are, <strong>in</strong> one word – <strong>and</strong>let this be our word <strong>of</strong> honor – good Europeans, the heirs <strong>of</strong>Europe, the rich, oversupplied, but also overly obligatedheirs <strong>of</strong> thous<strong>and</strong>s <strong>of</strong> years <strong>of</strong> European spirit. As such, wehave also outgrown Christianity <strong>and</strong> are averse to it –precisely because we have grown out <strong>of</strong> it, because ourancestors were Christians who <strong>in</strong> their Christianity wereuncompromis<strong>in</strong>gly upright: for their faith they will<strong>in</strong>glysacrificed possessions <strong>and</strong> position, blood <strong>and</strong> fatherl<strong>and</strong>.We – do the same. For what? For our unbelief? For everyk<strong>in</strong>d <strong>of</strong> unbelief? No, you know better than that, friends!The hidden Yes <strong>in</strong> you is stronger than all Nos <strong>and</strong> Maybesthat afflict you <strong>and</strong> your age like a disease; <strong>and</strong> when youhave to embark on the sea, you emigrants, you, too, arecompelled to this by – a faith!(Nietzsche 1974)Insertion IIFriedrich Nietzsche: Die Genealogie der MoralZweite Abh<strong>and</strong>lung1.E<strong>in</strong> Tier heranzüchten, das versprechen darf – ist das nicht gerade jene paradoxeAufgabe selbst, welche sich die Natur <strong>in</strong> H<strong>in</strong>sicht auf den Menschen gestellthat, ist es nicht das eigentliche Problem vom Menschen?. . . . Daß dies Problembis zu e<strong>in</strong>em hohen Grad gelöst ist, muß dem um so erstaunlicher ersche<strong>in</strong>en,der die entgegen wirkende Kraft, die der Vergeßlichkeit, vollauf zu würdigenweiß. Vergeßlichkeit ist ke<strong>in</strong>e bloße vis <strong>in</strong>ertiae, wie die Oberflächlichen


116 Jürgen G. Backhausglauben, sie ist vielmehr e<strong>in</strong> aktives, im strengsten S<strong>in</strong>ne positivesHemmungsvermögen, dem es zuzuschreiben ist, daß was nur von uns erlebt,erfahren, <strong>in</strong> uns h<strong>in</strong>e<strong>in</strong>genommen wird, uns im Zust<strong>and</strong>e der Verdauung(man dürfte ihn “E<strong>in</strong>verseelung” nennen) ebensowenig <strong>in</strong>s Bewußtse<strong>in</strong> tritt,als der ganze tausendfältige Prozeß, mit dem sich unsre leibliche Ernährung,die sogenannte “E<strong>in</strong>verleibung” abspielt. Die Türen und Fenster desBewußtse<strong>in</strong>s zeitweilig schließen; von dem Lärm und Kampf, mit dem unsreUnterwelt von dienstbaren Organen für-und gegene<strong>in</strong><strong>and</strong>er arbeitet,unbehelligt bleiben; e<strong>in</strong> wenig Stille, e<strong>in</strong> wenig tabula rasa des Bewußtse<strong>in</strong>s,damit wieder Platz wird für Neues, vor allem für die vornehmerenFunktionen und Funktionäre, für Regieren, Voraussehn, Vorausbestimmen(denn unser Organismus ist oligarchisch e<strong>in</strong>gerichtet) – das ist der Nutzender, wie gesagt, aktiven Vergeßlichkeit, e<strong>in</strong>er Türwärter<strong>in</strong> gleichsam,e<strong>in</strong>er Aufrechterhalter<strong>in</strong> der seelischen Ordnung, der Ruhe, der Etikette:womit s<strong>of</strong>ort abzusehn ist, <strong>in</strong>wiefern es ke<strong>in</strong> Glück, ke<strong>in</strong>e Heiterkeit, ke<strong>in</strong>eH<strong>of</strong>fnung, ke<strong>in</strong>en Stolz ke<strong>in</strong>e Gegenwart geben könnte ohne Vergeßlichkeit.Der Mensch, <strong>in</strong> dem dieser Hemmungsapparat beschädigt wird und aussetzt,ist e<strong>in</strong>em Dyspeptiker zu vergleichen (und nicht nur zu vergleichen) – er wirdmit nichts “fertig” ... Eben dieses notwendig vergeßliche Tier, an dem dasVergessen e<strong>in</strong>e Kraft, e<strong>in</strong>e Form der starken Gesundheit darstellt, hat sichnun e<strong>in</strong> Gegenvermögen angezüchtet, e<strong>in</strong> Gedächtnis, mit Hilfe dessen fürgewisse Fälle die Vergeßlichkeit ausgehängt wird, – für die Fälle nämlich,daß versprochen werden soll: somit ke<strong>in</strong>eswegs bloß e<strong>in</strong> passivisches Nichtwieder-los-werden-Könnendes e<strong>in</strong>mal e<strong>in</strong>geritzten E<strong>in</strong>drucks, nicht bloßdie Indigestion an e<strong>in</strong>em e<strong>in</strong>mal verpfändeten Wort, mit dem man nichtwieder fertig wird, sondern e<strong>in</strong> aktives Nicht-wieder-los-werden-Wollen, e<strong>in</strong>Fort-und-fort-Wollen des e<strong>in</strong>mal Gewollten, e<strong>in</strong> eigentliches Gedächtnis desWillens: so daß zwischen das ursprüngliche “ich will” “ich werde tun” und dieeigentliche Entladung des Willens, se<strong>in</strong>en Akt, unbedenklich e<strong>in</strong>e Welt vonneuen fremden D<strong>in</strong>gen, Umständen, selbst Willensakten dazwischengelegtwerden darf, ohne daß diese lange Kette des Willens spr<strong>in</strong>gt. Was setzt dasaber alles voraus! Wie muß der Mensch, um dermaßen über die Zukunftvoraus zu verfügen, erst gelernt haben, das notwendige vom zufälligenGeschehen scheiden, kausal denken, das Ferne wie gegenwärtig sehn undvorwegnehmen, was Zweck ist, was Mittel dazu ist, mit Sicherheit anzusetzen,überhaupt rechnen, berechnen können, – wie muß dazu der Mensch selbstvorerst berechenbar, regelmäßig, notwendig geworden se<strong>in</strong>, auch sich selbst fürse<strong>in</strong>e eigene Vorstellung, um endlich dergestalt, wie es e<strong>in</strong> Versprechendertut, für sich als Zukunft gutsagen zu können!2.Eben das ist die lange Geschichte von der Herkunft der Verantwortlichkeit.Jene Aufgabe, e<strong>in</strong> Tier heranzuzüchten, das versprechen darf, schließt, wiewir bereits begriffen haben, als Bed<strong>in</strong>gung und Vorbereitung die nähereAufgabe <strong>in</strong> sich, den Menschen zuerst bis zu e<strong>in</strong>em gewissen Grade


Lel<strong>and</strong>’s favorite economists 117notwendig, e<strong>in</strong>förmig, gleich unter Gleichen, regelmäßig und folglichberechenbar zu machen. Die ungeheure Arbeit dessen, was von mir“Sittlichkeit der Sitte” genannt worden ist (vgl. Morgenröte, S. 13 f., 18, 21)– die eigentliche Arbeit des Menschen an sich selber <strong>in</strong> der längsten Zeitdauerdes Menschengeschlechts, se<strong>in</strong>e ganze vorhistorische Arbeit hat hier<strong>in</strong> ihrenS<strong>in</strong>n, ihre große Rechtfertigung, wieviel ihr auch von Härte, Tyrannei,Stumpfs<strong>in</strong>n und Idiotismus <strong>in</strong>newohnt: der Mensch wurde mit Hilfe derSittlichkeit der Sitte und der sozialen Zwangsjacke wirklich berechenbargemacht. Stellen wir uns dagegen ans Ende des ungeheuren Prozesses, dorth<strong>in</strong>,wo der Baum endlich se<strong>in</strong>e Früchte zeitigt, wo die Sozietät und ihreSittlichkeit der Sitte endlich zutage br<strong>in</strong>gt, wozu sie nur das Mittel war: s<strong>of</strong><strong>in</strong>den wir als reifste Frucht an ihrem Baum das souveräne Individuum, das nursich selbst gleiche, das von der Sittlichkeit der Sitte wieder losgekommene,das autonome übersittliche Individuum (denn “autonom” und “sittlich”schließt sich aus), kurz den Menschen des eignen, unabhängigen, langenWillens, der versprechen darf – und <strong>in</strong> ihm e<strong>in</strong> stolzes, <strong>in</strong> allen Muskelnzuckendes Bewußtse<strong>in</strong> davon, was da endlich errungen und <strong>in</strong> ihm leibhaftgeworden ist, e<strong>in</strong> eigentliches Macht-und Freiheits-Bewußtse<strong>in</strong>, e<strong>in</strong>Vollendungs-Gefühl des Menschen überhaupt. Dieser Freigewordene, derwirklich versprechen darf, dieser Herr des freien Willens, dieser Souverän –wie sollte er es nicht wissen, welche Überlegenheit er damit vor allem voraushat, was nicht versprechen und für sich selbst gutsagen darf, wievielVertrauen, wieviel Furcht, wieviel Ehrfurcht er erweckt – er “verdient” allesDreies-und wie ihm, mit dieser Herrschaft über sich, auch die Herrschaftüber die Umstände, über die Natur und alle willenskürzeren und unzuverlässigerenKreaturen notwendig <strong>in</strong> die H<strong>and</strong> gegeben ist? Der “freie”Mensch, der Inhaber e<strong>in</strong>es langen unzerbrechlichen Willens, hat <strong>in</strong> diesemBesitz auch se<strong>in</strong> Wertmaß: von sich aus nach den <strong>and</strong>eren h<strong>in</strong>blickend, ehrt eroder verachtet er; und ebenso notwendig als er die ihm Gleichen, die Starkenund Zuverlässigen (die, welche versprechen dürfen) ehrt, – also jedermann,der wie e<strong>in</strong> Souverän verspricht, schwer, selten, langsam, der mit se<strong>in</strong>emVertrauen geizt, der auszeichnet, wenn er vertraut, der se<strong>in</strong> Wort gibt alsetwas, auf das Verlaß ist, weil er sich stark genug weiß, es selbst gegen Unfälle,selbst “gegen das Schicksal” aufrechtzuerhalten-: ebenso notwendig wird erse<strong>in</strong>en Fußtritt für die schmächtigen W<strong>in</strong>dhunde bereit halten, welcheversprechen, ohne es zu dürfen, und se<strong>in</strong>e Zuchtrute für den Lügner, der se<strong>in</strong>Wort bricht, im Augenblick schon, wo er es im Munde hat. Das stolze Wissenum das außerordentliche Privilegium der Verantwortlichkeit, das Bewußtse<strong>in</strong>dieser seltenen Freiheit, dieser Macht über sich und das Geschick hat sich beiihm bis <strong>in</strong> se<strong>in</strong>e unterste Tiefe h<strong>in</strong>abgesenkt und ist zum Inst<strong>in</strong>kt geworden,zum dom<strong>in</strong>ierenden Inst<strong>in</strong>kt: – wie wird er ihn heißen, diesen dom<strong>in</strong>ierendenInst<strong>in</strong>kt, gesetzt, daß er e<strong>in</strong> Wort dafür bei sich nötig hat? Aber es ist ke<strong>in</strong>Zweifel: dieser souveräne Mensch heißt ihn se<strong>in</strong> Gewissen . . .(Nietzsche 1988)


118 Jürgen G. Backhaus1.To breed an animal which is able to make promise – is thatnot precisely the paradoxical task which nature hasset herself with regard to humank<strong>in</strong>d? is it not the realproblem <strong>of</strong> humank<strong>in</strong>d? . . . The fact that this problemhas been solved to a large degree must seem all themore surpris<strong>in</strong>g to the person who can fully appreciatethe oppos<strong>in</strong>g force, forgetfulness. Forgetfulness is notjust a vis <strong>in</strong>ertiae, as superficial people believe, but israther an active ability to suppress, positive <strong>in</strong> thestrongest sense <strong>of</strong> the word, to which we owe the factthat what we simply live through, experience, take <strong>in</strong>,no more enters our consciousness dur<strong>in</strong>g digestion(one could call it spiritual <strong>in</strong>gestion) than does thethous<strong>and</strong>-fold process which takes place with ourphysical consumption <strong>of</strong> food, our so-called <strong>in</strong>gestion.To shut the doors <strong>and</strong> w<strong>in</strong>dows <strong>of</strong> consciousness for awhile; not to be bothered by the noise <strong>and</strong> battle withwhich our underworld <strong>of</strong> serviceable organs workwith <strong>and</strong> aga<strong>in</strong>st each other; a little peace, a littletabula rasa <strong>of</strong> consciousness to make room forsometh<strong>in</strong>g new, above all for the nobler functions <strong>and</strong>functionaries, for rul<strong>in</strong>g, predict<strong>in</strong>g, predeterm<strong>in</strong><strong>in</strong>g(our organism runs along oligarchic l<strong>in</strong>es, you see) –that, as I said, is the benefit <strong>of</strong> active forgetfulness, likea doorkeeper or guardian <strong>of</strong> mental order, rest <strong>and</strong>etiquette: from which we can immediately see howthere could be no happ<strong>in</strong>ess, cheerfulness, hope,pride, immediacy, without forgetfulness. The person <strong>in</strong>whom this apparatus <strong>of</strong> suppression is damaged, sothat it stops work<strong>in</strong>g, can be compared (<strong>and</strong> not justcompared) – to a dyspeptic; he cannot “cope” withanyth<strong>in</strong>g . . . And precisely this necessarily forgetfulanimal, <strong>in</strong> whom forgett<strong>in</strong>g is a strength, represent<strong>in</strong>ga form <strong>of</strong> robust health, has bred for himself a counterdevice,memory, with the help <strong>of</strong> which forgetfulnesscan be suspended <strong>in</strong> certa<strong>in</strong> cases, – namely <strong>in</strong> thosecases where a promise is to be made: consequently, itis by no means merely a passive <strong>in</strong>ability to be rid <strong>of</strong>an impression once it has made its impact, nor is it just<strong>in</strong>digestion caused by giv<strong>in</strong>g your word on someoccasion <strong>and</strong> f<strong>in</strong>d<strong>in</strong>g you cannot cope, <strong>in</strong>stead it is anactive desire not to let go, a desire to keep on desir<strong>in</strong>gwhat has been, on some occasion, desired, really it isthe will’s memory: so that a world <strong>of</strong> strange new th<strong>in</strong>gs,Here, we f<strong>in</strong>d the criticalissue <strong>of</strong> conclud<strong>in</strong>gcontracts, the basicnotion <strong>of</strong> a marketeconomy. Yet, this has tohold for the state as well.Nietzsche is concernedhere with the build<strong>in</strong>gblocks <strong>of</strong> society.This speaks directly toissues <strong>of</strong> property taken<strong>and</strong> contract nonperformance.Currently,<strong>in</strong> the German transitioneconomy, “forgetfulness”is a big item. Only <strong>in</strong> thiscontext can policies beplaced which withholdproperty from theirrightful owners <strong>and</strong>thereby br<strong>in</strong>gunemployment upontheir dependents.The word <strong>of</strong> honorestablishes the contract<strong>and</strong> implies liability <strong>in</strong>case the promise isbroken. Althoughliability is not mentionedas such, Nietzscheexpresses the very ideaas “reliability.”


circumstances <strong>and</strong> even acts <strong>of</strong> will may be placedquite safely <strong>in</strong> between the orig<strong>in</strong>al “I will”, “I shalldo” <strong>and</strong> the actual discharge <strong>of</strong> the will, its act, withoutbreak<strong>in</strong>g this long cha<strong>in</strong> <strong>of</strong> the will. But what a lot <strong>of</strong>preconditions there are for this! In order to have thatdegree <strong>of</strong> control over the future, man must first havelearnt to dist<strong>in</strong>guish between what happens by acci -dent <strong>and</strong> what by design, to th<strong>in</strong>k causally, to view thefuture as the present <strong>and</strong> anticipate it, to grasp withcerta<strong>in</strong>ty what is end <strong>and</strong> what is means, <strong>in</strong> all, to beable to calculate, compute – <strong>and</strong> before he can do this,man himself will really have to become reliable, regular,automatic [notwendig], even <strong>in</strong> his own self-image, sothat he, as someone mak<strong>in</strong>g a promise is, is answerablefor his own future!Lel<strong>and</strong>’s favorite economists 1192.That is precisely what constitutes the long history <strong>of</strong>the orig<strong>in</strong>s <strong>of</strong> responsibility. That particular task <strong>of</strong>breed<strong>in</strong>g an animal which has the right to make apromise <strong>in</strong>cludes, as we have already understood, asprecondition <strong>and</strong> prepar ation, the more immediatetask <strong>of</strong> first mak<strong>in</strong>g man to a certa<strong>in</strong> degree undeviat<strong>in</strong>g[notwendig], uniform, a peer amongst peers, orderly<strong>and</strong> consequently predictable. The immense amount<strong>of</strong> labour <strong>in</strong>volved <strong>in</strong> what I have called the “morality<strong>of</strong> custom” (see Daybreak, I, 9; 14; 16), the actuallabour <strong>of</strong> man on himself dur<strong>in</strong>g the longest epoch <strong>of</strong>the human race, his whole labour before history, isexpla<strong>in</strong>ed <strong>and</strong> justified on a gr<strong>and</strong> scale, <strong>in</strong> spite <strong>of</strong> thehardness, tyranny, stupidity <strong>and</strong> idiocy it also conta<strong>in</strong>ed,by this fact: with the help <strong>of</strong> the morality <strong>of</strong>custom <strong>and</strong> the social straitjacket, man was made trulypredictable. Let us place ourselves, on the other h<strong>and</strong>,at the end <strong>of</strong> this immense process where the treeactually bears fruit, where society <strong>and</strong> its morality <strong>of</strong>custom f<strong>in</strong>ally reveal what they were simply the meansto: we then f<strong>in</strong>d the sovereign <strong>in</strong>dividual as the ripest fruiton its tree, like only to itself, hav<strong>in</strong>g freed itself fromthe morality <strong>of</strong> custom, an autonomous, supra-ethical<strong>in</strong>dividual (because “autonomous” <strong>and</strong> “ethical” aremutually exclusive), <strong>in</strong> short, we f<strong>in</strong>d a man with hisown, <strong>in</strong>dependent, durable will, who has the right tomake a promise – <strong>and</strong> has a proud consciousness quiver<strong>in</strong>g<strong>in</strong> every muscle <strong>of</strong> what he has f<strong>in</strong>ally achieved <strong>and</strong>Here, Nietzscheemphasizes the rule <strong>of</strong>law as a pre-conditionfor human activity ata high level <strong>of</strong>development.


120 Jürgen G. Backhaus<strong>in</strong>corporated, <strong>and</strong> actual awareness <strong>of</strong> power <strong>and</strong>freedom, a feel<strong>in</strong>g that man <strong>in</strong> general has reachedcompletion. This man who is now free <strong>and</strong> who reallydoes have the right to make a promise, this master <strong>of</strong>the free will, this sovereign – how could he rema<strong>in</strong>ignorant <strong>of</strong> this superiority over everybody who doesnot have the right to make a promise or answer forhimself, how much trust, fear <strong>and</strong> respect he arouses– he “merits” all three – <strong>and</strong> how could he, with his selfmastery,not realize that he has necessarily been givenmastery over circumstances, over nature <strong>and</strong> over allcreatures with a less durable <strong>and</strong> reliable will? The“free” man, the pr<strong>of</strong>essor <strong>of</strong> a durable, unbreak ablewill, thus has his own st<strong>and</strong>ard <strong>of</strong> value: <strong>in</strong> the possession<strong>of</strong> such a will, view<strong>in</strong>g others from his st<strong>and</strong>po<strong>in</strong>t, herespects or despises; <strong>and</strong> just as he will necessarilyrespect his peers, the strong <strong>and</strong> the reliable (thosewith the right to give their word), – that is everyone whomakes promises like a sovereign, ponderously, seldom,slowly, <strong>and</strong> is spar<strong>in</strong>g with his trust, who confersan honour when he places his trust, who gives his wordas someth<strong>in</strong>g which can be relied on, because he isstrong enough to rema<strong>in</strong> upright <strong>in</strong> the face <strong>of</strong> mishapor even “<strong>in</strong> the face <strong>of</strong> fate”-: so he will necessarily beready to kick the febrile whippets who make a promisewhen they have no right to do so, <strong>and</strong> will save the rodfor the liar who breaks his word <strong>in</strong> the very moment itpasses his lips. The proud realization <strong>of</strong> the extraord<strong>in</strong>aryprivilege <strong>of</strong> respon sibility, the awareness <strong>of</strong> thisrare freedom <strong>and</strong> power over himself <strong>and</strong> his dest<strong>in</strong>y,has penetrated him to the depths <strong>and</strong> become an<strong>in</strong>st<strong>in</strong>ct, his dom<strong>in</strong>ant <strong>in</strong>st<strong>in</strong>ct: – what will he call hisdom<strong>in</strong>ant <strong>in</strong>st<strong>in</strong>ct, assum<strong>in</strong>g that he needs a word forit? No doubt about the answer: this sovereign mancalls it his conscience . . .(Nietzsche 1994)Nietzsche even comesclose to the concept <strong>of</strong>producer <strong>and</strong> consumersovereignty.Aga<strong>in</strong>, he returns to thecrucial role <strong>of</strong> liability <strong>in</strong>economic affairs.Even somewhat go<strong>in</strong>gbeyond Eucken, heemphasizes theimportance <strong>of</strong> trust forefficient marketexchange.Although Nietzsche does not fully work out the basic <strong>in</strong>stitutions <strong>of</strong> a marketeconomy, the key notions are present <strong>and</strong> could readily be further developed.III The basic <strong>in</strong>stitutions <strong>of</strong> a market economy –reconsidered: price <strong>in</strong>dicesYet, read on. If man is the animal that can make <strong>and</strong> keep promises, <strong>and</strong> currencyis the language <strong>in</strong> which these promises can be kept, how about the state (<strong>of</strong> all


Lel<strong>and</strong>’s favorite economists 121conceivable agents) to monitor the stability <strong>of</strong> the currency. Fruitful advances <strong>in</strong>economic theory mesh with questionable public policy. Here is one example.Hav<strong>in</strong>g now turned to Nietzsche, the question naturally arises: can we get tomuch less disorganized economic discourse? First, we f<strong>in</strong>d an em<strong>in</strong>ent scholardeeply imm<strong>in</strong>gled <strong>in</strong> Christian thought try<strong>in</strong>g to derive economics out <strong>of</strong> Christian<strong>in</strong>sights. Then we f<strong>in</strong>d a deeply troubled philosopher, who comes up with fairly thesame suggestions as the first one. I repeat: ex falso quod libet. Here we now have a casewhich ties back to Lel<strong>and</strong> <strong>Yeager</strong>’s basic proposition, “<strong>in</strong> search <strong>of</strong> a monetaryconstitution” 16 <strong>in</strong> order to pose the question, where can we search for a truthfulmonetary constitution? It is true that any good that goes for a price has manycharacteristics. It is therefore also true that any good that goes for one economicprice has many characteristics upon which people may disagree. In due course,sensible entrepreneurs will try to disentangle these characteristics, sell<strong>in</strong>g theirgoods with some characteristics on one market <strong>and</strong> other characteristics on othermarkets. In this way, a price-spread would naturally occur.On this hook <strong>of</strong> Lancaster’s perfectly sound theory 17 <strong>in</strong>genious price <strong>in</strong>dexeng<strong>in</strong>eers have now mooted the notion <strong>of</strong> calculat<strong>in</strong>g hedonic price <strong>in</strong>dices. Takea simple example. If some good, such as typewriters, decl<strong>in</strong>e <strong>in</strong> their price, othergoods, such as computers, may all <strong>of</strong> a sudden appear. First, s<strong>in</strong>ce some people evenuse a computer as a typewriter, one could have attested an <strong>in</strong>crease <strong>in</strong> the price <strong>of</strong>typewriters, but this has never occurred. On the other h<strong>and</strong>, s<strong>in</strong>ce computers als<strong>of</strong>acilitate many ways <strong>of</strong> life, it can be said that the same product, orig<strong>in</strong>ally atypewriter, now a computer, has made many th<strong>in</strong>gs much easier to do. You couldconceivably say that the computer as opposed to the typewriter has improved ourlife. To measure this would be a sensible proposition for an economist.We can, however, also turn a legitimate theory <strong>in</strong>to someth<strong>in</strong>g else <strong>in</strong> order tomeasure the price <strong>in</strong>dex. It needs to be understood that the price <strong>in</strong>dex is now ahighly political piece <strong>of</strong> statistics. The price <strong>in</strong>dex, for <strong>in</strong>stance, turns the budget onsocial security entitlements. For this reason, it is by no means <strong>in</strong>conceivable thatpolitical power turns <strong>in</strong>telligent m<strong>in</strong>ds on manipulat<strong>in</strong>g the <strong>in</strong>dex. This can readilybe done. K<strong>in</strong>dly look at the graph <strong>in</strong> Figure 8.3 that Lel<strong>and</strong> himself has drawn.Yopportunities lost butrejected <strong>in</strong> the first place●opportunities ga<strong>in</strong>edFigure 8.3 Lel<strong>and</strong>’s Diagram.X


122 Jürgen G. BackhausIf one aspect <strong>of</strong> a good becomes more expensive, yet another aspect <strong>of</strong> the goodbecomes less expensive, <strong>and</strong> these may even be different goods, so an opportunityarises to buy more <strong>of</strong> the now less expensive good aspect, while a dis-opportunityhas also arisen, for clos<strong>in</strong>g, under the same budget constra<strong>in</strong>t, the opportunity tobuy more <strong>of</strong> the now more expensive aspects. It is not difficult to give a practicalexample. We do underst<strong>and</strong> that the black population has an obesity problem.This is readily revealed <strong>in</strong> health care costs, but also <strong>in</strong> mortality figures (heart conditions).The traditional diet <strong>of</strong> the black population conta<strong>in</strong>ed a lot <strong>of</strong> natural<strong>in</strong>gredients; gr<strong>and</strong>mother would cook the big pot <strong>of</strong> “greens.” As a consequence <strong>of</strong>various Wash<strong>in</strong>gton-sponsored government programmes, this family structure haslargely been eroded. We can now f<strong>in</strong>d a dramatic discrepancy between life expectancyamong black <strong>and</strong> white males <strong>in</strong> the Deep South. I do not want to suggestsimple conclusions. From the po<strong>in</strong>t <strong>of</strong> view <strong>of</strong> Lancaster’s sensible suggestion,however, we have to keep <strong>in</strong> m<strong>in</strong>d that the different characteristics <strong>of</strong> goods do notescape the consumers.If a calculator <strong>in</strong> Wash<strong>in</strong>gton wants to measure the consumer price <strong>in</strong>dex, hecannot fail to notice that produce is no longer <strong>in</strong> much dem<strong>and</strong>. In fact, freshproduce may be too difficult a product to market for many, <strong>in</strong> particular m<strong>in</strong>orityoperatedentrepreneurships. If the turnips do not get sold, you have to throw themaway, <strong>and</strong> you have to write that clearly as a loss. On the other h<strong>and</strong>, if you canorder pre-packaged assortments <strong>of</strong> groceries, perhaps deep-frozen, you do nothave the problem <strong>of</strong> hav<strong>in</strong>g to throw away the waste, as long as you can pay thepower company. Hence, the consumer <strong>in</strong> the supermarket is confronted with prefabricatedready-made deep-frozen vegetable assortments <strong>and</strong> next to this, dur<strong>in</strong>ga time <strong>of</strong> duration, fresh produce at, however, <strong>in</strong>creased prices. A simple avocadomay go for a dollar, an artichoke even for two. 18 If you now <strong>in</strong>terpret Lel<strong>and</strong>’sgraphic correctly, you can readily see that there is welfare <strong>in</strong>crease possible due tothe better availability <strong>of</strong> ready-made groceries, but only if you ignore the redux, i.e.the non-availability <strong>of</strong> fresh groceries due to price liberations. In due course, thefresh grocery department <strong>in</strong> the supermarket will disappear, <strong>and</strong> the customizedgrocery <strong>in</strong>dustry will prevail. If you look at this graph, this <strong>in</strong>dustry change will looklike a welfare <strong>in</strong>crease, from that po<strong>in</strong>t <strong>of</strong> view, <strong>and</strong> that will then be recalculated<strong>in</strong>to the rate <strong>of</strong> <strong>in</strong>flation. When, for <strong>in</strong>stance, the price <strong>of</strong> eggplants has doubled,while on the other h<strong>and</strong> the price <strong>of</strong> a product <strong>in</strong>to which eggplants have beenmeshed ready-made might have even decl<strong>in</strong>ed, the hedonic <strong>in</strong>dex-measurer willtake the general welfare <strong>in</strong> m<strong>in</strong>d <strong>and</strong> conclude that not withst<strong>and</strong><strong>in</strong>g the exorbitant<strong>in</strong>crease <strong>in</strong> the price <strong>of</strong> eggplant, the price <strong>in</strong>dex may actually have gone down, <strong>and</strong>the general welfare been <strong>in</strong>creased.Instead <strong>of</strong> eggplants, let us look at college education. In the state <strong>of</strong> Alabama,where Lel<strong>and</strong> resides, most families have one or two, sometimes more childrenwhom they want to send to college. The cost <strong>of</strong> tuition is now between $20,000<strong>and</strong> $30,000 per year <strong>and</strong> child, <strong>and</strong> this is certa<strong>in</strong>ly an item that does not escapeattention. In Alabama, tuition costs rose at Auburn by 42.8 percent, at Alabamastate by 40.8 percent, at the University <strong>of</strong> Alabama by 40.6 percent, atAlabama A&M by 38.1 percent, <strong>and</strong> I could conclude the whole list, with Troy at


Lel<strong>and</strong>’s favorite economists 123Dothan by a mere 26.3 percent. This compares to a consumer price <strong>in</strong>dex thathovers under 2 percent.In economics, we picture the economic man (Der Wirt) as the agent who takesprudent decisions. An agent who sees these figures will draw his conclusions. One<strong>of</strong> his conclusions would necessarily be that he has to doubt the national statistics.Not only is the peculiar hedonic price statistic calculation <strong>in</strong> doubt, <strong>in</strong> addition wehave all the fees. There are school taxes, garbage taxes that double henceforth,sewer taxes that even triple, many other such <strong>in</strong>struments, <strong>and</strong> they do not getreflected <strong>in</strong> the price <strong>in</strong>dex. And yet, prom<strong>in</strong>ent economists lend their services tobl<strong>in</strong>d<strong>in</strong>g the statistics.In fact, with the weak European economies, the performance <strong>of</strong> the US dollarsupports my case. The United States <strong>of</strong> America, as they could never meetthe Maastricht criteria, are currently the ail<strong>in</strong>g brother <strong>of</strong> the Western world.(The other sibl<strong>in</strong>gs are not particularly well either.) It is a poor idea to take <strong>in</strong>pr<strong>in</strong>ciple perfectly sensible economic notions <strong>in</strong> order to whitewash otherwiseawful scenarios.And where can we f<strong>in</strong>d a solution?Lel<strong>and</strong> <strong>Yeager</strong> has given us such a solution <strong>in</strong> his remarkable article <strong>in</strong> theAmerican Economic Review (cited above). What is happen<strong>in</strong>g here is that the unit <strong>of</strong>account is constantly be<strong>in</strong>g falsified. Hence, competition among agencies, such asfolio-manag<strong>in</strong>g agencies, should decide on the best <strong>in</strong>dex for price stability. Thecurrent price stability <strong>in</strong>dex is all but credible. In fact, it is hard to see why there isnot yet a protest group aga<strong>in</strong>st all these falsifications. Public choice theory searchesfor an answer. The majority <strong>of</strong> the w<strong>in</strong>ners from this course are still vot<strong>in</strong>g, alive<strong>and</strong> well. The heirs will visit their graveyards <strong>in</strong> grief, but also perhaps with secondthoughts.Notes* Contribution to the Southern Economics Annual Meet<strong>in</strong>g. Session No. 65D*: TheHumble Truth. <strong>Honor</strong><strong>in</strong>g Lel<strong>and</strong> <strong>Yeager</strong> II. New Orleans, November 21–23, 2004.1 The lecture was guest-edited by Gerrit Meijer <strong>in</strong> the Journal <strong>of</strong> Economic Studies (1994)under the title “Eucken on Capital <strong>and</strong> Interest” ( Journal <strong>of</strong> Economic Studies, 21(4):61–75).2 Footnotes have been omitted from translation: “Methodisches: Das Vorgehen Euckens,das auf die ‘phänomenologische[n] Wesenserfassung’ zurückgeht, kann im modernenwissenschaftstheoretischen Diskurs ke<strong>in</strong>en Best<strong>and</strong>haben. Die Rückb<strong>in</strong>dung an Husserl,dessen Philosophie letzliche ‘e<strong>in</strong>e Ontologie auf idealistischer Grundlage’ ist und somite<strong>in</strong>en ‘Absolutismus im Übergang’ bedeutet, muß zerfließen: Im Wissen um e<strong>in</strong>eevolutive Naturgeschichte bietet e<strong>in</strong>e transzendentalphilosophische Methodik und ihreRückb<strong>in</strong>dung an e<strong>in</strong>e ‘Erste Philosophie’ ke<strong>in</strong>en Halt mehr <strong>in</strong> der sozialwissenschaftlichenDebatte – auch wenn e<strong>in</strong>e ähnliche Vorgehensweise die unausgesprochene Grundlagezahlreicher ökonomischer Theorien bildet.”3 Page 37. In German: “Ethisches Wollen: Wurzelt die ökonomische Theorie nicht auf‘ewigen Wahrheiten’, schw<strong>in</strong>det ihre Möglichkeit, Wirtschaftsethik absolut zubegründen. Entthront man also den metaphysisch legitimierten Ordo, entfällt derAnspruch, von ökonomischer Erkenntnis zu unverrückbaren moralischen Postulatenfortzuschreiten.”


124 Jürgen G. Backhaus4 Page 41. In German: “Somit verbleibt e<strong>in</strong>er ökonomischen Theorie, die sich <strong>in</strong> derTradition Euckens neu formulieren will, die betrübliche, aber notwendige E<strong>in</strong>sicht, wiesie bereits von Joseph Schumpeter formuliert wurde: ‘Statt scharfe Konturen fürDiszipl<strong>in</strong>en und Richtungen zu gew<strong>in</strong>nen, müssen wir uns damit abf<strong>in</strong>den, daß alles<strong>in</strong>e<strong>in</strong><strong>and</strong>er fließt.’”5 Rudolf Eucken (1846–1926) taught philosophy from 1871 <strong>in</strong> Basel, <strong>and</strong> from 1874 <strong>in</strong>Jena. He propagated a neo-idealistic philosophy <strong>of</strong> creative activism <strong>and</strong> received theNobel Prize for Literature <strong>in</strong> 1908.6 The issue is not arcane. The accession <strong>of</strong> Turkey to the European Union is said by someto revolve on Turkish policy be<strong>in</strong>g compatible with European Christian values.7 Unfortunately, Eucken turned, to his later chagr<strong>in</strong>, explicitly aga<strong>in</strong>st Schmoller’sunresentful quest for empirical evidence.8 This was when we had just completed our conference on Friedrich Nietzsche’s <strong>in</strong>fluenceon the social sciences, <strong>and</strong> Wolfgang Schluchter gave his lecture <strong>in</strong> Erfurt on MaxWeber, detail<strong>in</strong>g how Friedrich Nietzsche had <strong>in</strong>fluenced both Max <strong>and</strong> Alfred Weber’swork (see Schluchter et al. forthcom<strong>in</strong>g).9 In contrast to his teacher Schumacher, or to Schmoller <strong>and</strong> Sombart, he seems to havebeen extremely alo<strong>of</strong> <strong>of</strong> economic activities, as they actually happen. An <strong>in</strong>ternship <strong>in</strong> abank would probably have pushed his <strong>in</strong>sight extremely, but perhaps he would havethen been lost from the academic community.10 See <strong>in</strong>sertion I.11 See <strong>in</strong>sertion II.12 The source <strong>of</strong> this identification is the purpose <strong>of</strong> this essay (see Buchanan 1969).13 For an analysis <strong>of</strong> the importance <strong>of</strong> the first three options see Hirschman (1970).14 The legal implications <strong>of</strong> this rather apodictive statement have to be further explored.15 See for <strong>in</strong>stance for a short statement Lel<strong>and</strong> B. <strong>Yeager</strong> (1985: 103–7 with furtherreferences).16 Cambridge: Harvard University Press, 1962.17 Journal <strong>of</strong> Political Economy.18 Own price observation.ReferencesBackhaus, Jürgen (1989). Sombart’s Modern Capitalism. Kyklos, 42(4): 599–611. Repr<strong>in</strong>ted <strong>in</strong>:Blaug, Mark (ed.) (1992) Pioneers <strong>in</strong> Economics, Volume 30, Section III. Aldershot: EdwardElgar, pp. 93–105.Backhaus, Jürgen (1999). L<strong>and</strong> Rents <strong>and</strong> Ecological Crisis: The Case <strong>of</strong> the Oder RiverValley. American Journal <strong>of</strong> Economics <strong>and</strong> Sociology, 58(2): 249–52.Backhaus, Jürgen (ed.) (<strong>in</strong> press). The Social Question. Journal <strong>of</strong> Economic Studies.Backhaus, Jürgen (ed.) with Günter Krause (1997). On Political Economy <strong>of</strong> Transformation:Country Studies. Metropolis Verlag.Backhaus, Jürgen (ed.) with Plamen Tchipev <strong>and</strong> Frank Stephen (1998). Mass PrivatisationSchemes <strong>in</strong> Central <strong>and</strong> East European Countries. Implications on Corporate Governance. S<strong>of</strong>ia:GorexPress.Buchanan, James (1969). Cost <strong>and</strong> Choice. Chicago, IL: Markham.Eucken, Walter (1950). The Foundations <strong>of</strong> Economics (translated by Terence W. Hutchison).London: W. Hodge.Eucken, Walter (1951). This Unsuccessful Age <strong>of</strong> the Pa<strong>in</strong>s <strong>of</strong> Economic Progress, with anIntroduction by John Jewkes. London: W. Hodge.Gehrken, Lüder (ed.) (2000). Walter Eucken und se<strong>in</strong> Werk: Rückblick auf den Vordenker der SozialenMarktwirtschaft (Walter Eucken <strong>and</strong> his Œuvre: Look<strong>in</strong>g Back at the Intellectual Founder<strong>of</strong> the Social Market Economy). Tüb<strong>in</strong>gen: Mohr Siebeck.


Lel<strong>and</strong>’s favorite economists 125Goldschmidt, Nils (2002). Entstehung und Vermächtnis ordo-liberalen Denkens: Walter Eucken und dieNotwendigkeit e<strong>in</strong>er kulturellen Ökonomik (Emergence <strong>and</strong> Legacy <strong>of</strong> Ordo-Liberal Th<strong>in</strong>k<strong>in</strong>g:Walter Eucken <strong>and</strong> the Necessity <strong>of</strong> Cultural Economics). Münster: LIT.Hirschman, Albert O. (1970). Exit, Voice, <strong>and</strong> Loyalty: Responses to Decl<strong>in</strong>e <strong>in</strong> Firms, Organizations,<strong>and</strong> States. Cambridge, MA: Harvard University Press.Külp, Bernhard <strong>and</strong> Victor Vanberg (eds.) (2003). Freiheit und wettbewerbliche Ordnung(Freedom <strong>and</strong> Competitive Order). Freiburg: Haufe.Meijer, Gerrit (ed.) (1994). The Intellectual Roots <strong>of</strong> Market Economies: Walter Eucken’sContribution to Economics. Journal <strong>of</strong> Economic Studies, 20(4).Nietzsche, Friedrich (1974). The Gay Science – with a Prelude <strong>in</strong> Rhymes <strong>and</strong> an Appendix <strong>of</strong> Songs.Walter Kaufmann (ed.). New York: V<strong>in</strong>tage Books.Nietzsche, Friedrich (1988). Kritische Studienausgabe, 15 vols. G. Colli <strong>and</strong> M. Mont<strong>in</strong>ari (eds.).München-Berl<strong>in</strong>/New York: DTV – de Gruyter. Repr. <strong>of</strong> 2nd edn.Nietzsche, Friedrich (1994). On the Genealogy <strong>of</strong> Morality. K. Ansell-Pearson (ed.). Cambridge:Cambridge University Press.Peukert, Helge (2004). Der 20. Juli und die wirtschafts-und ordnungspolitischen Konzeptionender Opposition gegen den Nationalsozialismus. Perspektiven der Wirtschaftspolitik,5(4).Schluchter, Wolfgang (forthcom<strong>in</strong>g). Max und Alfred Weber. In Thomas Beschorner <strong>and</strong>Thomas Eger (eds.) Das Ethische <strong>in</strong> der Ökonomie. Festschrift zum 60. Geburtstag von Hans G.Nutz<strong>in</strong>ger. Marburg: Metropolis.Schwartze, Andreas (1990). LLM-Thesis. Florence: European University Institute, pp. 30–3.Smith, Adam (1776). An Inquiry <strong>in</strong>to the Nature <strong>and</strong> Causes <strong>of</strong> the Wealth <strong>of</strong> Nations.Sombart, Werner (1928). Der moderne Kapitalismus, I–III. Leipzig und München: Duncker &Humblot.Storch, Henri (1823–24). Cours d’économie politique, I–V. Paris: Aillaud.<strong>Yeager</strong>, Lel<strong>and</strong> (1985). Deregulation <strong>and</strong> Monetary Reform. American Economic Review,Papers <strong>and</strong> Proceed<strong>in</strong>gs, 75(2): 103–7.<strong>Yeager</strong>, Lel<strong>and</strong> (1994). Eucken on Capital <strong>and</strong> Interest. Journal <strong>of</strong> Economic Studies, 21(4):61–75.<strong>Yeager</strong>, Lel<strong>and</strong> (2001). Ethics as Social Science. Cheltenham: Elgar.


9 The genesis <strong>of</strong> an ideaClassical economics <strong>and</strong> the birth <strong>of</strong>monetary disequilibrium theoryMichael R. MontgomeryIntroductionAs Lel<strong>and</strong> <strong>Yeager</strong> establishes impressively <strong>in</strong> The Flutter<strong>in</strong>g Veil (<strong>Yeager</strong> 1997a), thenotion <strong>of</strong> monetary disequilibrium is one <strong>of</strong> the core ideas <strong>of</strong> macroeconomictheory. That monetary distortions orig<strong>in</strong>at<strong>in</strong>g on either the supply or dem<strong>and</strong> side<strong>of</strong> the “money market” can have important impacts on the price level <strong>and</strong> on real<strong>in</strong>come is decisively argued <strong>in</strong> his volume. That these impacts are likely to bestronger <strong>in</strong> the event <strong>of</strong> monetary change than they are for changes <strong>in</strong> other majormacroeconomic magnitudes is a proposition for which an ample <strong>and</strong> impressivecase appears <strong>in</strong> this book. That money has unique status not only as medium <strong>of</strong>exchange but also as the sole asset without a “price” <strong>of</strong> its own, so that consequences<strong>of</strong> excess dem<strong>and</strong>s for, or supplies <strong>of</strong>, money must be worked out piecemeal amongthe millions <strong>of</strong> markets that employ money for transactions purposes, is, properly,the central <strong>in</strong>sight <strong>of</strong> the volume. That this central <strong>in</strong>sight, which I have not seenemphasized elsewhere <strong>in</strong> modern macro-theory, substantially simplifies monetarytheory by establish<strong>in</strong>g a uniqueness factor to the monetary asset that the existence<strong>of</strong> numerous “near-moneys” cannot overturn is one <strong>of</strong> the book’s major achievements.That this uniqueness, when considered <strong>in</strong> comb<strong>in</strong>ation with the existence<strong>of</strong> a complex, <strong>in</strong>terlock<strong>in</strong>g bus<strong>in</strong>ess structure where the fact that costs <strong>of</strong> somebus<strong>in</strong>esses are revenues <strong>of</strong> others, <strong>and</strong> cost changes for some lag beh<strong>in</strong>d pricechanges for others, leads directly to a monetary theory <strong>of</strong> the bus<strong>in</strong>ess cycle, followsquickly from the analysis. That all this matters crucially for macroeconomic theoryis difficult to deny once one has read the volume.The Flutter<strong>in</strong>g Veil matters not only as a contribution to modern macroeconomictheory. It is also notable <strong>in</strong> its establishment <strong>of</strong> numerous l<strong>in</strong>ks with past th<strong>in</strong>kers<strong>in</strong> the monetary disequilibrium tradition. The present paper seeks to make acontribution <strong>in</strong> this spirit, by explor<strong>in</strong>g the development <strong>of</strong> the monetarydisequilibrium idea <strong>in</strong> the h<strong>and</strong>s <strong>of</strong> the Classical economists. It will be argued belowthat the “Classicals” were considerably more broad-based <strong>in</strong> their approach tomacroeconomics than is acknowledged by the modern <strong>in</strong>terpretation emphasiz<strong>in</strong>gwage/price flexibility, Say’s Law, <strong>and</strong> the neutrality <strong>of</strong> money. It was, I will argue,precisely out <strong>of</strong> this broad-based approach that the monetary disequilibrium<strong>in</strong>sight emerged – first by Hume, <strong>and</strong> then, most notably, <strong>in</strong> the h<strong>and</strong>s <strong>of</strong> John


The genesis <strong>of</strong> an idea 127Stuart Mill. I will argue that Mill’s <strong>in</strong>sights represent the start <strong>of</strong> monetarydisequilibrium theory as that theory is conceived <strong>of</strong> today.The Classical macroeconomic tradition as popularly<strong>in</strong>terpretedThat the genesis <strong>of</strong> monetary disequilibrium theory can rightly be attributed to theClassical economists – by which I mean Hume, Smith, Say, Ricardo, James <strong>and</strong>John Stuart Mill, <strong>and</strong> their contemporary like-th<strong>in</strong>kers on money <strong>and</strong> macroeconomicissues 1 – will come as a surprise to some. The reputation <strong>of</strong> the Classicaleconomists has never quite recovered from the tarr<strong>in</strong>g delivered by Keynes <strong>in</strong> TheGeneral Theory (1965 [1936]). In Chapters 2 <strong>and</strong> 3 <strong>of</strong> that book, Keynes portrayedthe Classicals (as well as early twentieth-century theorists, whom he also, strangely,labeled “Classical”) as cloddish believers <strong>in</strong> simplistic versions <strong>of</strong> Say’s Law, price/wage flexibility <strong>and</strong> the strict neutrality <strong>of</strong> money. Despite the qualified rebuke <strong>of</strong>Keynes on this po<strong>in</strong>t by Robert Skidelsky (arguably the world’s lead<strong>in</strong>g authorityon Keynes), 2 modern macroeconomists have, too <strong>of</strong>ten, picked up Keynes’ <strong>in</strong>terpretationwholesale.Thus, Snowdon et al. (1994: 52), writ<strong>in</strong>g on Say’s Law, state “That the act <strong>of</strong>supply created an equivalent dem<strong>and</strong> seemed obvious to the Classical writers.” TheClassicals allowed for “the possibility that a misallocation <strong>of</strong> resources can occur<strong>and</strong> that a glut <strong>of</strong> certa<strong>in</strong> commodities can develop, but this problem would be temporary<strong>and</strong> no such excess supply could occur for goods as a whole” (ibid.). Likewiseecho<strong>in</strong>g Keynes on flexible prices <strong>and</strong> wages, Abel <strong>and</strong> Bernanke (2005: 355) ma<strong>in</strong>ta<strong>in</strong>that, “Classical macroeconomists assume that prices <strong>and</strong> wages adjust quicklyto equate quantities supplied <strong>and</strong> dem<strong>and</strong>ed <strong>in</strong> each market.” 3 Stiglitz (1993: 680)also emphasizes price <strong>and</strong> wage flexibility, stat<strong>in</strong>g that Classical economics “recognizedthat the economy might have short periods <strong>of</strong> unemployment, but believedthat market forces would quickly restore the economy to full employment.” 4, 5Regard<strong>in</strong>g the strict neutrality <strong>of</strong> money, Mankiw (2000: 187) tells us that “<strong>in</strong>classical economic theory, changes <strong>in</strong> the money supply do not <strong>in</strong>fluence realvariables.” Snowdon et al. make the l<strong>in</strong>k between the neutrality <strong>of</strong> money <strong>and</strong> Say’sLaw explicit:In general classical economists, notably Ricardo <strong>and</strong> Mill, gave support to Say’slaw, which they believed also held true for a monetary exchange economy.<strong>Money</strong> was noth<strong>in</strong>g more than a convenient medium <strong>of</strong> exchange which enabledmarket participants to avoid the awkwardness <strong>and</strong> <strong>in</strong>convenience <strong>of</strong> barter.(Snowdon et al. 1994: 52)The over-emphasis on price flexibility <strong>in</strong> <strong>in</strong>terpretations<strong>of</strong> Classical theoryActually, it is quite possible to argue plausibly that none <strong>of</strong> these three propositions– Say’s Law, price/wage flexibility, the neutrality <strong>of</strong> money – accurately


128 Michael R. Montgomerycharacterize Classical macroeconomic thought, at least not <strong>in</strong> the simplistic forms<strong>in</strong> which modern parlance asserts them. Take, for example, wage <strong>and</strong> price flexibility,supposedly at the very heart <strong>of</strong> eighteenth- <strong>and</strong> n<strong>in</strong>eteenth-century Classicalmacroeconomic doctr<strong>in</strong>e. If the Classical economists were apostles <strong>of</strong> a wage/priceflexibility so powerful as to guarantee that deviations from equilibrium output“would be temporary <strong>and</strong> very short-lived” (Snowdon et al. 1994: 43), then why dowe not read more about such flexibility <strong>and</strong> its mechanics <strong>in</strong> the most importantmacroeconomic writ<strong>in</strong>gs <strong>of</strong> the lead<strong>in</strong>g Classical economists? John Stuart Mill’sfamous chapter <strong>in</strong> The Pr<strong>in</strong>ciples <strong>of</strong> Political Economy “Of Excess <strong>of</strong> Supply” mentionsprice (not wage) flexibility only <strong>in</strong> pass<strong>in</strong>g <strong>and</strong> only at the start <strong>of</strong> the chapter, prelim<strong>in</strong>aryto the ma<strong>in</strong> argument, <strong>in</strong> order to establish early on how there can be aglut <strong>of</strong> an <strong>in</strong>dividual commodity (Mill 1965 [1848]: 570) – an argument which hethen <strong>in</strong>validates as an argument for general gluts. His earlier essay on the samegeneral topic, “On the Influence <strong>of</strong> Consumption on Production,” <strong>in</strong> <strong>Essays</strong> on SomeUnsettled Questions <strong>in</strong> Political Economy, is similarly bereft <strong>of</strong> any focus on flexible wagesor prices (Mill 1983 [1844]). 6 J.B. Say’s chapter “Of the Dem<strong>and</strong> or Market forProducts” <strong>in</strong> his Traite d’Economie Politique (Treatise on Political Economy) (1983 [1803])discusses price <strong>and</strong> wage flexibility only briefly <strong>and</strong> as an aside after the core <strong>of</strong> hisargument is complete. 7 Ricardo has even less to say about price <strong>and</strong> wage flexibility<strong>in</strong> his macroeconomic mus<strong>in</strong>gs <strong>in</strong> the Pr<strong>in</strong>ciples (1951 [1817]: Ch. XXI, “Effects<strong>of</strong> Accumulation on Pr<strong>of</strong>its <strong>and</strong> Interest”). He follows Say <strong>in</strong> argu<strong>in</strong>g for the <strong>in</strong>satiability<strong>of</strong> “effectual” dem<strong>and</strong> <strong>in</strong> ways that do not appeal to price, wage, or <strong>in</strong>terestrateflexibility; his occasional references to the latter concepts are very muchby-the-way <strong>and</strong>, on the face <strong>of</strong> it, <strong>in</strong>essential to his argument. 8Naturally it is tempt<strong>in</strong>g to argue that the Classical economists did fully endorsethe necessary-<strong>and</strong>-sufficient role <strong>of</strong> wage/price flexibility <strong>in</strong> guarantee<strong>in</strong>g fullemployment, <strong>and</strong> that their failure to focus explicitly on how such flexibility providessuch a guarantee is merely additional evidence that such flexibility was somuch part <strong>of</strong> their th<strong>in</strong>k<strong>in</strong>g that it never occurred to them to actually discuss it <strong>in</strong>detail. The fact is, however, that the Classical economists did not openly emphasizewage/price flexibility as the core adjustment mechanism guarantee<strong>in</strong>g macroeconomicstability. What the Classicals did emphasize repeatedly is the notion thatevery act <strong>of</strong> production is an act <strong>of</strong> potential-dem<strong>and</strong> creation. Such potentialwould be rapidly <strong>and</strong> <strong>in</strong>evitably transformed <strong>in</strong>to spend<strong>in</strong>g due to the self-<strong>in</strong>terest<strong>of</strong> the producer – either by the producer’s direct consumption or by the producer’slend<strong>in</strong>g to another who would <strong>in</strong> turn consume.Just how that actualization would occur was not detailed. Certa<strong>in</strong>ly given theClassicals’ microeconomics, one may presume that wage- <strong>and</strong> price- (<strong>and</strong> <strong>in</strong>terestrate-)flexibility would play an important role <strong>in</strong> this actualization. But presumptionsaside, the fact rema<strong>in</strong>s that, precisely where one might have expected them to makethe details <strong>of</strong> their adjustment mechanism explicit, the Framers <strong>of</strong> moderneconomic theory left an <strong>in</strong>kblot.S<strong>in</strong>ce the Classical economists were not slipshod th<strong>in</strong>kers, it is worth consider<strong>in</strong>gthe possibility that the <strong>in</strong>kblot is there because they meant it to be there. In particular,there are those occasional jarr<strong>in</strong>g passages where the Classical economists


The genesis <strong>of</strong> an idea 129suggest that the idea <strong>of</strong> full-employment equilibrium, <strong>and</strong> the path to that equilibrium,is longer, more treacherous <strong>and</strong> more mysterious at the macro-level than atthe micro-level. In these mus<strong>in</strong>gs, one can <strong>in</strong>fer a certa<strong>in</strong> skepticism that price/wage flexibility would assure rapid convergence to macro-equilibrium. Adam Smith(1937 [1776]: 406) writes about a sometimes general compla<strong>in</strong>t <strong>of</strong> a “scarcity <strong>of</strong>money” occurr<strong>in</strong>g throughout “whole mercantile towns” due to “over-trad<strong>in</strong>g.” Inthe Unsettled Questions, Mill builds on this l<strong>in</strong>e <strong>of</strong> thought, associat<strong>in</strong>g such a statewith times when “general delusion is afloat” (1983 [1844]: 40), <strong>and</strong> even emphasiz<strong>in</strong>g,as a cause, the thoroughly modern notion that the “<strong>in</strong>crease <strong>in</strong> productionreally takes place dur<strong>in</strong>g the progress <strong>of</strong> [currency] depreciation, as long as theexistence <strong>of</strong> depreciation is not suspected” (ibid.). So far all is still much <strong>in</strong> l<strong>in</strong>e withSmith’s “over-trad<strong>in</strong>g” story. Next, however, Mill <strong>in</strong>troduces someth<strong>in</strong>g new,po<strong>in</strong>t<strong>in</strong>g out that:when the delusion vanishes <strong>and</strong> the truth is disclosed, those whose commoditiesare relatively <strong>in</strong> excess must dim<strong>in</strong>ish their production or be ru<strong>in</strong>ed: <strong>and</strong> if dur<strong>in</strong>gthe high prices they have built mills <strong>and</strong> erected mach<strong>in</strong>ery, they will be likely to repent at leisure.(1983 [1844]: 40, italics added)Repent at leisure? How is such a th<strong>in</strong>g to be reconciled with full price flexibility?Will not this unwanted capital see its price fall until it is disposed <strong>of</strong> to the highestbidder, <strong>and</strong> will not the economy quickly return to equilibrium? It is a clear-cutimplication <strong>of</strong> the price flexibility assumption allegedly at the core <strong>of</strong> Classicalmacro-thought, <strong>and</strong> yet no such suggestion is forthcom<strong>in</strong>g from Mill at thisjuncture. The same question may be raised <strong>of</strong> certa<strong>in</strong> passages by Ricardo <strong>in</strong> his“On Sudden Changes <strong>in</strong> the Channels <strong>of</strong> Trade,” <strong>in</strong> the Pr<strong>in</strong>ciples (Ch. XIX).Ricardo, however, spells out the fixed-capital mechanism more carefully (he haddoubtless had opportunity to contemplate numerous such cases dur<strong>in</strong>g his career asa stockbroker). Says Ricardo, “A great manufactur<strong>in</strong>g country is peculiarly exposedto temporary reverses . . . produced by the removal <strong>of</strong> capital from one employmentto another” (1951 [1817]: 263). When there is such a sudden shift <strong>in</strong> relativedem<strong>and</strong>s for products, 9It changes <strong>in</strong> a great degree the nature <strong>of</strong> the employments to which therespective capitals <strong>of</strong> countries were before devoted; <strong>and</strong> dur<strong>in</strong>g the <strong>in</strong>tervalwhile they are settl<strong>in</strong>g <strong>in</strong> the situations which new circumstances have made themost beneficial, much fixed capital is unemployed, perhaps wholly lost, <strong>and</strong>labourers are without full employment. The duration <strong>of</strong> this distress will belonger or shorter accord<strong>in</strong>g to the strength <strong>of</strong> that dis<strong>in</strong>cl<strong>in</strong>ation, which mostmen feel to ab<strong>and</strong>on that employment <strong>of</strong> their capital to which they have longbeen accustomed.(1951 [1817]: 265)This l<strong>in</strong>k between fixed capital <strong>and</strong> potentially lengthy periods <strong>of</strong> stress on bus<strong>in</strong>ess– dur<strong>in</strong>g which time “labourers are without full employment” – poses a challenge


130 Michael R. Montgomeryto those who would portray Classical theory as imply<strong>in</strong>g rapid adjustment to fullemployment <strong>in</strong> response to macroeconomic shocks. The fly <strong>in</strong> the o<strong>in</strong>tment is thespecter <strong>of</strong> expensive, illiquid, debt-creat<strong>in</strong>g, <strong>in</strong>dustry-specific, <strong>and</strong> <strong>of</strong>ten also firmspecific,capital goods. 10 As Ricardo notes, “[i]t is <strong>of</strong>ten impossible to divert themach<strong>in</strong>ery which may have been erected for one manufacture, to the purposes <strong>of</strong>another . . . ” (1951 [1817]: 266).It is true that, if pressed, Ricardo <strong>and</strong> Mill might without contradiction haveclaimed that these were <strong>in</strong>dustry-specific problems, tend<strong>in</strong>g to cause some<strong>in</strong>dustries to decl<strong>in</strong>e while others prospered <strong>in</strong> precisely <strong>in</strong>verse proportion, so thatfull employment overall would be ma<strong>in</strong>ta<strong>in</strong>ed. This would almost certa<strong>in</strong>ly havebeen Say’s view. 11 However, Ricardo <strong>and</strong> Mill choose not to proceed <strong>in</strong> this way.Ricardo does not say how long “temporary” is <strong>in</strong> his prediction <strong>of</strong> a temporaryfail<strong>in</strong>g health <strong>of</strong> the economy given sudden changes <strong>in</strong> the “channels <strong>of</strong> trade.”Later <strong>in</strong> his essay, Mill emphasizes the transitory nature <strong>of</strong> the commercial crisis hedescribes – but his “repent at leisure” remark (see above) raises concerns likeRicardo’s about the speed <strong>of</strong> recovery.Neither Mill nor Ricardo denies that the widespread capital losses alluded to willbr<strong>in</strong>g on a general decl<strong>in</strong>e <strong>in</strong> economic activity – <strong>in</strong>deed, Mill affirms it specifically. 12Neither believes the distress should be confused with a secular overproductionproblem like that which, say, Malthus would have suggested (Mill 1983 [1844]:43–5). On the other h<strong>and</strong>, neither Ricardo nor Mill is prepared to put theirthoughts about the length <strong>of</strong> the “temporary” period <strong>of</strong> distress <strong>in</strong>to calendar units.How long, then, will the period <strong>of</strong> general distress last? Once nonmarketablefixed capital enters the picture, it is not enough for the crisis <strong>in</strong> confidence to end <strong>in</strong>order to guarantee recovery. The large capital losses associated with the overhang<strong>of</strong> excess capital will cont<strong>in</strong>ue to hold the economy down for some period <strong>of</strong> time.Nor did Ricardo <strong>and</strong> Mill seem prepared to <strong>in</strong>voke wage/price flexibility as thesolution to the economy’s “wrong-capital” problem. So it is hard to imag<strong>in</strong>e theirperceived adjustment period as fail<strong>in</strong>g to be quite a bit more lengthy than, forexample, Snowdon et al.’s brisk characterization <strong>of</strong> it as “very short-lived” (1994: 52).Based on how Ricardo <strong>and</strong> Mill raised <strong>and</strong> addressed these issues, I suggest thatthe Classicals, generally speak<strong>in</strong>g, were aware, <strong>in</strong> an <strong>in</strong>tuitive sort <strong>of</strong> way, <strong>of</strong> thepotential problems such capital-based speculations posed for any argument thatpure wage <strong>and</strong> price flexibility was enough to guarantee rapid return to fullemployment. 13 On this <strong>in</strong>terpretation, the orig<strong>in</strong>al Classical Economists, unlikesome work<strong>in</strong>g recently <strong>in</strong> the New Classical <strong>and</strong> Real Bus<strong>in</strong>ess Cycle schools, didnot see the role played by price flexibility <strong>in</strong> achiev<strong>in</strong>g economy-wide equilibrium tobe simple <strong>and</strong> clear-cut; for example, as a straightforward blowup <strong>of</strong> the role playedby price flexibility <strong>in</strong> a microeconomic problem. It would appear that they saw themacro-version <strong>of</strong> this problem as considerably more complex.The Classicals had great respect for, <strong>and</strong> confidence <strong>in</strong>, the power <strong>of</strong> prices toalter behavior <strong>in</strong> socially desirable ways. They had also a general underst<strong>and</strong><strong>in</strong>gthat the <strong>in</strong>visible-h<strong>and</strong> idea depended crucially on such price flexibility. But theydid not rely explicitly on price flexibility as the th<strong>in</strong>g that guaranteed fullemployment <strong>in</strong> the economy. Nor did they have to underst<strong>and</strong> the subtleties <strong>of</strong> the


The genesis <strong>of</strong> an idea 131macroeconomic implications <strong>of</strong> price flexibility <strong>in</strong> order to guarantee that “supplyequaled dem<strong>and</strong>” for the economy as a whole. They had someth<strong>in</strong>g much simplerthat, they thought, got them to the same result without hav<strong>in</strong>g to venture <strong>in</strong>to theuncharted territory <strong>of</strong> price flexibility <strong>in</strong> a macroeconomic context. It was thisalternate strategy that set them on a path that ended, after considerable resistance,<strong>in</strong> the recognition <strong>of</strong> the monetary disequilibrium idea.Say’s Law <strong>and</strong> moneyThe simple idea, <strong>of</strong> course, was Say’s Law. The very act <strong>of</strong> production guaranteedthat an equivalent amount <strong>of</strong> consum<strong>in</strong>g power would be created. In a bartereconomy, supply<strong>in</strong>g was dem<strong>and</strong><strong>in</strong>g by def<strong>in</strong>ition, <strong>and</strong> one’s purchas<strong>in</strong>g power wasexactly equal to the value <strong>of</strong> that which one had produced <strong>and</strong> then supplied tomarket. It was literally <strong>in</strong>conceivable that supply could exceed dem<strong>and</strong> or viceversa, regardless <strong>of</strong> whether or not price ratios were flexible or fixed. Somehow supply wouldhave to equal dem<strong>and</strong>. Price flexibility governed how it would happen, not whether itwould happen. This was the great simplification that the Classicals sought to keepas they turned from the barter to the monetary economy.Keep<strong>in</strong>g this simplification, however, required deal<strong>in</strong>g first with the complication<strong>of</strong> money. <strong>Money</strong> <strong>of</strong>fered a way to put one’s wealth <strong>in</strong>to the form <strong>of</strong> storablegeneral purchas<strong>in</strong>g power. It constituted a clear threat to the transfer <strong>of</strong> the analysisbuilt around Say’s Law over from a barter to a monetary economy. The vital needto bottle-up money accounts <strong>in</strong> large part for the emphasis placed <strong>in</strong> the classicalliterature on the idea that money is used only for transactions purposes. 14 ToHume, money is “none <strong>of</strong> the wheels <strong>of</strong> trade: It is the oil which renders the motion<strong>of</strong> the wheels more smooth <strong>and</strong> easy” (1970 [1752]: 33). Smith th<strong>in</strong>ks that “[i]twould be too ridiculous to prove, that . . . [money] is valuable only for purchas<strong>in</strong>g”(1937 [1776]: 406). Say claims that money’s “whole utility” consists <strong>in</strong> facilitat<strong>in</strong>gtransactions, <strong>and</strong> compares it to “a public vehicle successively transport[<strong>in</strong>g]objects one after another” (1983 [1803]: 13). To J.S. Mill, money units “are a sort<strong>of</strong> tickets or orders” usable <strong>in</strong> purchas<strong>in</strong>g, <strong>and</strong> money is “a mach<strong>in</strong>e for do<strong>in</strong>gquickly <strong>and</strong> commodiously, what would be done, though less quickly <strong>and</strong> commodiously,without it” (1965 [1848]: 506).But if Say’s Law was to be smoothly transferable from a barter to a moneyeconomy, it was also essential that money not be a store <strong>of</strong> value, so that it could notserve as a “s<strong>in</strong>k” <strong>in</strong> which unspent purchas<strong>in</strong>g power might accumulate. In writ<strong>in</strong>gwhat Blaug has called “a h<strong>in</strong>t <strong>of</strong> Say’s Law” (Blaug 1978: 56), Smith had beenaware that there were crucial assumptions <strong>in</strong>volved regard<strong>in</strong>g the tim<strong>in</strong>g <strong>of</strong>spend<strong>in</strong>g: “What is annually saved is as regularly consumed as what is annuallyspent, <strong>and</strong> nearly <strong>in</strong> the same time too; but it is consumed by a different set <strong>of</strong> people”(1937 [1776]: 321, emphasis added). As Blaug put it, “[t]he operative propositionhidden away <strong>in</strong> Smith’s phraseology is that sav<strong>in</strong>g is tantamount to <strong>in</strong>vestmentbecause ‘hoard<strong>in</strong>g,’ the build<strong>in</strong>g up <strong>of</strong> monetary hold<strong>in</strong>gs, is regarded as anexceptional occurrence” (1978: 57).Say goes to great lengths <strong>in</strong> seek<strong>in</strong>g to establish the irrelevance <strong>of</strong> the hoard<strong>in</strong>g


132 Michael R. Montgomeryissue. He states that the money “you will have received on the sale <strong>of</strong> your ownproducts, <strong>and</strong> given <strong>in</strong> the purchase <strong>of</strong> those <strong>of</strong> other people, will the next momentexecute the same between other contract<strong>in</strong>g parties” (1983 [1803]: 13, emphasisadded). It is risky to hold money, s<strong>in</strong>ce “the value <strong>of</strong> money is also perishable”(p. 15) – presumably referr<strong>in</strong>g, not only to the possibility <strong>of</strong> physical destruction <strong>of</strong>certa<strong>in</strong> k<strong>in</strong>ds <strong>of</strong> money, but also, as Mill would later put it, to the notion that “[n]ocommodity is quite free from such fluctuations [<strong>in</strong> value]” (1965 [1848]: 504).Buried <strong>in</strong> a footnote, Say recognized that there would be the occasional “miser”(1983 [1803]: 13) who would obta<strong>in</strong> money “with a view to hoard or bury it” (ibid.).But he considered this to be an isolated case, <strong>and</strong> <strong>in</strong> any event “[t]he heir <strong>of</strong> thelucky f<strong>in</strong>der [would spend it], if the miser do not” (ibid.).With this po<strong>in</strong>t established to Say’s satisfaction, the Law that bears his name was,<strong>in</strong> his eyes, just as applicable to a monetary economy as to a barter one: “a productis no sooner created, than it, from that <strong>in</strong>stant, affords a market for other products tothe full extent <strong>of</strong> its own value” (p. 15). Ricardo is content with Say’s analysis,writ<strong>in</strong>g that “M. Say has, however, most satisfactorily shown that there is noamount <strong>of</strong> capital which may not be employed <strong>in</strong> a country, because dem<strong>and</strong> isonly limited by production” (1951 [1817]: 290). In the Pr<strong>in</strong>ciples, he simply states theneeded condition for money <strong>and</strong> then moves on without comment: “money is onlythe medium by which exchange is effected” (ibid.). In sum, Smith, Say, <strong>and</strong> Ricardosaw clearly that “[b]y rul<strong>in</strong>g out hoard<strong>in</strong>g, money is <strong>in</strong>deed reduced to serv<strong>in</strong>g as amedium <strong>of</strong> exchange <strong>and</strong> no more: <strong>in</strong> consequence, sav<strong>in</strong>g or nonconsumption isnecessarily equal to <strong>in</strong>vestment” (Blaug 1978: 57).It is this denial <strong>of</strong> money’s potential store-<strong>of</strong>-value function, not the assumption<strong>of</strong> a powerful wage <strong>and</strong> price (<strong>and</strong> <strong>in</strong>terest rate) flexibility, that was the key plankallow<strong>in</strong>g Classical economists prior to J.S. Mill to aggressively assert Say’s Law. Ifmoney is only a medium-<strong>of</strong>-exchange, then all worries about wage/price flexibilityare neatly f<strong>in</strong>essed (how would the issue <strong>of</strong> price flexibility arise <strong>in</strong> a critical way <strong>in</strong>an aggregate context if there were noth<strong>in</strong>g but goods to buy, as <strong>in</strong> a bartereconomy?). And it is the extraord<strong>in</strong>ary importance <strong>of</strong> this assumption to theirframework that enticed three generations <strong>of</strong> lead<strong>in</strong>g Classical economists (Smith,Say, Ricardo) to stick doggedly to a position that, with the benefit <strong>of</strong> h<strong>in</strong>dsight, was<strong>in</strong>defensible. Indeed, the tenuousness <strong>of</strong> the ground on which they had built isrevealed by the qualifiers Smith <strong>and</strong> Say felt obliged to <strong>in</strong>clude <strong>in</strong> their corestatements. Smith’s use <strong>of</strong> the qualifier nearly (see above), <strong>and</strong> Say’s recognition thatsome will hoard, already cede the basic pr<strong>in</strong>ciple. The recognition that money couldbe stored <strong>and</strong> would be stored by some overwhelmed the Classicals’ bald assertionsthat such activities were rare. What if they were not?Mill’s fateful reckon<strong>in</strong>g with the problem <strong>of</strong> storablemoneyAccord<strong>in</strong>gly, by John Stuart Mill’s day, Mill seemed to have felt compelled toshore-up the Classical macro-framework by seek<strong>in</strong>g to reconcile it with the clearlyobservable fact that money was not just a medium <strong>of</strong> exchange but also a store <strong>of</strong>


The genesis <strong>of</strong> an idea 133value. His attempt to do so was published as “On the Influence <strong>of</strong> Consumption onProduction,” <strong>in</strong> his <strong>Essays</strong> on Some Unsettled Questions <strong>in</strong> Political Economy, a volumepublished <strong>in</strong> 1844, but <strong>in</strong> fact written <strong>in</strong> 1829–30 (Hazlitt 1983: 23). Mill thought hewas just mak<strong>in</strong>g some second-order f<strong>in</strong>e-tun<strong>in</strong>gs to the Classical framework. Whathe was really do<strong>in</strong>g was <strong>in</strong>vent<strong>in</strong>g monetary disequilibrium theory, <strong>and</strong>, as a byproductat the same time, modern macroeconomics.Early <strong>in</strong> his essay, Mill states its purpose as a k<strong>in</strong>d <strong>of</strong> mopp<strong>in</strong>g-up exercise, “<strong>of</strong>see<strong>in</strong>g that no scattered particles <strong>of</strong> important truth are buried <strong>and</strong> lost <strong>in</strong> the ru<strong>in</strong>s<strong>of</strong> exploded error” (1983 [1844]: 26–7). Accord<strong>in</strong>gly, later <strong>in</strong> the essay, immediatelyafter expla<strong>in</strong><strong>in</strong>g how a “general delusion” can br<strong>in</strong>g about a commercialcrisis, Mill notes that <strong>in</strong> this case “it is commonly said that there is a general superabundance”(p. 40), <strong>and</strong> that he will show the difference between a “crisis” <strong>and</strong>general overproduction. After a st<strong>and</strong>ard restatement <strong>of</strong> Say’s Law (“whoever<strong>of</strong>fers a commodity for sale, desires to obta<strong>in</strong> a commodity <strong>in</strong> exchange for it, <strong>and</strong> istherefore a buyer by the mere fact <strong>of</strong> his be<strong>in</strong>g a seller” (p. 41)), Mill makes themomentous concession that earlier Classical writers had sought to avoid:This argument is evidently founded on the supposition <strong>of</strong> a state <strong>of</strong> barter; <strong>and</strong>,on that supposition, it is perfectly <strong>in</strong>contestable. When two persons perform anact <strong>of</strong> barter, each . . . cannot sell without buy<strong>in</strong>g. . . . If, however, we supposethat money is used, these propositions cease to be exactly true. It must be admittedthat no person desires money for its own sake, (unless some very rare cases <strong>of</strong>misers be an exception,) <strong>and</strong> that he who sells his commodity, receiv<strong>in</strong>g money<strong>in</strong> exchange, does so with the <strong>in</strong>tention <strong>of</strong> buy<strong>in</strong>g with that same money someother commodity. Interchange by means <strong>of</strong> money is therefore, as has been<strong>of</strong>ten observed, ultimately noth<strong>in</strong>g but barter. But there is this difference – that <strong>in</strong> thecase <strong>of</strong> barter, the sell<strong>in</strong>g <strong>and</strong> the buy<strong>in</strong>g are simultaneously confounded <strong>in</strong> one operation; yousell what you have, <strong>and</strong> buy what you want, by one <strong>in</strong>divisible act, <strong>and</strong> youcannot do the one without do<strong>in</strong>g the other. Now the effect <strong>of</strong> the employment <strong>of</strong>money, <strong>and</strong> even the utility <strong>of</strong> it, is, that it enables this one act <strong>of</strong> <strong>in</strong>terchange to bedivided <strong>in</strong>to two separate acts or operations; one <strong>of</strong> which may be performednow, <strong>and</strong> the other a year hence, or whenever it shall be most convenient.Although he who sells, really sells only to buy, he needs not buy at the samemoment when he sells; <strong>and</strong> he does not therefore necessarily add to the immediatedem<strong>and</strong> for one commodity when he adds to the supply <strong>of</strong> another. The buy<strong>in</strong>g<strong>and</strong> sell<strong>in</strong>g be<strong>in</strong>g now separated, it may very well occur, that there may be, atsome given time, a very general <strong>in</strong>cl<strong>in</strong>ation to sell with as little delay as possible,accompanied with an equally general <strong>in</strong>cl<strong>in</strong>ation to defer all purchases as longas possible.(1983 [1844]: 41–2, italics added)Therefore, he concludes,In order to render the argument for the impossibility <strong>of</strong> an excess <strong>of</strong> allcommodities applicable to the case <strong>in</strong> which a circulat<strong>in</strong>g medium is employed,


134 Michael R. Montgomerymoney must itself be considered as a commodity. It must, undoubtedly, beadmitted that there cannot be an excess <strong>of</strong> all other commodities, <strong>and</strong> an excess<strong>of</strong> money at the same time.(1983 [1844]: 43)However, such a state <strong>of</strong> affairs should not be confused with a state <strong>of</strong> “generalsuperabundance” – mean<strong>in</strong>g overproduction <strong>of</strong> goods <strong>in</strong> a strictly real sense, not<strong>in</strong>volv<strong>in</strong>g a role for money. What is actually go<strong>in</strong>g on at these times is that:persons <strong>in</strong> general, at that particular time, from a general expectation <strong>of</strong> be<strong>in</strong>gcalled upon to meet sudden dem<strong>and</strong>s, liked better to possess money than anyother commodity. <strong>Money</strong>, consequently, was <strong>in</strong> request, <strong>and</strong> all other commoditieswere <strong>in</strong> comparative disrepute. In extreme cases, money is collected <strong>in</strong>masses, <strong>and</strong> hoarded; <strong>in</strong> the milder cases, people merely defer part<strong>in</strong>g with theirmoney, or com<strong>in</strong>g under any new engagements to part with it. But the result is,that all commodities fall <strong>in</strong> price, or become unsaleable.(1983 [1844]: 43)So Say’s Law must be qualified. Once money is recognized as a store <strong>of</strong> value aswell as a medium <strong>of</strong> exchange, it is possible for the dem<strong>and</strong> for goods-<strong>in</strong>-general tobe less than (or, though Mill does not consider it, greater than) that which isrequired for full employment. There can be an excess supply <strong>of</strong> goods-<strong>in</strong>-general,the mirror-image <strong>of</strong> which is an excess dem<strong>and</strong> for money. It is true, Mill states, that“this state can only be temporary . . . s<strong>in</strong>ce those who have sold without buy<strong>in</strong>gwill certa<strong>in</strong>ly buy at last” (1983 [1844]: 42). But he does not state – <strong>in</strong>deed, onemight say that he is careful not to state – how long a calendar period “temporary” islikely to be.Earlier <strong>in</strong> this paper, it was asserted that the Classical economists easily could beread as reject<strong>in</strong>g each <strong>of</strong> the three propositions <strong>of</strong>ten claimed to def<strong>in</strong>e Classicalmacroeconomic thought by lead<strong>in</strong>g macro-theorists like Stiglitz, Mankiw, <strong>and</strong>others – the neutrality <strong>of</strong> money, Say’s Law, <strong>and</strong> wage/price flexibility. Let us nowsee how we st<strong>and</strong> with respect to this claim. (1) It is clear that the last great Classicaleconomist, J.S. Mill, saw clearly how money could be pr<strong>of</strong>oundly non-neutral dueto its function as a store <strong>of</strong> value dur<strong>in</strong>g times <strong>of</strong> “crisis” (though only <strong>in</strong> a transitionalphase <strong>of</strong> <strong>in</strong>determ<strong>in</strong>ate – not necessarily trivial – duration). And, (2) due to money’snon-neutral role, Say’s Law as understood by all Classical economists before Mill is<strong>in</strong>correct unless money itself is considered a commodity – open<strong>in</strong>g up the possibility<strong>of</strong> a lack <strong>of</strong> dem<strong>and</strong> for goods-<strong>in</strong>-general for considerable, though not <strong>in</strong>def<strong>in</strong>ite,periods. F<strong>in</strong>ally, as already argued above, (3) wage-price flexibility as the heart <strong>of</strong>Classical doctr<strong>in</strong>e is, arguably, a projection <strong>of</strong> modern beliefs onto the Classicalviewpo<strong>in</strong>t <strong>and</strong> is, at the very least, an exaggeration <strong>of</strong> that viewpo<strong>in</strong>t. And, wemight add, (3A): The notion that the Classicals thought economic downturnswould be necessarily short, also, does not survive close <strong>in</strong>spection.<strong>Yeager</strong> (1997b) has po<strong>in</strong>ted out that the so-called “New Keynesians” are notKeynesian at all if words mean anyth<strong>in</strong>g. It appears the same is true <strong>of</strong> the other


The genesis <strong>of</strong> an idea 135half <strong>of</strong> modern macro-theory. “New Classical” economics (<strong>in</strong>clud<strong>in</strong>g Real Bus<strong>in</strong>essCycle theory) is not very “Classical” either – at least not <strong>in</strong> the sense that Classicaleconomists would have understood the term.The regrettable projection <strong>of</strong> Keynesian ideas ontoClassical traditionUpon reflection, it makes sense that this would be so. It is hardly surpris<strong>in</strong>g, forexample, to f<strong>in</strong>d that the Classicals differ fundamentally with those com<strong>in</strong>g afterKeynes on the question <strong>of</strong> the proper emphasis to be placed on wage/price flexibilityas the guarantor <strong>of</strong> full employment. Those com<strong>in</strong>g after Keynes started withthe proposition that Aggregate Dem<strong>and</strong> would, <strong>in</strong> general, be <strong>in</strong>sufficient to securefull employment. To them, <strong>in</strong> the absence <strong>of</strong> activist government stimulus, theentire, massive burden <strong>of</strong> return<strong>in</strong>g the economy to full employment would fall uponthe wage/price/<strong>in</strong>terest-rate adjustment mechanism. In the absence <strong>of</strong> governmentaid on the dem<strong>and</strong> side, it was up to wage/price/<strong>in</strong>terest-rate flexibility tocreate the additional dem<strong>and</strong> that would be needed for full employment. TheClassicals, by contrast, started with the idea that there was, by def<strong>in</strong>ition, alwaysenough dem<strong>and</strong> already created to assure full employment. Wage/price/<strong>in</strong>terestrateflexibility did not need to create new dem<strong>and</strong>, it only needed to allocate production<strong>in</strong>to channels that would call forth <strong>in</strong>to activity the dem<strong>and</strong> that wasalready there.The difference <strong>in</strong> perspective is far more than just semantics. The problem asconceived by Keynes <strong>and</strong> his followers is a massive one, while the difficultyperceived by the Classicals is much smaller. The problem <strong>of</strong> creat<strong>in</strong>g new dem<strong>and</strong>dem<strong>and</strong>ed, quite naturally, all the complexities <strong>and</strong> subtleties <strong>of</strong> the macroeconomictheories emphasized by Keynes <strong>and</strong> his followers. The problem <strong>of</strong> allocat<strong>in</strong>g exist<strong>in</strong>gdem<strong>and</strong>, by contrast, was much simpler. It was far more easily conceived as be<strong>in</strong>gsolvable by merely a wave <strong>of</strong> the Invisible H<strong>and</strong>.Mill made the Classical argument more complex, but weaker, by broaden<strong>in</strong>g theframework to <strong>in</strong>clude rout<strong>in</strong>ely storable money. Now the necessity-<strong>of</strong>-sufficientdem<strong>and</strong>idea held good as a “long run,” not an immediate, proposition, where the“long run” was the unspecified period <strong>of</strong> time required for the excess dem<strong>and</strong> formoney to end (<strong>in</strong> his Unsettled Questions framework, this was the time required forthose spooked by the commercial crisis who have postponed buy<strong>in</strong>g for now butwho “must buy at last,” to re-enter the dem<strong>and</strong> side <strong>of</strong> the market). But even thepost-Mill Classical framework took the return <strong>of</strong> dem<strong>and</strong> as automatic, so that thesolution to the short-term crisis was not to create new dem<strong>and</strong>, but merely to allowthe pent-up dem<strong>and</strong> stored <strong>in</strong> money to return to the markets.The <strong>in</strong>vention <strong>of</strong> monetary disequilibrium theory <strong>and</strong>modern macroeconomicsMill’s discovery <strong>in</strong> the Unsettled Questions <strong>of</strong> a way <strong>in</strong> which dem<strong>and</strong> for goods-<strong>in</strong>generalcould for a time be deficient due to the unique role played by money <strong>in</strong> the


136 Michael R. Montgomeryeconomy marks the beg<strong>in</strong>n<strong>in</strong>gs <strong>of</strong> a transition from the Classical to the modern“macro-view.” It is, <strong>in</strong> a sense, the start <strong>of</strong> ma<strong>in</strong>stream macroeconomic theory. Millshowed how dem<strong>and</strong> for goods-<strong>in</strong>-general could be <strong>in</strong>adequate to guarantee fullemployment, without a decl<strong>in</strong>e <strong>in</strong> the money supply, <strong>and</strong> <strong>in</strong>dependently <strong>of</strong> thequestion <strong>of</strong> whether or not there is <strong>in</strong> place the correct “proportionality” <strong>in</strong>production. He did this while still ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g that overproduction <strong>in</strong> the longterm,Malthusian sense was impossible. 15 In other words, he identified the keyaspect <strong>of</strong> modern bus<strong>in</strong>ess cycle theory: that deviations from full employment areself-correct<strong>in</strong>g but occur for reasons that, s<strong>in</strong>ce they occur <strong>in</strong> truly economy-widefashion, are not essentially microeconomic <strong>in</strong> nature.This was a new idea. To the extent that the earlier Classicals had a theory <strong>of</strong>aggregate economic difficulties, it <strong>in</strong>volved circumstances where problems <strong>in</strong> <strong>in</strong>dividualcommodity markets were large enough to exert a significant aggregateeffect, as <strong>in</strong> Ricardo’s “sudden changes <strong>in</strong> the channels <strong>of</strong> trade” argument (seeabove). The notion that someth<strong>in</strong>g might occur that would push more or lessuniformly downward on goods-<strong>in</strong>-general is, to be sure, not entirely miss<strong>in</strong>g fromearlier Classical thought, 16 but it is safe to say that it plays little role <strong>in</strong> Classicalth<strong>in</strong>k<strong>in</strong>g (with the exception <strong>of</strong> Hume <strong>in</strong> the specific context <strong>of</strong> a change <strong>in</strong> themoney supply). Aggregate economic issues, to the pre-Mill Classicals, were just theaggregate outcome <strong>of</strong> the issues <strong>of</strong> all the <strong>in</strong>dividual <strong>in</strong>dustries, a problem <strong>of</strong> microeconomicswrit large. There were no “exclusively macro problems” that needed tobe tackled <strong>in</strong> a manner separate from microeconomics. 17 In the Unsettled Questions,Mill showed otherwise: Monetary disequilibrium, whether orig<strong>in</strong>at<strong>in</strong>g from thedem<strong>and</strong> side or the supply side <strong>of</strong> the “money market,” could generate aggregateeconomic disturbances that were superimposed onto the microeconomic structure<strong>of</strong> the economy.Mill’s framework was broader than that presented by Hume, whose analysispredicted problems only <strong>in</strong> the event <strong>of</strong> a change <strong>in</strong> money supply. Moreover, Millwas able to explicitly <strong>in</strong>tegrate his idea <strong>in</strong>to the guid<strong>in</strong>g macroeconomic pr<strong>in</strong>ciple<strong>of</strong> his day: Say’s Law. F<strong>in</strong>ally, Mill’s macro-framework implied that the sole cause<strong>of</strong> aggregate economic problems on the dem<strong>and</strong> side was money – either its supply orits dem<strong>and</strong>. Thus, Mill is also found<strong>in</strong>g Monetarist bus<strong>in</strong>ess-cycle theory at thismoment. This, then, is arguably one <strong>of</strong> the most fundamental contributions <strong>in</strong> all <strong>of</strong>macroeconomic theory.What makes it all the more remarkable is that Mill chose to carry over virtuallynone <strong>of</strong> these <strong>in</strong>sights <strong>in</strong>to his far-more-<strong>in</strong>fluential Pr<strong>in</strong>ciples <strong>of</strong> Political Economy, whichhe published <strong>in</strong> 1848, four years after the publication <strong>of</strong> the Unsettled Questions. In“Of Excess <strong>of</strong> Supply” <strong>in</strong> the Pr<strong>in</strong>ciples, after referr<strong>in</strong>g to a prior discussion <strong>of</strong>commercial crises, he simply announces perfunctorily that “[a]t such times there isreally an excess <strong>of</strong> all commodities above the money dem<strong>and</strong>: <strong>in</strong> other words, thereis an under-supply <strong>of</strong> money” (1965 [1848]: 574). In the crisis, due to “the suddenannihilation <strong>of</strong> a great mass <strong>of</strong> credit . . . [a]lmost everybody therefore is a seller, <strong>and</strong>there are scarcely any buyers” (ibid.). The analysis l<strong>in</strong>k<strong>in</strong>g money’s role as a store<strong>of</strong>-valueto the need to amend the <strong>in</strong>terpretation <strong>of</strong> Say’s Law is omitted from thediscussion. Also notably absent is the careful explanation he had made <strong>in</strong> the


The genesis <strong>of</strong> an idea 137Unsettled Questions <strong>of</strong> how money allows sell<strong>in</strong>g now to become buy<strong>in</strong>g later <strong>and</strong> socauses the barter-economy <strong>in</strong>terpretation <strong>of</strong> Say’s Law to cease to be “exactly true”(1983 [1844]: 41). In the Unsettled Questions the consequences <strong>of</strong> “an under-supply <strong>of</strong>money” are clearly broader than those perta<strong>in</strong><strong>in</strong>g merely to a “commercial crisis,”while <strong>in</strong> the Pr<strong>in</strong>ciples Mill seems at pa<strong>in</strong>s to closely limit the dangerous idea [?] <strong>of</strong> anexcess dem<strong>and</strong> for money to the commercial crisis episode only. It is thereforeironic that the actual term, “under-supply <strong>of</strong> money,” appears nowhere <strong>in</strong> theUnsettled Questions essay where the concept is so richly <strong>and</strong> fully treated, but is<strong>in</strong>troduced <strong>in</strong>stead <strong>in</strong> the Pr<strong>in</strong>ciples where the idea’s full power seems carefullysuppressed. 18Conclusion: aggregate economic theory on a new pathIn sum, Mill’s identification <strong>of</strong> how an excess dem<strong>and</strong> for money can occur, <strong>and</strong>how it m<strong>and</strong>ates a s<strong>of</strong>ten<strong>in</strong>g <strong>of</strong> Say’s Law, is the beg<strong>in</strong>n<strong>in</strong>g <strong>of</strong> macroeconomics <strong>in</strong>the modern sense. Of equal significance, however, is that Mill’s identification wasalso the beg<strong>in</strong>n<strong>in</strong>g <strong>of</strong> monetary disequilibrium theory (along with Hume’s essay Of<strong>Money</strong>). And like all good theories, his raised additional questions. How general wasthe monetary disequilibrium phenomenon (was it only the feature <strong>of</strong> a “commercialcrisis,” or someth<strong>in</strong>g more fundamental)? Through what mechanism(s) could/didan excess dem<strong>and</strong> for money generate real effects? What was the magnitude, <strong>and</strong>duration, <strong>of</strong> such effects on the macroeconomy? Such questions would, <strong>in</strong> the ma<strong>in</strong>,be left to future economists like Irv<strong>in</strong>g Fisher, Ralph Hawtrey, Harry GunnisonBrown, Clark Warburton, Milton Friedman, <strong>and</strong> Lel<strong>and</strong> <strong>Yeager</strong>.Notes1 Thus I exclude Malthus, Sismondi, <strong>and</strong> similar skeptics <strong>of</strong> Say’s Law.2 Skidelsky is the author <strong>of</strong> a three-volume biography <strong>of</strong> Keynes. In an <strong>in</strong>terview, Snowdenet al. asked Skidelsky whether Keynes gave the Classical economists “a raw deal.” Hereplied “Yes. He set up an Aunt Sally. No classical economist ever believed <strong>in</strong> the th<strong>in</strong>gsKeynes claimed that classical economics stood for . . . .” However, it is a qualified rebuke,s<strong>in</strong>ce Skidelsky goes on to say that Keynes was identify<strong>in</strong>g “the th<strong>in</strong>gs they would need tobelieve to make sense <strong>of</strong> what they were say<strong>in</strong>g” (Skidelsky 1994: 84). The “they” <strong>in</strong>this quote refers to people like Pigou, but it may plausibly be applied to the Classicalsas well.3 On pages 17–18, Abel <strong>and</strong> Bernanke make it clear that they are referr<strong>in</strong>g to trueClassical economists, not just the modern approach called “New Classical.”4 Moreover, Stiglitz actually follows Keynes so far as to carry forward Keynes’ egregiouserror <strong>of</strong> us<strong>in</strong>g the term “Classical” to mean “the dom<strong>in</strong>ant group <strong>of</strong> economists beforethe Great Depression” (ibid.). The notion that early twentieth-century macroeconomistsblithely presumed wage <strong>and</strong> price flexibility is very decisively rejected by history (see<strong>Yeager</strong> 1973, 1993, 1997b; see also Warburton 1951).5 Often such portrayals <strong>of</strong> Classical theory are followed immediately by a triumphantpresentation <strong>of</strong> the “commonsense, middle-<strong>of</strong>-the-road” Keynesian position. Forexample, unlike those silly Classicals, “Keynesians usually agree that prices <strong>and</strong> wageseventually change as needed to clear markets; however, they believe that <strong>in</strong> the short runprice <strong>and</strong> wage adjustment is likely to be <strong>in</strong>complete” (Abel <strong>and</strong> Bernanke 2005: 355).


138 Michael R. MontgomeryPresented on the heels <strong>of</strong> the Classical caricature, the “Keynesians” look pretty good bycomparison. Lel<strong>and</strong> <strong>Yeager</strong> (1997b) has po<strong>in</strong>ted out that such “Keynesianism” is noth<strong>in</strong>g<strong>of</strong> the sort: Wage/price stick<strong>in</strong>ess is also a key part <strong>of</strong> pre-Keynesian macro-theory, <strong>and</strong>a core work<strong>in</strong>g assumption <strong>of</strong> Monetarist thought. The only people who have disagreedwith this so-called “Keynesian” position are the modern “New Classical” school(<strong>in</strong>clud<strong>in</strong>g “Real Bus<strong>in</strong>ess Cycle” advocates). “New Classicals” claim to be new-<strong>and</strong>improvedversions <strong>of</strong> Classical thought. Accord<strong>in</strong>gly, it is convenient for exposition if the“old” versions <strong>of</strong> those labels are packaged to match closely with the “new” ones.Certa<strong>in</strong>ly “New Classical Economics” (particularly its Real-Bus<strong>in</strong>ess-Cycle w<strong>in</strong>g)aggressively asserts a simplistic belief <strong>in</strong> perfect price/wage flexibility, the neutrality <strong>of</strong>money, <strong>and</strong> (by implication) Say’s Law. The real Classicals were more sophisticated thantheir self-appo<strong>in</strong>ted successors (see discussion below).6 The closest Mill comes is late <strong>in</strong> the essay when he writes:Noth<strong>in</strong>g can be more chimerical than the fear that the accumulation <strong>of</strong> capital shouldproduce poverty <strong>and</strong> not wealth, or that it will ever take place too fast for its own end.Noth<strong>in</strong>g is more true than that it is produce which constitutes the market for produce,<strong>and</strong> that every <strong>in</strong>crease <strong>of</strong> production, if distributed without miscalculation among all k<strong>in</strong>ds <strong>of</strong> produce<strong>in</strong> the proportion which private <strong>in</strong>terest would dictate, creates, or rather constitutes, its own dem<strong>and</strong>.(1983 [1844]: 44, emphasis added)Here one is tempted to presume that such a distribution is created by the “<strong>in</strong>visibleh<strong>and</strong>” through wage-, price-, <strong>and</strong> <strong>in</strong>terest-rate flexibility. Mill himself, however – whoeasily could have emphasized such mechanisms at this juncture – chooses to let thematter <strong>of</strong> the adjustment process rest. More to the po<strong>in</strong>t: To say that “production .. .creates, or rather constitutes . .. its own dem<strong>and</strong>” “if distributed without miscalculation” is not tosay that such miscalculation will not occur. Nor is it to say how long-last<strong>in</strong>g the result<strong>in</strong>gdeleterious consequences are likely to be if there is “miscalculation,” or that it is wage/price flexibility that will cure the problem. Mill emphasizes “the return <strong>of</strong> confidence,”not flexible wages <strong>and</strong> prices, as the key event that will end the economy’s difficulties. Itshould also be noted that when Mill uses the word “creates” <strong>in</strong> the context <strong>of</strong> dem<strong>and</strong> heimmediately corrects himself <strong>and</strong> substitutes the more apt word “constitutes” (Mill 1983[1844]: 42, 45, emphasis added). Mill’s most well-known passage on the subject is <strong>in</strong> the“Of Excess <strong>of</strong> Supply” chapter <strong>of</strong> the Pr<strong>in</strong>ciples <strong>of</strong> Political Economy, where he contemplatesan assumed doubl<strong>in</strong>g <strong>of</strong> a country’s productive powers. There Mill states that, shouldthis doubl<strong>in</strong>g lead to a “superfluity <strong>of</strong> certa<strong>in</strong> th<strong>in</strong>gs,” then “[i]f so, the supply will adoptitself accord<strong>in</strong>gly, <strong>and</strong> the values <strong>of</strong> th<strong>in</strong>gs will cont<strong>in</strong>ue to accord to their costs <strong>of</strong>production” (Mill 1965 [1848]: 558). Exactly how this will occur – <strong>and</strong> how long theprocess will take – is left unaddressed.7 Thus:Hav<strong>in</strong>g once arrived at the clear conviction, that the general dem<strong>and</strong> for products isbrisk <strong>in</strong> proportion to the activity <strong>of</strong> production, we need not trouble ourselves muchto <strong>in</strong>quire towards what channel <strong>of</strong> <strong>in</strong>dustry production may be most advantageouslydirected. The products created give rise to various degrees <strong>of</strong> dem<strong>and</strong>, accord<strong>in</strong>g tothe wants, the manners, the comparative capital, <strong>in</strong>dustry, <strong>and</strong> natural resources <strong>of</strong>each country; the article most <strong>in</strong> request, ow<strong>in</strong>g to the competition <strong>of</strong> buyers, yieldsthe best <strong>in</strong>terest <strong>of</strong> money to the capitalist, the largest pr<strong>of</strong>its to the adventurer, <strong>and</strong>the best wages to the labourer; <strong>and</strong> the agency <strong>of</strong> their respective services is naturallyattracted by the advantages towards those particular channels.(Say 1983 [1803]: 21)To Say, the core issue is the demonstration that [Aggregate] Dem<strong>and</strong> cannot be<strong>in</strong>adequate – hav<strong>in</strong>g once established that po<strong>in</strong>t, price <strong>and</strong> wage flexibility determ<strong>in</strong>e that thedesired types <strong>of</strong> goods will be produced <strong>and</strong> <strong>in</strong> the right quantities. The Adequacy-<strong>of</strong>-Dem<strong>and</strong> proposition is established prior to, <strong>and</strong> not because <strong>of</strong>, wage <strong>and</strong> price flexibility.


The genesis <strong>of</strong> an idea 1398 “M. Say has, however, most satisfactorily shown that there is no amount <strong>of</strong> capital thatmay not be employed <strong>in</strong> a country, because a dem<strong>and</strong> is only limited by production”(Ricardo 1951 [1817]: 290). In a footnote, Ricardo has a backh<strong>and</strong>ed reference tomarket forces, though not specifically to price- or wage-flexibility. He criticizes AdamSmith for seem<strong>in</strong>g to imply that Engl<strong>and</strong>’s capital might rema<strong>in</strong> unemployed <strong>in</strong> theabsence <strong>of</strong> a foreign market for British products. Ricardo argues that the capital will f<strong>in</strong>duse domestically, <strong>and</strong>, with<strong>in</strong> this specific context, argues thatIt is, however, always a matter <strong>of</strong> choice <strong>in</strong> what way a capital will be employed, <strong>and</strong>therefore there can never for any length <strong>of</strong> time be a surplus <strong>of</strong> any commodity; for ifthere were, it would fall below its natural price, <strong>and</strong> capital would be removed tosome more pr<strong>of</strong>itable employment. No writer has more ably <strong>and</strong> satisfactorily shownthan Dr. Smith the tendency <strong>of</strong> capital to move from employments <strong>in</strong> which thegoods produced do not repay by their price the whole expenses, <strong>in</strong>clud<strong>in</strong>g theord<strong>in</strong>ary pr<strong>of</strong>its, <strong>of</strong> produc<strong>in</strong>g <strong>and</strong> br<strong>in</strong>g<strong>in</strong>g them to market.(Ricardo 1951 [1817]: n. 3, 193–4)As is <strong>of</strong>ten the case for Ricardo, the question <strong>of</strong> the speed <strong>of</strong> the implied adjustment isdeftly f<strong>in</strong>essed (what is “any length <strong>of</strong> time”? how fast-act<strong>in</strong>g is “a tendency”?). Back <strong>in</strong>the text, as part <strong>of</strong> his argument that dem<strong>and</strong> for luxuries is <strong>in</strong>f<strong>in</strong>ite, he seeks to establishthat the supply <strong>of</strong> such goods will be readily forthcom<strong>in</strong>g: “The poor, <strong>in</strong> order to obta<strong>in</strong>food, exert themselves to gratify those fancies <strong>of</strong> the rich; <strong>and</strong> to obta<strong>in</strong> it more certa<strong>in</strong>ly,they vie with one another <strong>in</strong> the cheapness <strong>and</strong> perfection <strong>of</strong> their work .. . Hence arisesa dem<strong>and</strong> for every sort <strong>of</strong> material which human <strong>in</strong>vention can employ ... ” (Ricardo1951 [1817]: 197).These isolated passages, however, do not add up to an argument that Ricardo’sprimary macroeconomic focus was on wage <strong>and</strong> price flexibility. Like Mill <strong>and</strong> Say, thecrucial po<strong>in</strong>t to be established was that dem<strong>and</strong> was unlimited, given the means topurchase. On the other h<strong>and</strong>, when challenged by Malthus specifically on the question<strong>of</strong> wage-flexibility, Ricardo was quick to contest the assertion <strong>of</strong> wage-stick<strong>in</strong>ess. WhenMalthus claimed that “We know from repeated experience that the money price <strong>of</strong>labour never falls till many workmen have been for some time out <strong>of</strong> work” (Letter <strong>of</strong>Malthus to Ricardo, 16 July, 1821), Ricardo denied it vigorously, respond<strong>in</strong>g thatI know no such th<strong>in</strong>g, <strong>and</strong> if wages were previously high, I can see no reason whateverwhy they should not fall before many labourers are thrown out <strong>of</strong> work. All generalreason<strong>in</strong>g I apprehend is <strong>in</strong> favour <strong>of</strong> my view <strong>of</strong> this question, for why should someagree to go without any wages while others were most liberally rewarded.(Letter from Ricardo to Malthus, 21 July, 1821)The question however is not whether Ricardo <strong>and</strong>, presumably, the other Classicalsbelieved <strong>in</strong> wage/price flexibility, but rather, as discussed <strong>in</strong> the text, what was its role <strong>in</strong>their macroeconomics.9 While Ricardo emphasized transitions from war to peace <strong>in</strong> his discussion, we can easilyimag<strong>in</strong>e macroeconomic disturbances such as confusion between nom<strong>in</strong>al <strong>and</strong> realforces (Pr<strong>in</strong>ciples, 297–8) as likely causes <strong>of</strong> similar events, if we assume they lead to aconsiderable build-up <strong>of</strong> excess capital stock.10 A glance at recent graduate macro (or micro) textbooks, with their now-st<strong>and</strong>ardassumptions <strong>of</strong> (1) <strong>in</strong>f<strong>in</strong>itely-divisible (2) homogeneous capital that is (3) exclusivelyacquired <strong>in</strong> debt-free ways, suggests that the field has yet to seriously confront the thornydifficulties posed by true-to-life capital. For two useful treatments from outside the ma<strong>in</strong>stream<strong>of</strong> such difficulties, see Garrison (2001) <strong>and</strong> Davidson (2002). For a broad,<strong>in</strong>sightful survey on capital’s role <strong>in</strong> economic theory, see Lew<strong>in</strong> (1999).11 “It is observable, moreover, that precisely at the same time that one commodity makes aloss, another commodity is mak<strong>in</strong>g excessive pr<strong>of</strong>it” (Say 1983 [1803]: 16).12 “ ... as there may be a temporary excess <strong>of</strong> any one article considered separately, so may


140 Michael R. Montgomerythere <strong>of</strong> commodities generally, not <strong>in</strong> consequence <strong>of</strong> over-production, but <strong>of</strong> a want <strong>of</strong>commercial confidence” (Mill 1983 [1844]: 45, the last l<strong>in</strong>e <strong>of</strong> his essay).13 Perhaps – to <strong>in</strong>dulge for a moment <strong>in</strong> pure speculation – they also sensed other complications,such as the general equilibrium problem at the heart <strong>of</strong> the macro-adjustmentquestion, with prices <strong>of</strong> some be<strong>in</strong>g <strong>in</strong>comes <strong>of</strong> others (see <strong>Yeager</strong> 1999 for a usefuldiscussion <strong>of</strong> the advantages <strong>of</strong> the general equilibrium approach <strong>in</strong> macroeconomics).14 Another reason for these assertions is that the Classicals were engaged <strong>in</strong> a contest <strong>of</strong>ideas with the Mercantilists <strong>and</strong> their view <strong>of</strong> “bullion <strong>and</strong> treasure as the essence <strong>of</strong>wealth” (Blaug 1978: 10). However, many <strong>of</strong> these statements occurred <strong>in</strong> the midst <strong>of</strong> adiscussion <strong>of</strong> Say’s Law, not Mercantilism.15 This paper, with its emphasis on Say’s Law, has somewhat de-emphasized the pathbreak<strong>in</strong>gcontributions <strong>of</strong> David Hume. Hume perceived, as an empirical observation,that periods <strong>of</strong> money <strong>in</strong>flow corresponded to periods where “<strong>in</strong>dustry has encreased”(1970 [1752]: 37) <strong>and</strong> vice versa (p. 40), <strong>and</strong> he even reached the momentous deductionthat it is only <strong>in</strong> the <strong>in</strong>terval while prices are adjust<strong>in</strong>g that such monetary change has realeffects (ibid.: 38, 40). Moreover, Hume saw that such effects are symmetric, s<strong>in</strong>cethe alterations <strong>in</strong> the quantity <strong>of</strong> money, either on one side or the other, are notimmediately attended with proportionable alterations <strong>in</strong> the price <strong>of</strong> commodities.There is always an <strong>in</strong>terval before matters be adjusted to their new situation; <strong>and</strong> this<strong>in</strong>terval is as pernicious to <strong>in</strong>dustry, when gold <strong>and</strong> silver are dim<strong>in</strong>ish<strong>in</strong>g, as it isadvantageous when these metals are encreas<strong>in</strong>g.(1970 [1752]: 40)But Hume addressed only cases <strong>of</strong> change <strong>in</strong> money supply. Of Mill’s notion thatchanges <strong>in</strong> money dem<strong>and</strong> might occur <strong>and</strong> generate analogous effects, we see no sign <strong>in</strong>his essay. In fact, Hume’s essay aggressively denies that money is anyth<strong>in</strong>g but a medium<strong>of</strong>-exchange<strong>and</strong> a unit-<strong>of</strong>-account.16 For example, Ricardo, <strong>in</strong> his Chapter XXI <strong>in</strong> the Pr<strong>in</strong>ciples on the effects <strong>of</strong> accumulation,briefly discusses how a substantial change <strong>in</strong> the money supply can impact the rate<strong>of</strong> <strong>in</strong>terest dur<strong>in</strong>g the <strong>in</strong>terval <strong>of</strong> adjustment, <strong>and</strong> – though he does not say so – one mayargue this would have an aggregate impact (1951 [1817]: 297–8). Just prior to thesethoughts, Ricardo traces out the bare bones <strong>of</strong> a money-driven cycle based on confusion<strong>of</strong> real <strong>and</strong> nom<strong>in</strong>al effects (ibid.). But Ricardo discusses these with<strong>in</strong> the context <strong>of</strong> as<strong>in</strong>gle representative merchant, <strong>and</strong> does not go on to draw out any economy-wideimplications from these <strong>in</strong>sights. Moroever, he places no special emphasis on thesepassages – they are merely rum<strong>in</strong>ations <strong>in</strong> the midst <strong>of</strong> other loosely related rum<strong>in</strong>ations.17 In this one sense, the Real Bus<strong>in</strong>ess Cycle school is truly Classical <strong>in</strong> its orientation.Such was also Wesley Mitchell’s approach <strong>in</strong> his Bus<strong>in</strong>ess Cycles (Mitchell 1913). But,historically, these movements are exceptions to the rule started by Mill <strong>in</strong> his UnsettledQuestions essay.18 In the Unsettled Questions, Mill had expressed concerns that the phrase “excess <strong>of</strong> allcommodities” should, “perhaps,” not be used, s<strong>in</strong>ce the phrase wrongly suggests “theidea <strong>of</strong> excessive production” (1983 [1844]: 43). Of course, an “excess <strong>of</strong> all commodities”is just the “flip-side” <strong>of</strong> an “under-supply <strong>of</strong> money.” One is rem<strong>in</strong>ded <strong>of</strong> the ancientPythagoreans, who suppressed knowledge <strong>of</strong> the square root <strong>of</strong> two due to their beliefthat all numbers should be derivable from the ratios <strong>of</strong> other numbers, a trait not sharedby the square root <strong>of</strong> two (see Sagan 1980: 185). If some Pythagoreanesque desire tosuppress the full implications <strong>of</strong> his concept did lead Mill to tone down its presentation <strong>in</strong>the Pr<strong>in</strong>ciples, it is ironic. It is doubtful that Keynes (1965 [1936]: 18–21) could haveproceeded with his famously distorted <strong>in</strong>terpretation <strong>of</strong> Mill, based on the chapter “OfExcess <strong>of</strong> Supply” <strong>in</strong> the Pr<strong>in</strong>ciples, had Mill <strong>in</strong>cluded there more <strong>of</strong> his discussion <strong>in</strong> theUnsettled Questions.


ReferencesThe genesis <strong>of</strong> an idea 141Abel, Andrew <strong>and</strong> Ben S. Bernanke (2005). Macroeconomics, 5th edn. New York: Addison-Wesley.Blaug, Mark (1978). Economic Theory <strong>in</strong> Retrospect, 3rd edn. Cambridge: Cambridge UniversityPress.Davidson, Paul (2002). F<strong>in</strong>ancial <strong>Markets</strong>, <strong>Money</strong> <strong>and</strong> the Real World, Ch. 4. Cheltenham:Edward Elgar.Garrison, Roger (2001). Time <strong>and</strong> <strong>Money</strong>: The Macroeconomics <strong>of</strong> Capital Structure. London <strong>and</strong>New York: Routledge.Hazlitt, Henry (1983). The Critics <strong>of</strong> Keynesian Economics. Lanham, MD: University Press.Hume, David (1970 [1752]). Of <strong>Money</strong>. In Eugene Rotwe<strong>in</strong> (ed.) David Hume: Writ<strong>in</strong>gs onEconomics. Madison, WI: The University <strong>of</strong> Wiscons<strong>in</strong> Press.Keynes, John Maynard (1965 [1936]). The General Theory <strong>of</strong> Employment, Interest <strong>and</strong> <strong>Money</strong>.New York: Harb<strong>in</strong>ger (Harcourt, Brace).Lew<strong>in</strong>, Peter (1999). Capital <strong>in</strong> Disequilibrium: The Role <strong>of</strong> Capital <strong>in</strong> a Chang<strong>in</strong>g World. London<strong>and</strong> New York: Routledge.Malthus, Thomas (1952 [1821]). Letter <strong>of</strong> Malthus to Ricardo, 16 July, 1821. In Piero Sraffa(ed.) The Works <strong>and</strong> Correspondence <strong>of</strong> David Ricardo, Vol. IX. Cambridge: CambridgeUniversity Press for the Royal Economic Society.Mankiw, Gregory (2000). Macroeconomics, 4th edn. New York: Worth Publishers.Mill, John Stuart (1983 [1844]). On the Influence <strong>of</strong> Consumption on Production. In HenryHazlitt, The Critics <strong>of</strong> Keynesian Economics. Lanham, MD: University Press. Orig<strong>in</strong>allypublished <strong>in</strong> Mill, John Stuart (1844). <strong>Essays</strong> on Some Unsettled Questions <strong>in</strong> Political Economy.Mill, John Stuart (1965 [1848]). Pr<strong>in</strong>ciples <strong>of</strong> Political Economy with Some <strong>of</strong> Their Applications toSocial Philosophy. Toronto: University <strong>of</strong> Toronto Press.Mitchell, Wesley Clair (1913). Bus<strong>in</strong>ess Cycles. Berkeley, CA: University <strong>of</strong> California Press.Ricardo, David (1951 [1817]). Effects <strong>of</strong> Accumulation on Pr<strong>of</strong>its <strong>and</strong> Interest. Ch. XXI, <strong>in</strong>The Pr<strong>in</strong>ciples <strong>of</strong> Political Economy <strong>and</strong> Taxation. In Piero Sraffa (ed.) The Works <strong>and</strong> Correspondence<strong>of</strong> David Ricardo, Vol. I. Cambridge: Cambridge University Press for the RoyalEconomic Society.Ricardo, David (1952 [1821]). Letter <strong>of</strong> Ricardo to Thomas Malthus, 21 July, 1821. In PieroSraffa (ed.) The Works <strong>and</strong> Correspondence <strong>of</strong> David Ricardo, Vol. IX. Cambridge: CambridgeUniversity Press for the Royal Economic Society.Sagan, Carl (1980). Cosmos. New York: R<strong>and</strong>om House.Say, J.B. (1983 [1803]). Of the Dem<strong>and</strong> or Market for Products. In Henry Hazlitt, The Critics<strong>of</strong> Keynesian Economics. Lanham, MD: University Press. Orig<strong>in</strong>ally published <strong>in</strong> English <strong>in</strong>A Treatise on Political Economy, 1832. Orig<strong>in</strong>ally published <strong>in</strong> French <strong>in</strong> 1803 <strong>in</strong> Traited’Economie Politique.Skidelsky, Robert (1994). [Interview with] Robert Skidelsky. In Brian Snowdon, Howard R.Vane <strong>and</strong> Peter Wynarczyk (1994). A Modern Guide to Macroeconomics: An Introduction toCompet<strong>in</strong>g Schools <strong>of</strong> Thought. Aldershot: Edward Elgar, pp. 79–88.Smith, Adam (1937 [1776]). An Inquiry <strong>in</strong>to the Nature <strong>and</strong> Causes <strong>of</strong> the Wealth <strong>of</strong> Nations. Editedwith an <strong>in</strong>troduction <strong>and</strong> notes by Edw<strong>in</strong> Cannan. New York: Modern Library.Snowdon, Brian, Howard R.Vane <strong>and</strong> Peter Wynarczyk (1994). A Modern Guide to Macroeconomics:An Introduction to Compet<strong>in</strong>g Schools <strong>of</strong> Thought. Aldershot: Edward Elgar.Stiglitz, Joseph E. (1993). Economics. New York: W. W. Norton.Warburton, Clark (1951). The Misplaced Emphasis <strong>in</strong> Contemporary Bus<strong>in</strong>ess-FluctuationTheory. In Depression, Inflation, <strong>and</strong> Monetary Policy: Selected Papers, 1945–1953. Baltimore,


142 Michael R. MontgomeryMD: The Johns Hopk<strong>in</strong>s Press, pp. 73–102. Repr<strong>in</strong>ted with m<strong>in</strong>or revisions fromRead<strong>in</strong>gs <strong>in</strong> Monetary Theory (Philadelphia: Blakiston, 1951). Orig<strong>in</strong>ally published <strong>in</strong> Journal<strong>of</strong> Bus<strong>in</strong>ess, XIX: 4 (October 1946).<strong>Yeager</strong>, Lel<strong>and</strong> B. (1973). The Keynesian Diversion. In The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> on MonetaryDisequilibrium. Indianapolis, IN: Liberty Fund, 1997, pp. 199–216. Orig<strong>in</strong>ally published<strong>in</strong> the Western Economic Journal, 11(June 1973): 150–63.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1993). The Keynesian Heritage <strong>in</strong> Economics. In Walter Allan (ed.) ACritique <strong>of</strong> Keynesian Economics. London: St. Mart<strong>in</strong>’s Press <strong>in</strong> association with the Institutefor Economic Affairs.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1997a). The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> on Monetary Disequilibrium. Indianapolis,IN: Liberty Fund. Edited <strong>and</strong> with an Introduction by George Selg<strong>in</strong>.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1997b) New Keynesians <strong>and</strong> Old Monetarists. In The Flutter<strong>in</strong>g Veil: <strong>Essays</strong>on Monetary Disequilibrium. Indianapolis, IN: Liberty Fund, pp. 281–302.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1999). Should Austrians Scorn General-Equilibrium Theory? Review <strong>of</strong>Austrian Economics, II(1/2): 19–30.


10 The macroeconomics <strong>of</strong> money,sav<strong>in</strong>g, <strong>and</strong> <strong>in</strong>vestmentRobert L. GreenfieldTroubles adjust<strong>in</strong>g to collegeI grew up <strong>in</strong> a home that stressed sav<strong>in</strong>g as an unquestioned virtue. At 18 years old,however, hav<strong>in</strong>g gone back to college for my sophomore year, I found both mymacroeconomics pr<strong>of</strong>essor <strong>and</strong> the textbook that he had assigned say<strong>in</strong>g someth<strong>in</strong>gfar less complimentary about sav<strong>in</strong>g than my parents had said about it. Both thepr<strong>of</strong>essor <strong>and</strong> the textbook said that, if people tried to save more, production <strong>and</strong>employment would suffer (not “could suffer,” they said, but “would suffer”). Farfrom see<strong>in</strong>g sav<strong>in</strong>g as a virtue, I should now see it as a vice, public even if notprivate, the cause <strong>of</strong> economic depressions, <strong>in</strong>clud<strong>in</strong>g the Great Depression, whichmy parents themselves had lived through. My days as an undergraduate are nowmore than thirty-five years beh<strong>in</strong>d me. Yet some economists <strong>and</strong> textbooks teachthis anti-sav<strong>in</strong>g lesson still, <strong>and</strong> all the more remarkably, I must say, to judge by the1980s <strong>and</strong> 1990s lament that we Americans save too little, that we concern ourselvestoo little with the future.Depressed economic conditions, <strong>of</strong> course, do not mean that the public is actuallydo<strong>in</strong>g too much sav<strong>in</strong>g. In fact, quite the opposite is true: under depressed economicconditions, the public can’t do as much sav<strong>in</strong>g as it would otherwise like to do. In anyevent, we economists don’t want to risk giv<strong>in</strong>g even the appearance <strong>of</strong> h<strong>and</strong><strong>in</strong>g upa blanket <strong>in</strong>dictment <strong>of</strong> <strong>in</strong>tended sav<strong>in</strong>g as the cause <strong>of</strong> depressed economicconditions. After all, where would we be if people didn’t save <strong>and</strong> the world had nocapital whatsoever?The follow<strong>in</strong>g classroom story aims at show<strong>in</strong>g what, years ago, Lel<strong>and</strong> <strong>Yeager</strong>helped me underst<strong>and</strong>, namely, that what causes economic depressions isn’t thepublic’s want<strong>in</strong>g to save, but rather a money supply too small to permit the public’sthrifty <strong>in</strong>tentions to bear fruit as real capital. More than anyth<strong>in</strong>g else, <strong>Yeager</strong>’sfame as a teacher emboldens me, here <strong>in</strong> a volume honor<strong>in</strong>g his long <strong>and</strong> dist<strong>in</strong>guishedcareer <strong>in</strong> academe, to present my simple, classroom story. The story<strong>in</strong>cludes a section on <strong>in</strong>direct convertibility, which <strong>Yeager</strong> gives serious considerationas a means <strong>of</strong> keep<strong>in</strong>g the quantity <strong>of</strong> money adjusted, automatically, to thedem<strong>and</strong> for money hold<strong>in</strong>gs. After f<strong>in</strong>ish<strong>in</strong>g the section on <strong>in</strong>direct convertibility, Irem<strong>in</strong>isce just a bit about Mr. <strong>Yeager</strong>.


144 Robert L. GreenfieldA one-classroom economyMy story beg<strong>in</strong>s. Here <strong>in</strong> our one-classroom economy, we five people work hard.We produce chairs – one chair each, let’s say, per month, or 12 chairs per year.Each <strong>of</strong> the five <strong>of</strong> us, then, has a 12-chair real <strong>in</strong>come flow per year. If we cared todo so, we could devote our entire 60 chair per year real <strong>in</strong>come to current consumption;we could use the chairs <strong>in</strong> our d<strong>in</strong><strong>in</strong>g rooms, on our patios, or wherever.If used now, each chair will last a year <strong>and</strong> then disappear.It’s always somebody else’s chair, <strong>of</strong> course, that appeals to us, <strong>and</strong> gett<strong>in</strong>g itrequires trade. Conduct<strong>in</strong>g trade on the basis <strong>of</strong> barter, <strong>of</strong> course, would be<strong>in</strong>convenient for everyone. Luckily, however, each one <strong>of</strong> us has a check<strong>in</strong>g accountwith the one-room economy’s only bank. I can sell a chair to one person, have thebank add the proceeds to my account, <strong>and</strong> then, by writ<strong>in</strong>g a check myself, buy a chairfrom someone else. We use no money other than the check<strong>in</strong>g accounts issued by this– our one <strong>and</strong> only – bank. (The bank would issue fold<strong>in</strong>g money, too, but becausenobody prefers it to check<strong>in</strong>g account money, has no call to do so.)Now, who knows when I’ll come across the chair <strong>of</strong> my dreams? It may happenwhen I have no chair to sell or when I just can’t f<strong>in</strong>d anyone who wants to buy mychair. To make sure that I don’t f<strong>in</strong>d myself <strong>in</strong> such a circumstance, to make sure thatI can buy a chair on even a moment’s notice, I f<strong>in</strong>d it convenient to hold a check<strong>in</strong>gaccount balance that is roughly the equivalent <strong>of</strong> two months’ <strong>in</strong>come (i.e., twochairs), as does everyone else. All <strong>of</strong> my receipts <strong>and</strong> expenditures flow through mycheck<strong>in</strong>g account balance, receipts enlarg<strong>in</strong>g that balance <strong>and</strong> expenditures reduc<strong>in</strong>git. When I deposit someone else’s check, my balance grows <strong>and</strong> that other person’sbalance falls; <strong>and</strong> when someone else deposits a check <strong>of</strong> m<strong>in</strong>e, my balance falls <strong>and</strong>that other person’s balance rises. In neither case does the sum <strong>of</strong> the two balanceschange.Say, then, that there exist 1,000 <strong>of</strong> these check<strong>in</strong>g account dollars, total. Mak<strong>in</strong>gthe 1,000-unit stock <strong>of</strong> money the equivalent <strong>of</strong> two months’ flow <strong>of</strong> <strong>in</strong>come requiresthat the annual flow <strong>of</strong> <strong>in</strong>come be $6,000. Each <strong>of</strong> the 60 chairs that we produceannually must therefore have a $100 price tag.The dem<strong>and</strong> for money <strong>and</strong> the supply <strong>of</strong> capitalNow our population doubles, from five people to ten. Like each <strong>of</strong> us old timers,each <strong>of</strong> the five newcomers can produce one chair per month, 12 per year, <strong>and</strong>,aga<strong>in</strong> like each <strong>of</strong> us old timers, each newcomer wants to hold a $200 check<strong>in</strong>gaccountbalance, the equivalent <strong>of</strong> two months’ <strong>in</strong>come. With the newcomers’arrival, then, potential total real <strong>in</strong>come jumps from 60 chairs per year to 120chairs per year, <strong>and</strong> the aggregate dem<strong>and</strong> for money balances grows from $1,000to $2,000.To accumulate a $200 check<strong>in</strong>g account balance, each <strong>of</strong> the five newcomers iswill<strong>in</strong>g to make a one-time sacrifice <strong>of</strong> two months’ <strong>in</strong>come. The newcomers as agroup, <strong>in</strong> other words, are will<strong>in</strong>g just to hold the money that sell<strong>in</strong>g ten <strong>of</strong> their firstyear’s 60 chairs br<strong>in</strong>gs <strong>in</strong>, <strong>in</strong>stead <strong>of</strong> us<strong>in</strong>g that money to buy chairs for themselves.


The macroeconomics <strong>of</strong> money, sav<strong>in</strong>g, <strong>and</strong> <strong>in</strong>vestment 145The newcomers’ dem<strong>and</strong> for money hold<strong>in</strong>gs, then, is actually a supply <strong>of</strong> real capital. Byhold<strong>in</strong>g money, they rel<strong>in</strong>quish the chairs that they could have bought with thatmoney. Thanks to the newcomers’ thrift<strong>in</strong>ess, those chairs sit poised, ready to becomepart <strong>of</strong> the economy’s capital stock.Now, at the very moment that our population doubles, you come up with ascheme for transform<strong>in</strong>g an ord<strong>in</strong>ary chair <strong>in</strong>to someth<strong>in</strong>g better, a chair that willlast two years. To transform ord<strong>in</strong>ary chairs <strong>in</strong>to new, improved chairs, however,you need ord<strong>in</strong>ary chairs to work with – you need capital. Not want<strong>in</strong>g to devoteyour own chairs to the project or to borrow chairs from someone else directly, yougo to the bank. You ask for a $1,000 loan. The bank consents <strong>and</strong> credits yourcheck<strong>in</strong>g account $1,000. With the newly created money, you buy ten chairs, plugg<strong>in</strong>gthe hole <strong>in</strong> the spend<strong>in</strong>g stream that the five newcomers create by dem<strong>and</strong><strong>in</strong>gcheck<strong>in</strong>g account balances <strong>of</strong> their own. By dem<strong>and</strong><strong>in</strong>g money hold<strong>in</strong>gs <strong>of</strong> theirown, then, the newcomers are actually committ<strong>in</strong>g ten chairs to the bank’s care,<strong>and</strong> the bank, by creat<strong>in</strong>g new money on loan, transfers the ten chairs to you. Your<strong>in</strong>tended <strong>in</strong>vestment <strong>in</strong> chairs equals the newcomers’ <strong>in</strong>tended sav<strong>in</strong>g <strong>of</strong> chairs, or,what is the same th<strong>in</strong>g, the total quantity <strong>of</strong> check<strong>in</strong>g account money just satisfiesthe now enlarged community’s total dem<strong>and</strong> for hold<strong>in</strong>gs <strong>of</strong> check<strong>in</strong>g accountmoney.Forced sav<strong>in</strong>gThere is noth<strong>in</strong>g to guarantee, however, that the plans <strong>of</strong> chair <strong>in</strong>vestors <strong>and</strong> theplans <strong>of</strong> chair savers will mesh as nicely as they did <strong>in</strong> this case. After all, the bankerdoesn’t know what portion <strong>of</strong> their first year’s production the newcomers arewill<strong>in</strong>g to give up as a means <strong>of</strong> acquir<strong>in</strong>g check<strong>in</strong>g account balances <strong>of</strong> their own.How could the banker know anyth<strong>in</strong>g about the dem<strong>and</strong> for hold<strong>in</strong>gs <strong>of</strong> check<strong>in</strong>gaccount money? How could the banker know how many checks people plan towrite or <strong>in</strong> what amounts they plan to write them? On a face-to-face basis, thebanker deals with you, the borrower, but never actually speaks with the people whow<strong>in</strong>d up hold<strong>in</strong>g the newly created money.Nor would the banker have any reason to speak with them; their not want<strong>in</strong>g tohold new money can’t block the bank’s creat<strong>in</strong>g it on loan for people who areseek<strong>in</strong>g chair capital. Hop<strong>in</strong>g to work on 20 chairs, for example, you might ask for<strong>and</strong> actually get a $2,000 loan. Now, the community doesn’t want to add $2,000 toits money hold<strong>in</strong>gs: the new total quantity <strong>of</strong> money, $3,000, is the equivalent <strong>of</strong>three months’ <strong>in</strong>come [($3,000/$12,000) × 12 months], not two months’ <strong>in</strong>come.We have no choice, however, other than to accept the new money when it comesour way; refus<strong>in</strong>g the money would mean refus<strong>in</strong>g to make ord<strong>in</strong>ary sales. We’llgladly accept the new money, plann<strong>in</strong>g to spend it away ourselves. Next day, whenwe go to the store, however, look<strong>in</strong>g for chairs to buy, what will we f<strong>in</strong>d? We’ll f<strong>in</strong>dten fewer chairs than we want to buy, 100 chairs <strong>in</strong>stead <strong>of</strong> 110. The bank, <strong>in</strong> effect,gives you, its borrower, keys to the chair stores, <strong>and</strong> with those keys <strong>in</strong> h<strong>and</strong>, youbeat the rest <strong>of</strong> us to the chairs. Instead <strong>of</strong> those 10 chairs, then, we 9 people getmoney.


146 Robert L. GreenfieldOur <strong>in</strong>creased hold<strong>in</strong>gs <strong>of</strong> money give concrete evidence <strong>of</strong> the sav<strong>in</strong>g that wedo. One-half <strong>of</strong> our sav<strong>in</strong>g, however, we do under duress. As a group, we get stuckwith $1,000 more money than we f<strong>in</strong>d it convenient to hold <strong>and</strong> have ten fewerchairs than we f<strong>in</strong>d it desirable to use. We’re forced to save.No trace <strong>of</strong> the forced sav<strong>in</strong>g – or what is the same th<strong>in</strong>g, the excess supply <strong>of</strong>check<strong>in</strong>g account money – shows up on the bank’s balance sheet. On the bank’sbalance sheet, your promissory note appears as an asset <strong>and</strong>, <strong>of</strong>fsett<strong>in</strong>g it, the community’scheck<strong>in</strong>g accounts appear as liabilities. After you spend it, every check<strong>in</strong>gaccount dollar that the bank creates to buy your promissory note w<strong>in</strong>ds up <strong>in</strong> somebody’saccount. The bank’s balance sheet has to balance.The account<strong>in</strong>g balance does no more, however, than confirm what everyoneknows about money, namely, that people will always accept money, even if they haveno <strong>in</strong>tention <strong>of</strong> hold<strong>in</strong>g it. They can get rid <strong>of</strong> money that they don’t want to hold,<strong>of</strong> course, just by spend<strong>in</strong>g it. But their spend<strong>in</strong>g money just passes it along tosomeone else. The community as a whole can’t get rid <strong>of</strong> the money that the bankcreates when it too generously accommodates you, its borrower. The best thecommunity as a whole can do is to keep spend<strong>in</strong>g the enlarged money supply around<strong>and</strong> thus make it once aga<strong>in</strong>, through the permanently <strong>in</strong>creased spend<strong>in</strong>g-<strong>and</strong><strong>in</strong>comeflow, the equivalent <strong>of</strong> only two months’ <strong>in</strong>come.Now, by the very def<strong>in</strong>ition <strong>of</strong> the balance sheet, the bank’s loan assets also mustbe the equivalent <strong>of</strong> two months’ <strong>in</strong>come, <strong>and</strong> this account<strong>in</strong>g fact may seem tosuggest that the bank cannot transfer to its borrowers any more real capital (aga<strong>in</strong>,chairs) than the newcomers entrusted to it voluntarily. Such a conclusion would be<strong>in</strong>correct, however, for the bank has transferred to you not just the two months’<strong>in</strong>come (ten chairs) <strong>in</strong>come that the newcomers wanted to rel<strong>in</strong>quish but two moremonths’ <strong>in</strong>come (another ten chairs) besides. 1 In earlier times, when economistswere more given than they are now to us<strong>in</strong>g verbal imagery, the teller <strong>of</strong> this talemight have described the bank’s balance sheet, no different <strong>in</strong> <strong>in</strong>come-value termshere than <strong>in</strong> the previous case, as be<strong>in</strong>g like the cat sleep<strong>in</strong>g <strong>in</strong>nocently before thekitchen stove, after already hav<strong>in</strong>g swallowed the canary.Wasted sav<strong>in</strong>gIt was with a concern with the opposite case, however, that this tale began: the birdescapes the cat’s clutches, the verbally artistic economist would have said, <strong>and</strong> thenheads right out the open w<strong>in</strong>dow, gone forever.The wasted sav<strong>in</strong>g case beg<strong>in</strong>s as the two preced<strong>in</strong>g cases began: each <strong>of</strong> our fivenewcomers wants to hold a $200 check<strong>in</strong>g-account balance, the equivalent <strong>of</strong> twomonths’ <strong>in</strong>come. You come up with a scheme for transform<strong>in</strong>g an ord<strong>in</strong>ary chair,which if used now will last only one year, <strong>in</strong>to someth<strong>in</strong>g better, a chair that will lasttwo years. Aga<strong>in</strong>, you need capital, <strong>and</strong> aga<strong>in</strong>, you go to the bank. This time, however,you’re not quite as confident <strong>in</strong> your abilities. You ask for <strong>and</strong> get just a $500 loan –not enough money to enable you to take over all ten <strong>of</strong> the chairs that the fivenewcomers want to rel<strong>in</strong>quish <strong>in</strong> favor <strong>of</strong> money hold<strong>in</strong>gs, but only five <strong>of</strong> thosesacrificial chairs. The excess <strong>of</strong> the newcomers’ <strong>in</strong>tended chair sav<strong>in</strong>g over your chair


The macroeconomics <strong>of</strong> money, sav<strong>in</strong>g, <strong>and</strong> <strong>in</strong>vestment 147<strong>in</strong>vestment, or, what is the same th<strong>in</strong>g, the community’s excess dem<strong>and</strong> for hold<strong>in</strong>gs<strong>of</strong> check<strong>in</strong>g account money, doesn’t show up on the bank’s books; the bank’s loanassets are, as they must always be, <strong>of</strong> course, exactly equal to its deposit liabilities. Theimbalance shows up aga<strong>in</strong>, as it does <strong>in</strong> the case <strong>of</strong> forced sav<strong>in</strong>g, not at the bank buton the chair market. The excess dem<strong>and</strong> for money hold<strong>in</strong>gs has as its other <strong>and</strong> morepla<strong>in</strong>ly visible side an excess supply <strong>of</strong> chairs.The visibility <strong>of</strong> the one-classroom economy’s chair market <strong>and</strong> the temptation toapply supply-<strong>and</strong>-dem<strong>and</strong> type th<strong>in</strong>k<strong>in</strong>g to it might suggest that the price <strong>of</strong> chairswould just fall, thereby br<strong>in</strong>g<strong>in</strong>g the supply <strong>of</strong> <strong>and</strong> dem<strong>and</strong> for chairs (<strong>and</strong> thus supply<strong>of</strong> <strong>and</strong> dem<strong>and</strong> for money balances) back <strong>in</strong>to l<strong>in</strong>e with each other. Perhaps the pricewould fall if a chair were really a chair <strong>and</strong> noth<strong>in</strong>g else. “A chair,” however, is just ametaphor for what <strong>in</strong> reality, outside the one-classroom economy, are quantities <strong>of</strong>different goods <strong>and</strong> services, <strong>and</strong> the chair’s “price,” therefore, a metaphor for thegeneral price level.Despite the excess supply <strong>of</strong> chairs, then, their price won’t fall quickly <strong>and</strong> easily.It’s hard to get the general price level down because, for a while, anyway, untilpressure builds sufficiently <strong>and</strong> someone has no choice but to succumb; what <strong>Yeager</strong>(1997: 225) calls “the who-goes-first problem” blocks the downward adjustment.Lack<strong>in</strong>g assurance that suppliers <strong>and</strong> competitors will follow suit by cutt<strong>in</strong>g their ownprices, no chair producer wants to take the lead <strong>in</strong> what, when eventually it happens,has to be a piecemeal <strong>and</strong> decentralized downward adjustment. At a price now toohigh for equilibrium but resist<strong>in</strong>g adjust<strong>in</strong>g downward, therefore, the excess supply <strong>of</strong>metaphorical chairs persists.There the other five chairs just sit, then, gather<strong>in</strong>g dust, go<strong>in</strong>g to waste. More likely,because they can’t be sold, those other five chairs won’t even be produced at all. Theresources that would have been used to produce them will w<strong>in</strong>d up unemployed, <strong>and</strong>from there the waste will more than likely spread (though not limitlessly, because asmoney hold<strong>in</strong>gs became too large <strong>in</strong> relation to <strong>in</strong>comes shrunken any further,spend<strong>in</strong>g would resume).The bank, <strong>in</strong> this case, fails to translate some <strong>of</strong> the newcomers’ <strong>in</strong>tended chairsav<strong>in</strong>g <strong>in</strong>to real capital. <strong>Yeager</strong> would warn aga<strong>in</strong>st our be<strong>in</strong>g overly hard on thebank, however, despite its fail<strong>in</strong>g to translate <strong>in</strong>tended chair sav<strong>in</strong>g <strong>in</strong>to real capital.After all, savers commit chairs to the bank’s care by simply exercis<strong>in</strong>g restra<strong>in</strong>t <strong>in</strong>spend<strong>in</strong>g – by writ<strong>in</strong>g fewer checks aga<strong>in</strong>st the bank <strong>and</strong> writ<strong>in</strong>g even those fewerchecks <strong>in</strong> smaller denom<strong>in</strong>ations, too. The bank has no way <strong>of</strong> gaug<strong>in</strong>g the savers’thrifty <strong>in</strong>tentions, however, <strong>and</strong> therefore doesn’t know that, by creat<strong>in</strong>g newmoney on loan, it should transfer to chair <strong>in</strong>vestors all <strong>of</strong> the furniture rel<strong>in</strong>quishedvoluntarily by the savers. 2 No market mechanism, <strong>in</strong> other words, l<strong>in</strong>ks the bank’slend<strong>in</strong>g <strong>and</strong> hence the actual quantity <strong>of</strong> money to savers’ dem<strong>and</strong> for money hold<strong>in</strong>gs.Indirect convertibilitySuch a mechanism could be established, however, by requir<strong>in</strong>g that the bank ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>direct convertibility <strong>of</strong> the money that it issues. A $1 deposit (or banknote), that is,


148 Robert L. Greenfieldwould be redeemable <strong>in</strong> <strong>and</strong> issuable aga<strong>in</strong>st a designated conversion medium – itmight even be gold – not a predeterm<strong>in</strong>ed physical quantity <strong>of</strong> the conversionmedium, however, but whatever physical quantity had the same market value as acomprehensively def<strong>in</strong>ed bundle <strong>of</strong> goods <strong>and</strong> services. 3 No scope would exist for thecomprehensively def<strong>in</strong>ed bundle’s relative price to change; any change <strong>in</strong> the bundle’scomposite price would be a change <strong>in</strong> the general price level <strong>and</strong> thus a sign thatthe quantity <strong>of</strong> money had become either too big or too small <strong>in</strong> relation to the public’sdem<strong>and</strong> for money hold<strong>in</strong>gs.Say, then, that either because the public wanted to hold less money than it didbefore or because the bank itself had over exp<strong>and</strong>ed, the bundle’s composite pricebegan ris<strong>in</strong>g toward $2. In this circumstance, I could do better with a $1 deposit (orbanknote) than just spend it on goods <strong>and</strong> services. For $1, the bank would give mea quantity <strong>of</strong> gold that I could sell for $2. Then, I could turn the $2 <strong>in</strong> for gold worth$4 <strong>and</strong> start over aga<strong>in</strong>. Arbitrage would thus shr<strong>in</strong>k the quantity <strong>of</strong> money, match<strong>in</strong>git to the dem<strong>and</strong> for money hold<strong>in</strong>gs <strong>and</strong> prevent<strong>in</strong>g the bundle’s compositeprice from ris<strong>in</strong>g <strong>in</strong> the first place.In the opposite case, either because the public wanted to hold more money than itdid before or because the bank had for some reason scaled back its operations, thebundle’s composite price would start fall<strong>in</strong>g, say toward $0.50. Now, for whateverquantity <strong>of</strong> gold I delivered to it, the bank would give me enough new money to buytwice that quantity <strong>of</strong> gold. Arbitrage would thus exp<strong>and</strong> the quantity <strong>of</strong> money, aga<strong>in</strong>match<strong>in</strong>g it to the dem<strong>and</strong> for money hold<strong>in</strong>gs <strong>and</strong> this time prevent<strong>in</strong>g the postulatedrise <strong>of</strong> the bundle’s composite price.As a means <strong>of</strong> shr<strong>in</strong>k<strong>in</strong>g the money supply <strong>and</strong> thus <strong>of</strong> resist<strong>in</strong>g any tendency thebundle’s composite price might show <strong>of</strong> ris<strong>in</strong>g above par, decreased lend<strong>in</strong>g wouldsupplement <strong>and</strong> probably even supercede actual money redemptions. The bankwould have just m<strong>in</strong>imal gold reserves to conduct redemptions with, anyway; hold<strong>in</strong>ggold reserves would give the bank no protection, because the dollar would be redeemablenot <strong>in</strong> a pre-specified quantity <strong>of</strong> gold (as under an ord<strong>in</strong>ary gold st<strong>and</strong>ard) but,<strong>in</strong>stead, <strong>in</strong> whatever quantity <strong>of</strong> gold would permit buy<strong>in</strong>g the comprehensivebundle. 4 Say, aga<strong>in</strong>, then, that the bundle’s price rose toward $2. Aga<strong>in</strong>, <strong>in</strong> redeem<strong>in</strong>ga dollar, the bank would have to pay out twice as much gold as the dollar would actuallybuy. To avoid arbitrage losses on actual redemptions, the bank would quicklyshr<strong>in</strong>k the quantity <strong>of</strong> money through decreased lend<strong>in</strong>g.In the opposite case, aga<strong>in</strong>, the bundle’s price would show signs <strong>of</strong> fall<strong>in</strong>g toward$0.50. The bank would see the arbitrageurs com<strong>in</strong>g, gold <strong>in</strong> h<strong>and</strong> <strong>and</strong>, <strong>in</strong> exchangefor the gold, entitled to twice as many dollars as they had just paid for it. Preferr<strong>in</strong>g<strong>in</strong>terest bear<strong>in</strong>g assets to non-<strong>in</strong>terest bear<strong>in</strong>g gold, the bank would pre-empt thearbitrageurs by exp<strong>and</strong><strong>in</strong>g its loans <strong>and</strong> thereby, too, the quantity <strong>of</strong> money.Indirect convertibility would appropriately l<strong>in</strong>k the bank’s lend<strong>in</strong>g <strong>and</strong> thus theactual quantity <strong>of</strong> money to the public’s dem<strong>and</strong> for money hold<strong>in</strong>gs. Under <strong>in</strong>directconvertibility, the bank could not <strong>in</strong>flict forced sav<strong>in</strong>g upon an unwill<strong>in</strong>g public. Norcould the bank fail, however <strong>in</strong>nocently, to transform the public’s <strong>in</strong>tended sav<strong>in</strong>g <strong>in</strong>toreal capital.


Mr. <strong>Yeager</strong>The macroeconomics <strong>of</strong> money, sav<strong>in</strong>g, <strong>and</strong> <strong>in</strong>vestment 149So ends the classroom story that I use to pass along an important piece <strong>of</strong> whatLel<strong>and</strong> <strong>Yeager</strong> has taught me about macroeconomics. I close, now, by rem<strong>in</strong>isc<strong>in</strong>gjust a little bit.Sometime back <strong>in</strong> the early 1980s, when my friendship <strong>and</strong> collaboration with<strong>Yeager</strong> had just begun, I attended the American Economic Association meet<strong>in</strong>gs,held that particular year <strong>in</strong> Atlanta. Between two <strong>of</strong> the first morn<strong>in</strong>g’s sessions, Istood on the hotel’s mezzan<strong>in</strong>e level, wait<strong>in</strong>g for the elevator. The bell rang toannounce its arrival, <strong>and</strong> two <strong>of</strong> the disembark<strong>in</strong>g passengers, graduate students, Ithought, a young man <strong>and</strong> a young woman, stepped from the elevator to themezzan<strong>in</strong>e’s rail<strong>in</strong>g. “Oh look!” the young woman exclaimed, as she looked down tothe crowded lobby; <strong>and</strong> then she cont<strong>in</strong>ued, us<strong>in</strong>g the time honored title given malepr<strong>of</strong>essors at the University <strong>of</strong> Virg<strong>in</strong>ia, “There’s Mr. <strong>Yeager</strong>!” The young mancraned his neck, as with his eyes he tried to follow the woman’s extended arm <strong>and</strong>po<strong>in</strong>ted <strong>in</strong>dex f<strong>in</strong>ger to their target. Then, with enthusiasm that matched <strong>and</strong> perhapseven exceeded hers: “Oh yes,” he answered. “Now I see him!”As I watched the pair hurry <strong>of</strong>f, I remembered one <strong>of</strong> my boyhood Talmud lessons.“F<strong>in</strong>d a master teacher,” the Talmud says, “so that you will avoid mak<strong>in</strong>g dubiousdecisions.” They had found a master teacher, <strong>in</strong>deed; <strong>and</strong> <strong>in</strong> the same man, so had I.Notes1 Only with the bank’s <strong>in</strong>tervention can we have forced sav<strong>in</strong>g <strong>in</strong>flicted upon us. Withoutthe bank’s <strong>in</strong>tervention, you would have to use your own chairs as capital, or else, t<strong>of</strong><strong>in</strong>ance the chair improvement scheme, approach the rest <strong>of</strong> us directly <strong>and</strong>, by <strong>of</strong>fer<strong>in</strong>g ahigher <strong>in</strong>terest rate on your promissory notes, persuade us to lend you our chairs.2 If our new savers had wanted to hold promissory notes, or bonds, themselves, not check<strong>in</strong>gaccount money, then <strong>in</strong>tended sav<strong>in</strong>g could not have gone to waste. The <strong>in</strong>creaseddem<strong>and</strong> for bonds would have driven their <strong>in</strong>terest yields down, encourag<strong>in</strong>g <strong>in</strong>vestors totry their h<strong>and</strong>s at the chair improvement scheme (<strong>and</strong> perhaps even discourag<strong>in</strong>g saversfrom releas<strong>in</strong>g their chairs).3 An even more basic reform (see Greenfield <strong>and</strong> <strong>Yeager</strong> 1983; <strong>Yeager</strong> <strong>and</strong> Greenfield 1989)would def<strong>in</strong>e the value unit not as one unit <strong>of</strong> money but, <strong>in</strong>stead, as the comprehensivelydef<strong>in</strong>ed bundle itself. Private firms would issue deposits (<strong>and</strong> also notes <strong>and</strong> co<strong>in</strong>s) denom<strong>in</strong>ated<strong>in</strong> value units, <strong>and</strong> competition would require that the notes <strong>and</strong> deposits be keptworth their face values, someth<strong>in</strong>g more conveniently done, ow<strong>in</strong>g to the bundle’s comprehensivedef<strong>in</strong>ition, through <strong>in</strong>direct rather than through direct convertibility.4 Because the bank wouldn’t hold a large quantity <strong>of</strong> gold reserves, the “price” impliedarithmetically by the bank’s redemption calculation would not dom<strong>in</strong>ate the marketprice. If it actually had to redeem money, the bank would buy the needed gold, therebyadd<strong>in</strong>g as much to the dem<strong>and</strong> for gold as to the supply <strong>of</strong> gold <strong>and</strong> thus leav<strong>in</strong>g gold’smarket price unchanged (see Woolsey <strong>and</strong> <strong>Yeager</strong> 1994; Greenfield et al. 1995).ReferencesGreenfield, Robert L. <strong>and</strong> Lel<strong>and</strong> B. <strong>Yeager</strong> (1983). A Laissez-Faire Approach to MonetaryStability. Journal <strong>of</strong> <strong>Money</strong>, Credit, <strong>and</strong> Bank<strong>in</strong>g, 15(August): 302–15. Repr<strong>in</strong>ted <strong>in</strong> GeorgeSelg<strong>in</strong> (ed.) (1997). The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> <strong>in</strong> Monetary Disequilibrium by Lel<strong>and</strong> B. <strong>Yeager</strong>.


150 Robert L. GreenfieldIndianapolis: Liberty Fund. With authors’ addendum <strong>in</strong> Lawrence H. White (ed.) (1993).International Encyclopedia <strong>of</strong> Macroeconomics <strong>and</strong> F<strong>in</strong>ancial History, v. 11. Cheltenham: EdwardElgar.Greenfield, Robert L. <strong>and</strong> Lel<strong>and</strong> B. <strong>Yeager</strong> (1997). A Real-GNP Dollar. In George Selg<strong>in</strong>(ed.) The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> <strong>in</strong> Monetary Disequilibrium by Lel<strong>and</strong> B. <strong>Yeager</strong>. Indianapolis:Liberty Fund.Greenfield, Robert L., Lel<strong>and</strong> B. <strong>Yeager</strong> <strong>and</strong> W. William Woolsey (1995). Is IndirectConvertibility Impossible? Journal <strong>of</strong> <strong>Money</strong>, Credit, <strong>and</strong> Bank<strong>in</strong>g, 27(February): 293–7.Woolsey, W. William <strong>and</strong> Lel<strong>and</strong> B. <strong>Yeager</strong> (1994). Is There a Paradox <strong>of</strong> IndirectConvertibility? Southern Economic Journal, 61(July): 85–95.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1956). A Cash-Balance Interpretation <strong>of</strong> Depression. Southern EconomicJournal, 22(April): 438–47. Repr<strong>in</strong>ted <strong>in</strong> George Selg<strong>in</strong> (ed.) (1997) The Flutter<strong>in</strong>g Veil:<strong>Essays</strong> <strong>in</strong> Monetary Disequilibrium by Lel<strong>and</strong> B. <strong>Yeager</strong>. Indianapolis: Liberty Fund.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1968). Essential Properties <strong>of</strong> the Medium <strong>of</strong> Exchange. Kyklos, 21(1):45–69. Repr<strong>in</strong>ted <strong>in</strong> George Selg<strong>in</strong> (ed.) (1997). The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> <strong>in</strong> MonetaryDisequilibrium by Lel<strong>and</strong> B. <strong>Yeager</strong>. Indianapolis: Liberty Fund.<strong>Yeager</strong>, Lel<strong>and</strong> B. (1997). The Significance <strong>of</strong> Monetary Disequilibrium. In George Selg<strong>in</strong>(ed.) The Flutter<strong>in</strong>g Veil: <strong>Essays</strong> <strong>in</strong> Monetary Disequilibrium by Lel<strong>and</strong> B. <strong>Yeager</strong>. Indianapolis:Liberty Fund.<strong>Yeager</strong>, Lel<strong>and</strong> B. <strong>and</strong> Robert L. Greenfield (1989). Can Monetary Disequilibrium BeElim<strong>in</strong>ated? Cato Journal, 9(Fall): 405–19. Repr<strong>in</strong>ted <strong>in</strong> George Selg<strong>in</strong> (ed.) (1997). TheFlutter<strong>in</strong>g Veil: <strong>Essays</strong> <strong>in</strong> Monetary Disequilibrium by Lel<strong>and</strong> B. <strong>Yeager</strong>. Indianapolis: LibertyFund.


11 No-name moneyMaria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnik*The expectational aspect <strong>of</strong> <strong>in</strong>flationary momentum makes the credibility <strong>of</strong> ananti-<strong>in</strong>flationary policy <strong>of</strong> great importance to how severe the withdrawal pangs willbe . . . How, though, could a resolute policy be made conv<strong>in</strong>c<strong>in</strong>g from the start?(<strong>Yeager</strong> 1997: 67–8)IntroductionOn October 8, 1991, Slovenia <strong>in</strong>troduced its own currency, the Slovene tolar,thereby becom<strong>in</strong>g the first among the new economies <strong>in</strong> transition to achievemonetary <strong>in</strong>dependence. 1 The <strong>in</strong>troduction <strong>of</strong> the new currency was justified bythe goal <strong>of</strong> achiev<strong>in</strong>g political <strong>in</strong>dependence <strong>and</strong> <strong>of</strong> isolat<strong>in</strong>g the country fromYugoslav <strong>in</strong>flation. The success <strong>of</strong> the effort toward <strong>in</strong>dependence, however, restedon the achievement <strong>of</strong> macroeconomic stability, which, <strong>in</strong> turn, required monetarysoundness. With<strong>in</strong> this context, Slovenia’s currency conversion <strong>and</strong> achievement<strong>of</strong> monetary stability <strong>of</strong>fer an <strong>in</strong>terest<strong>in</strong>g example for the study <strong>of</strong> <strong>in</strong>flation <strong>and</strong> <strong>of</strong>successful stabilization programs.<strong>Yeager</strong> (1981) identifies some general features <strong>of</strong> <strong>in</strong>flation whose analysis isfunda mental when <strong>in</strong>vestigat<strong>in</strong>g ways to reduce its <strong>in</strong>cidence. Among thesefeatures, the importance <strong>of</strong> the <strong>in</strong>flationary momentum, that is the ability exhibitedby <strong>in</strong>flation to perpetuate <strong>and</strong> deepen itself, is especially emphasized. Specifically,the <strong>in</strong>flationary momentum is described as hav<strong>in</strong>g three dist<strong>in</strong>ct, though strictlyrelated, elements: (1) the credibility component; (2) the catch up component; <strong>and</strong>(3) the expectations component. Expectations are at the core <strong>of</strong> the <strong>in</strong>flationarymomentum. When prices rise at a brisk rate for a while, people recognize what ishappen<strong>in</strong>g <strong>and</strong> make their own pric<strong>in</strong>g decisions accord<strong>in</strong>gly. In particular, peoplemodify their calculations <strong>in</strong> order to catch up with what they expect <strong>in</strong>flation willbe. Thus, any attempt to alter the <strong>in</strong>flationary momentum has to be credible <strong>in</strong>order to have a chance <strong>of</strong> succeed<strong>in</strong>g. Interventions lack<strong>in</strong>g credibility <strong>in</strong>creaseuncerta<strong>in</strong>ty <strong>and</strong>, as a result, strengthen the catch-up effect <strong>and</strong> the <strong>in</strong>flationaryspiral. Of course, the three aspects may overlap <strong>and</strong> cannot be always clearlydist<strong>in</strong>guished. This paper supports <strong>Yeager</strong>’s analysis <strong>and</strong> shows that the Slovenianmonetary reform was successful because it addressed all three aspects <strong>of</strong> the<strong>in</strong>flationary momentum <strong>and</strong>, <strong>in</strong> particular, that the newly appo<strong>in</strong>ted Slovenian


152 Maria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnikmonetary authorities were able to leverage popular expectations <strong>in</strong> favor <strong>of</strong>stabilization.Inflation, <strong>of</strong> course, is a monetary phenomenon, <strong>and</strong> the successful trend couldnot have been susta<strong>in</strong>ed over time without an appropriate policy <strong>of</strong> the centralbank capable <strong>of</strong> modify<strong>in</strong>g the money supply appropriately. Nevertheless, thereforms could not have started if political credibility had been lack<strong>in</strong>g <strong>and</strong> ifSlovenes had not been will<strong>in</strong>g to accept the new currency even before know<strong>in</strong>g itsreal purchas<strong>in</strong>g power. 2 In other words, reforms would not have achieved theirobjectives if the dem<strong>and</strong> for the new currency had not adjusted suitably to thechange <strong>in</strong> monetary conditions.The Slovenian case illustrates the crucial role that people’s expectations play <strong>in</strong>determ<strong>in</strong><strong>in</strong>g the successful <strong>in</strong>terruption <strong>of</strong> the <strong>in</strong>flationary momentum <strong>and</strong> <strong>in</strong> conta<strong>in</strong><strong>in</strong>gthe costs associated with the adjustment process. Also, the credibility <strong>of</strong> theanti-<strong>in</strong>flation policy is shown to be <strong>of</strong> primary importance <strong>in</strong> <strong>in</strong>fluenc<strong>in</strong>g suchexpectations s<strong>in</strong>ce the political element <strong>in</strong> anti-<strong>in</strong>flationary policies has the potentialto condition expectations <strong>and</strong> to turn them around, thereby break<strong>in</strong>g themomentum <strong>of</strong> <strong>in</strong>flation. F<strong>in</strong>ally, the Slovenian experience suggests that, even for avery small country, the benefits <strong>of</strong> hav<strong>in</strong>g one’s own currency may outweigh costsbecause <strong>of</strong> the ability to conduct an <strong>in</strong>dependent monetary policy. 3The contribution <strong>of</strong> our paper is tw<strong>of</strong>old. First, we provide a review <strong>of</strong> the currencyconversion process <strong>in</strong> Slovenia <strong>and</strong> identify the economic circumstances thatmade the Slovenian reform successful. Second, we show how the asymmetricnature <strong>of</strong> expectations among different groups <strong>of</strong> d<strong>in</strong>ar holders played a crucialrole <strong>in</strong> determ<strong>in</strong><strong>in</strong>g the success <strong>of</strong> the currency conversion, <strong>and</strong> how the Bank<strong>of</strong> Slovenia successfully leveraged these expectations to break the <strong>in</strong>flationarymomentum.Yugoslavian monetary conditions <strong>and</strong> the <strong>in</strong>flationarymomentumThe Yugoslav economy <strong>of</strong> the 1980s was characterized by stagnation <strong>and</strong> rapidly<strong>in</strong>creas<strong>in</strong>g prices. Large companies, banks, <strong>and</strong> the government all lacked budgetarydiscipl<strong>in</strong>e. The National Bank <strong>of</strong> Yugoslavia allowed systematic <strong>and</strong> susta<strong>in</strong>ed<strong>in</strong>creases <strong>of</strong> the money supply which, eventually, led the federation <strong>in</strong>to hyper<strong>in</strong>flation.Average output growth decl<strong>in</strong>ed from 6.4 percent <strong>in</strong> the late 1970s to lessthan 1 percent <strong>in</strong> the late 1980s, while <strong>in</strong>flation began <strong>in</strong>creas<strong>in</strong>g <strong>in</strong> the early 1980s,<strong>and</strong> rose to 1,253 percent <strong>in</strong> 1989. 4 In 1987, <strong>in</strong> order to stop the hyper<strong>in</strong>flation,improve f<strong>in</strong>ancial discipl<strong>in</strong>e, <strong>and</strong> provide new economic <strong>in</strong>centives, the Yugoslaviangovernment <strong>in</strong>troduced a package <strong>of</strong> economic reforms. 5 These reformswere <strong>in</strong>tended to elim<strong>in</strong>ate social ownership <strong>of</strong> non-f<strong>in</strong>ancial enterprises, restructurelarge enterprises, reform taxation, <strong>and</strong> create a new credit distribution role forthe National Bank <strong>of</strong> Yugoslavia.Although the program was <strong>in</strong>itially successful, its overall results were veryuneven. Stabilization reforms were implemented amidst a series <strong>of</strong> free electionstak<strong>in</strong>g place <strong>in</strong> different republics. Pressed by the need to receive public support,


No-name money 153many political leaders were successful <strong>in</strong> ga<strong>in</strong><strong>in</strong>g popularity by circumvent<strong>in</strong>g thestabilization plan. In particular, some politicians created regulatory loopholes,weakened the popular perception <strong>of</strong> the desirability <strong>of</strong> the plan, <strong>and</strong> triggered new<strong>in</strong>flationary expectations. As a result, fiscal pressure prevented monetary discipl<strong>in</strong>e<strong>and</strong>, <strong>in</strong> spite <strong>of</strong> the temporary improvement, the federal government experienced asharp loss <strong>of</strong> credibility <strong>and</strong> the <strong>in</strong>flationary spiral resumed.After the failure <strong>of</strong> this attempt, it became evident that the Yugoslavian federalgovernment did not possess the political leverage necessary for a successfultransition from a socialist to a market economy. The situation worsened toward theend <strong>of</strong> 1990, when exports fell sharply. 6 On December 28, 1990, <strong>in</strong> an attempt tosupport exports, the federal government <strong>of</strong> Yugoslavia devalued the currency,from seven to n<strong>in</strong>e d<strong>in</strong>ars per Deutschemark. Because <strong>of</strong> the comb<strong>in</strong>ed effect <strong>of</strong> the<strong>in</strong>crease <strong>in</strong> monetary base <strong>and</strong> <strong>of</strong> the depreciation, the <strong>in</strong>flationary spiral ga<strong>in</strong>edfurther strength. In addition, the branch <strong>of</strong> the central bank located <strong>in</strong> Serbia issueda large quantity <strong>of</strong> additional currency without the approval <strong>of</strong> the ma<strong>in</strong> <strong>of</strong>fice <strong>of</strong>the Central Bank <strong>of</strong> Yugoslavia. 7 By the end <strong>of</strong> 1990, the annual <strong>in</strong>flation rate <strong>in</strong>Yugoslavia exceeded 500 percent. Crippled by monetary <strong>in</strong>stability, <strong>and</strong> <strong>in</strong> light <strong>of</strong>the uncerta<strong>in</strong> nature <strong>of</strong> the anticipated political restructur<strong>in</strong>g, many <strong>of</strong> the republicsceased to comply with federal regulations, refused to pay taxes to the federalgovernment, <strong>and</strong> precipitated the dissolution <strong>of</strong> the federation.The events <strong>in</strong> Yugoslavia triggered an <strong>in</strong>flationary momentum <strong>of</strong> significantstrength. History shows that hyper<strong>in</strong>flation may be caused by unsound monetary<strong>and</strong> fiscal policies (e.g., the Weimar Republic <strong>in</strong> the 1920s) sometimes coupled withpolitical dis<strong>in</strong>tegration. Yugoslavia <strong>in</strong> the late 1980s clearly comb<strong>in</strong>ed both elements.In addition to a change <strong>in</strong> monetary policy, the elim<strong>in</strong>ation <strong>of</strong> this type <strong>of</strong><strong>in</strong>flationary momentum requires the establishment <strong>of</strong> a new political order.Clearly, the Slovenian authorities (e.g., central bank <strong>and</strong> M<strong>in</strong>istry <strong>of</strong> F<strong>in</strong>ance)understood this problem <strong>and</strong> exhibited remarkable technical competence <strong>in</strong> tackl<strong>in</strong>gthe issue. From the beg<strong>in</strong>n<strong>in</strong>g, the stabilization program was based on isolat<strong>in</strong>gthe Slovenian economy from Yugoslavia by creat<strong>in</strong>g an <strong>in</strong>dependent central bank,sound monetary policy, <strong>and</strong> a freely convertible new currency. Nevertheless,although it is important to recognize its technical merit, it is also crucial to underst<strong>and</strong>the public choice aspects that contributed significantly to the success <strong>of</strong> thestabilization program.The declaration <strong>of</strong> <strong>in</strong>dependence <strong>and</strong> the return <strong>of</strong>credibilityAcross the republics, the climate <strong>of</strong> distrust for the Yugoslavian governmentprovided a fertile ground for politicians to <strong>of</strong>fer <strong>in</strong>dependence as an alternative. 8 Inthis climate, the Slovenian Assembly began nurtur<strong>in</strong>g the idea <strong>of</strong> <strong>in</strong>dependence<strong>and</strong> national sovereignty. Slovenian voters (as well as voters <strong>in</strong> Croatia) historicallysaw themselves as belong<strong>in</strong>g to the West <strong>and</strong> were very susceptible to argumentsmade by a number <strong>of</strong> Slovenian politicians that the Yugoslav government wasresponsible for Slovenia’s lagg<strong>in</strong>g beh<strong>in</strong>d Western Europe. S<strong>in</strong>ce Slovenia was the


154 Maria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnikrichest <strong>and</strong> most developed <strong>of</strong> the republics <strong>of</strong> Yugoslavia, arguments regard<strong>in</strong>g“exploitation” by less developed republics <strong>and</strong> prov<strong>in</strong>ces also found fertile ground.As a result, political <strong>in</strong>dependence from Yugoslavia became a major part <strong>of</strong> publicdiscourse <strong>and</strong> the preferred path for Slovenia to catch up <strong>and</strong> become part <strong>of</strong>Western Europe.The loose monetary policy <strong>in</strong> Yugoslavia had caused consumer prices <strong>in</strong>Slovenia to grow at an annual rate <strong>of</strong> 1,253 percent between 1988 <strong>and</strong> 1989, <strong>and</strong> ata rate <strong>of</strong> 552 percent between 1989 <strong>and</strong> 1990. 9 Also, be<strong>in</strong>g one <strong>of</strong> the more exportoriented <strong>of</strong> the republics, Slovenia’s GDP had decl<strong>in</strong>ed from $17.4 billion <strong>in</strong> 1990to $12.7 billion <strong>in</strong> 1991, a 27 percent decl<strong>in</strong>e. 10 Under pressure because <strong>of</strong> therapidly deteriorat<strong>in</strong>g economic situation <strong>of</strong> the late 1980s, the Slovene Parliamentvoted to hold a referendum on <strong>in</strong>dependence. While the economic rationale for<strong>in</strong>dependence was a successful transition to a market system, political <strong>and</strong> populistarguments focused on Slovenian higher productivity, better work ethics, <strong>and</strong> on itsmore than fair contribution to the federation. At the referendum, held on December26, 1990, about 90 percent <strong>of</strong> the population voted <strong>in</strong> favor <strong>of</strong> <strong>in</strong>dependence<strong>and</strong> Slovenia proposed the creation <strong>of</strong> a loose confederation among all Yugoslavrepublics. The ensu<strong>in</strong>g negotiations, however, did not produce any result. Thus, onJune 25, 1991, the Slovene Parliament declared full sovereignty which ultimatelybecame effective after a three month moratorium on October 8, 1991.The Yugoslavian response was immediate <strong>and</strong>, on June 27, the Yugoslav army<strong>in</strong>vaded Slovenia <strong>and</strong> took control <strong>of</strong> the country. Fortunately, the Slovenianpolitical leadership quickly created ties with the West <strong>and</strong> the <strong>in</strong>tervention <strong>of</strong>European Community mediators prevented the <strong>in</strong>vasion from develop<strong>in</strong>g <strong>in</strong>to awar. Most <strong>of</strong> the other Yugoslavian republics had no clear political or ethnic identity<strong>and</strong> were, therefore, more vulnerable to external attacks or <strong>in</strong>ternal struggles. In asituation where the war had begun develop<strong>in</strong>g quickly on many fronts, a deeper <strong>and</strong>prolonged attack aga<strong>in</strong>st Slovenia could have significantly endangered its existence.On July 7, a decisive agreement between all concerned parties <strong>and</strong> EC negotiatorswas reached <strong>and</strong> the war <strong>in</strong> Slovenia was avoided. Slovenia agreed to stop furtherimplementation <strong>of</strong> the declaration <strong>of</strong> <strong>in</strong>dependence for three months <strong>and</strong> theYugoslav side promised to end the hostilities <strong>and</strong> withdraw its army. Otherrepublics <strong>of</strong> the former Federation followed a different path <strong>and</strong> the formalsecession <strong>of</strong> Slovenia took place while a terrible war began to develop <strong>in</strong> the rest<strong>of</strong> Yugoslavia. After three additional months <strong>of</strong> negotiations that yielded nopositive results, <strong>and</strong> <strong>in</strong> light <strong>of</strong> the dis<strong>in</strong>tegration <strong>of</strong> other parts <strong>of</strong> Yugoslavia,Slovenia resumed its plans <strong>and</strong> achieved complete <strong>in</strong>dependence by the end <strong>of</strong>summer 1991. 11While the <strong>in</strong>dependence process was tak<strong>in</strong>g place, it had become clear that thecredibility <strong>of</strong> the new government was a crucial factor for a successful transition to<strong>in</strong>dependence. Such credibility rested on the government’s ability to nurturethe country’s self-confidence, reduce uncerta<strong>in</strong>ty, <strong>and</strong> restore sound market<strong>in</strong>centives. Thus, macroeconomic stability was a necessary element for a successfultransition. 12 Macroeconomic stability, <strong>in</strong> turn, required monetary discipl<strong>in</strong>e.Many questions arose about how monetary discipl<strong>in</strong>e was to be created, <strong>and</strong> alter -native monetary arrangements were debated. Aga<strong>in</strong>st the suggestions <strong>of</strong> foreign


No-name money 155consultants, who favored a currency board (Pleskovic <strong>and</strong> Sachs 1993, 1994),Slovenian authorities <strong>in</strong>sisted on creat<strong>in</strong>g their own national currency as the onlyway to <strong>in</strong>sure an <strong>in</strong>dependent monetary policy <strong>and</strong> successfully isolate the newcountry from Yugoslavia. Isolation had to be achieved <strong>in</strong> order to prevent theYugoslavian <strong>in</strong>flation from spread<strong>in</strong>g to the new currency <strong>and</strong> to strengthen thecredibility <strong>of</strong> the new government.Break<strong>in</strong>g the <strong>in</strong>flationary catch: the <strong>in</strong>troduction <strong>of</strong> thenew currencyIn late June 1991, before reach<strong>in</strong>g complete <strong>in</strong>dependence, Slovenia adopted theLaw <strong>of</strong> the Bank <strong>of</strong> Slovenia, which created <strong>and</strong> empowered the central bank. TheBank <strong>of</strong> Slovenia replaced the National Bank <strong>of</strong> Yugoslavia as the lender <strong>of</strong> lastresort. Immediately, all bank claims <strong>and</strong> liabilities were transferred to its balancesheet, new <strong>and</strong> lower reserve requirements were applied, <strong>and</strong> the use <strong>of</strong> the discountfacility was reduced.In the mean time, reports had circulated that the Yugoslavian government wasattempt<strong>in</strong>g to underm<strong>in</strong>e the newly <strong>in</strong>dependent country by us<strong>in</strong>g economicterrorism. Thus, rumors that Yugoslavia was plann<strong>in</strong>g to flood Slovenia withd<strong>in</strong>ars <strong>in</strong> order to destabilize the country accelerated further changes. On October7, 1991, three months after creat<strong>in</strong>g the central bank, parliament called for the<strong>in</strong>troduction <strong>of</strong> the Slovene tolar. One day later, on October 8, 1991, the Republic<strong>of</strong> Slovenia passed two additional <strong>and</strong> very specific laws. The first one, theRepublic <strong>of</strong> Slovenia Monetary Unit Act, declared the Slovene tolar as the newlegal tender <strong>of</strong> the country <strong>and</strong> the adoption <strong>of</strong> a flexible exchange rate regime. Thesecond law, the Monetary Unit Application Act, provided for the <strong>in</strong>troduction <strong>of</strong>currency tokens as legal tender until tolar banknotes <strong>and</strong> co<strong>in</strong>s could be issued.These provisional notes had been pr<strong>in</strong>ted secretly dur<strong>in</strong>g the last months <strong>of</strong> 1990.They were <strong>in</strong>tended for use <strong>in</strong> case the central bank <strong>in</strong> Belgrade stopped supply<strong>in</strong>gSlovenia with d<strong>in</strong>ars but, contrary to <strong>in</strong>itial expectations, <strong>in</strong>stead <strong>of</strong> prevent<strong>in</strong>g ashortage, they were put <strong>in</strong> circulation to neutralize a possible surplus <strong>of</strong> Yugoslavcurrency <strong>in</strong> Slovenia. Because <strong>of</strong> the <strong>in</strong>itial uncerta<strong>in</strong>ty about their use, the noteshad no pr<strong>in</strong>ted designation <strong>and</strong>, until the very last night before the currency switchtook place, rema<strong>in</strong>ed nameless. 13In practice, the conversion process required a well-organized implementationthat would not disrupt daily economic activity. On October 8, 1991, the same day<strong>of</strong> the <strong>of</strong>ficial <strong>in</strong>troduction <strong>of</strong> the tolar, all banks were closed. In addition, the centralbank <strong>in</strong>structed all banks, post <strong>of</strong>fices, <strong>and</strong> Social Account<strong>in</strong>g Offices regard<strong>in</strong>gthe terms <strong>and</strong> methods <strong>of</strong> conversion. The idea was simple: bank accounts, wages,<strong>and</strong> prices were to be converted automatically from d<strong>in</strong>ars <strong>in</strong>to the new currency,the tolar. D<strong>in</strong>ars <strong>in</strong> circulation, <strong>in</strong>stead, were to be physically exchanged dur<strong>in</strong>g ashort conversion period articulated <strong>in</strong> a ma<strong>in</strong> phase <strong>of</strong> three days, from October 9to October 11, <strong>and</strong> a second phase which lasted from October 12 to October 31.N<strong>in</strong>ety-n<strong>in</strong>e percent <strong>of</strong> all d<strong>in</strong>ar banknotes were replaced by new currency tokensdur<strong>in</strong>g the first phase, with most <strong>of</strong> the exchanges tak<strong>in</strong>g place through rout<strong>in</strong>epurchases, while only a few customers exchanged currency at banks. 14


156 Maria M<strong>in</strong>niti <strong>and</strong> Lidija PolutnikIn Slovenia, the catch up component implied simply transferr<strong>in</strong>g the <strong>in</strong>flationaryexpectations associated to the d<strong>in</strong>ar onto the tolar. In practice, there were no regulatoryor legal barriers aga<strong>in</strong>st this risk. In fact, dur<strong>in</strong>g the Yugoslavian <strong>in</strong>flation,d<strong>in</strong>ars had ceased to serve as a reliable store <strong>of</strong> wealth <strong>and</strong> people had alreadybecome accustomed to keep<strong>in</strong>g large hold<strong>in</strong>gs <strong>of</strong> foreign exchange. The timerequired for this <strong>in</strong>flationary transfer was also negligible, s<strong>in</strong>ce to adjust theirbalances Slovenes did not need to change their consumption patterns nor the form<strong>in</strong> which they held their wealth. And yet, because the Slovenian authoritieshad restored the credibility <strong>of</strong> the government, the <strong>in</strong>flationary momentum was<strong>in</strong>terrupted.In the earlier 1990s, the political <strong>and</strong> monetary disorder <strong>of</strong> Yugoslavia hadbecome so extreme that it created a general agreement that someth<strong>in</strong>g needed tobe done. In Slovenia, supported by a strong sense <strong>of</strong> national pride for the newcountry, this awareness nurtured a rapid change <strong>of</strong> expectations. As previouslyargued, Slovenes were eager for a clear break with past policies. Thus, the adoption<strong>of</strong> the new monetary unit strengthened the perception that policy had entirelychanged. Indeed, the <strong>in</strong>troduction <strong>of</strong> the Slovenian tolar had not only economiccauses but also rested heavily on political <strong>and</strong> social grounds. “The politiciansopted for our own money for another reason. [The Slovenes] . .. wanted ourmoney, like a flag, as the symbol <strong>of</strong> national <strong>in</strong>dependence <strong>and</strong> a fulfillment <strong>of</strong>dreams” (Ribnikar 1998: 9).The conversion process <strong>and</strong> the change <strong>in</strong> popularexpectationsThe conversion process was executed very smoothly <strong>and</strong> the newly created CentralBank <strong>of</strong> Slovenia exhibited remarkable competence. Yet, the asymmetric nature <strong>of</strong>the expectations <strong>of</strong> different groups <strong>of</strong> d<strong>in</strong>ars’ holders played a crucial role <strong>in</strong>determ<strong>in</strong><strong>in</strong>g the positive outcome. On the one side, given the uncerta<strong>in</strong>ty <strong>of</strong> thefuture <strong>of</strong> this newly formed country <strong>and</strong> its new currency, speculative <strong>in</strong>flows <strong>of</strong>d<strong>in</strong>ars from the rest <strong>of</strong> Yugoslavia were negligible. On the other side, the Slovenes’will<strong>in</strong>gness to accept the unknown tokens <strong>in</strong> exchange for well-known d<strong>in</strong>arsenabled the conversion process to proceed smoothly.Without a strong popular support, it is likely that the currency conversion wouldnot have been as successful. Because people’s expectations played such an importantrole, the Slovenian example po<strong>in</strong>ts out the importance <strong>of</strong> social conditions forthe successful <strong>in</strong>troduction <strong>of</strong> a new fiat money. Indeed, people’s expectations <strong>in</strong>Slovenia were not about “how credible the anti-<strong>in</strong>flationary program was go<strong>in</strong>g tobe.” It is also most unlikely that the population was aware <strong>of</strong> the necessity or desirability<strong>of</strong> controll<strong>in</strong>g the money supply. Instead, popular expectations were formedon the belief that Slovenia would be better <strong>of</strong>f as an <strong>in</strong>dependent state than as a part<strong>of</strong> Yugoslavia. Because <strong>of</strong> this belief, the Slovenes trusted, <strong>and</strong> will<strong>in</strong>gly accepted,the new national currency. In fact, they used <strong>in</strong> exchange, <strong>and</strong> held positive balances<strong>of</strong>, the nameless tokens even before learn<strong>in</strong>g what their real purchas<strong>in</strong>gpower was go<strong>in</strong>g to be. 15Conscious <strong>of</strong> the importance <strong>of</strong> people’s expectations, the Slovenian central


No-name money 157bank chose the one to one conversion ratio, <strong>in</strong> part to preserve the goodwill <strong>of</strong> thepopulation <strong>and</strong> prevent the re-emergence <strong>of</strong> old fears caused by negativeexperiences with past currency conversions. The argument that a more favorableexchange ratio would raise confidence <strong>in</strong> a new currency unit <strong>and</strong> lower <strong>in</strong>flationaryexpectations was rejected. So were other, more drastic, arguments <strong>in</strong>volv<strong>in</strong>gdifferent conversion rates depend<strong>in</strong>g on the owner, form, <strong>and</strong> value <strong>of</strong> the assetconverted. 16In a sense, the process by which the value <strong>of</strong> the tolar was eventually determ<strong>in</strong>ed<strong>in</strong> the market can be thought <strong>of</strong> as be<strong>in</strong>g analogous to the float <strong>of</strong> a new companywith very little track record on the stock market. People may be persuaded to buy itsshares <strong>in</strong>itially, just as people were <strong>in</strong>itially persuaded to hold tolars. But how thevalue <strong>of</strong> the shares will change <strong>in</strong> the future is anybody’s guess <strong>and</strong> it depends, to alarge extent, on how the company is managed. Likewise, the value <strong>of</strong> the tolarstabilized <strong>in</strong> terms <strong>of</strong> goods <strong>and</strong> other currencies as soon as it became clear that itwas managed well by the central bank. This meant that more <strong>and</strong> more peoplewere will<strong>in</strong>g to hold it, <strong>and</strong> to hold <strong>in</strong>creas<strong>in</strong>g amounts. As expected, <strong>in</strong>flationdecl<strong>in</strong>ed, the dem<strong>and</strong> for real cash balances <strong>in</strong> tolars <strong>in</strong>creased, <strong>and</strong> the <strong>in</strong>flationarymomentum was <strong>in</strong>terrupted. 17Indeed, <strong>in</strong> a situation like that <strong>of</strong> Slovenia <strong>in</strong> 1991, one cannot emphasize enoughhow important it was for the government strategy to be <strong>in</strong> tune with a w<strong>in</strong>n<strong>in</strong>gcoalition <strong>of</strong> voters. S<strong>in</strong>ce a real possibility existed that <strong>in</strong>flationary expectationsassociated with the d<strong>in</strong>ar would extend to the tolar, a crucial aspect <strong>of</strong> the success<strong>of</strong> the reform was the Slovenian central bank’s ability to successfully leveragethe unstable economic environment <strong>and</strong> to <strong>in</strong>fluence popular expectations,thereby break<strong>in</strong>g the <strong>in</strong>flationary momentum. On October 8, 1991, <strong>in</strong> addition to<strong>in</strong>troduc<strong>in</strong>g the tolar as sole legal tender <strong>in</strong> Slovenia, the Monetary Unit CurrencyAct also established that the new national currency was to be convertible from thebeg<strong>in</strong>n<strong>in</strong>g, <strong>and</strong> was to trade freely aga<strong>in</strong>st the d<strong>in</strong>ar <strong>and</strong> other <strong>in</strong>ternationalcurrencies.The importance <strong>of</strong> the coalition between the Slovenes <strong>and</strong> their monetaryauthorities is further illustrated by compar<strong>in</strong>g the Slovenian experience <strong>in</strong> stopp<strong>in</strong>g<strong>in</strong>flation with the <strong>in</strong>flationary dynamics with<strong>in</strong> the Croatian economy over theperiod January 1992–December 1999. In Croatia, the reform has not been able tocreate the alignment <strong>of</strong> <strong>in</strong>centives between monetary authority <strong>and</strong> populationwitnessed <strong>in</strong> Slovenia. In fact, the structural break <strong>in</strong> the <strong>in</strong>flationary processcorrespond<strong>in</strong>g to the Croatian anti-<strong>in</strong>flationary stabilization program <strong>of</strong> October1993 has shown the Croatian <strong>in</strong>flation to be positively related to wage growth <strong>and</strong>currency depreciation (Payne 2002). Despite almost 10 years <strong>of</strong> low <strong>in</strong>flation,Croatia cont<strong>in</strong>ues to experience high levels <strong>of</strong> currency substitution. Roughly,three-quarters <strong>of</strong> bank deposits <strong>and</strong> currency <strong>in</strong> circulation are held <strong>in</strong> foreigncurrency, especially US dollars <strong>and</strong> euros (Kraft 2003). This significantly limits theability <strong>of</strong> the Croatian central bank to conduct its own <strong>in</strong>dependent monetarypolicy. The country payment system is also affected s<strong>in</strong>ce banks, <strong>in</strong> try<strong>in</strong>g to avoidbalance sheet mismatches, are forced to l<strong>in</strong>k via <strong>in</strong>dexes all credit transactions tothe exchange rate. Such an environment <strong>in</strong>creases credit risk, reduces the amount


158 Maria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnik<strong>of</strong> lend<strong>in</strong>g, <strong>and</strong> may slow down the development <strong>of</strong> domestic markets. In addition,the possibility <strong>of</strong> some unexpected depreciation could lead to further flight from thecurrency. Although moderate <strong>in</strong> recent years, currency substitution could thenbecome an <strong>in</strong>flation pass-through. Policy options such as the adoption <strong>of</strong> the euroas the <strong>of</strong>ficial currency or the imposition <strong>of</strong> more strict limits for the dirty floatcurrently applied have all been discussed (Vujic <strong>and</strong> Wachtel 2003). Nevertheless,unlike Slovenia, Croatia rema<strong>in</strong>s vulnerable to the possibility <strong>of</strong> a new <strong>in</strong>flationaryspiral.The stabilization period <strong>and</strong> the virtuous circleA crucial aspect for the <strong>in</strong>troduction <strong>of</strong> the new currency <strong>and</strong>, <strong>in</strong> general, for thesuccess <strong>of</strong> the stabilization process was the central bank’s choice <strong>of</strong> an appropriateexchange rate. Several arrangements were possible with respect to the foreignexchange system. Among them was the use <strong>of</strong> a currency board <strong>in</strong> which the tolarwould be l<strong>in</strong>ked to the Deutschemark through a fixed conversion rate <strong>and</strong> the issue<strong>of</strong> tolars would be fully backed by foreign exchange reserves. 18 The currency boardwas ruled out because Slovenia did not have foreign exchange reserves <strong>and</strong> externalf<strong>in</strong>ancial support could not be secured to allow this arrangement to succeed. 19 Analternative proposal contemplated the <strong>in</strong>troduction <strong>of</strong> a parallel currency tocirculate alongside the Yugoslav d<strong>in</strong>ar. Under this arrangement, both currencieswould have rema<strong>in</strong>ed legal tenders. This proposal was strongly opposed from thebeg<strong>in</strong>n<strong>in</strong>g because the existence <strong>of</strong> the new currency alongside the old d<strong>in</strong>ar wouldhave reduced the perception <strong>of</strong> complete autonomy from the old regime <strong>and</strong>weakened popular support. This, <strong>in</strong> turn, would only aggravate the exist<strong>in</strong>gcurrency substitution problem while, at the same time, leav<strong>in</strong>g Slovenia exposed toYugoslav <strong>in</strong>flation <strong>and</strong> monetary attacks.Although the pegg<strong>in</strong>g option, favored by foreign experts, was debated for a fewmonths, the newly created central bank, <strong>and</strong> the political leadership headed byPrime M<strong>in</strong>ister Lojze Peterle, both stood firmly <strong>in</strong> favor <strong>of</strong> a s<strong>in</strong>gle <strong>in</strong>dependentcurrency, <strong>of</strong> a float<strong>in</strong>g exchange system, <strong>and</strong> <strong>of</strong> monetary rigor. Their position,eventually, prevailed. 20 Initially, the Deutschemark was used as the reference currency,<strong>and</strong> the start<strong>in</strong>g exchange rate for assets <strong>and</strong> liabilities <strong>in</strong> foreign currencieswas set to be 32 tolars per Deutschemark. 21 The <strong>in</strong>itial tolar exchange rate was setrather arbitrarily to match the real exchange rate <strong>of</strong> the d<strong>in</strong>ar. From October 1991to June 1992, the external value <strong>of</strong> the tolar decl<strong>in</strong>ed sharply. The depreciation hadseveral causes. First, the new central bank had not yet built its reputation. Second,while popular expectations about the new currency were very optimistic, there wasstill some currency substitution. Third, <strong>in</strong>flation, although decreas<strong>in</strong>g, was stillsignificant. Throughout 1992 the Bank <strong>of</strong> Slovenia ma<strong>in</strong>ta<strong>in</strong>ed its commitmentto domestic stability. Thus, monetary policy was aimed at regulat<strong>in</strong>g the moneysupply, while the exchange rate was determ<strong>in</strong>ed endogeneously. 22By April 1992, six months after the creation <strong>of</strong> the central bank, <strong>and</strong> less than ayear after <strong>in</strong>dependence, the creation <strong>of</strong> a new <strong>in</strong>dependent monetary area <strong>and</strong> the<strong>in</strong>troduction <strong>of</strong> a new stable fiat currency both had been successfully accomplished.


No-name money 159While <strong>in</strong>flation <strong>in</strong> the rest <strong>of</strong> Yugoslavia accelerated very quickly, Slovenianmonthly <strong>in</strong>flation, after a very short period <strong>of</strong> two-digit rates, decl<strong>in</strong>ed consistentlyuntil it slowed down to 1.4 percent <strong>in</strong> August 1992. The Slovenian monthly<strong>in</strong>flation rate <strong>in</strong> October 1991 had exceeded that <strong>of</strong> Yugoslavia, by April 1992 ithad decl<strong>in</strong>ed to 5.1 percent, while Yugoslavia was enter<strong>in</strong>g hyper<strong>in</strong>flation withmonthly rates exceed<strong>in</strong>g 70 percent. The Yugoslav <strong>in</strong>flation peaked at 102 percentper month <strong>in</strong> June 1992. In the same time period, Slovenian <strong>in</strong>flation had decreasedto 2.4 percent per month. 23Under a technical po<strong>in</strong>t <strong>of</strong> view, Slovenia made the “right” anti-<strong>in</strong>flationarydecisions by trigger<strong>in</strong>g a “virtuous circle” (<strong>Yeager</strong> 1981: 34). Specifically, a virtuouscircle is created by the simultaneous adoption <strong>of</strong> a restrictive monetary policy <strong>and</strong> afloat<strong>in</strong>g exchange rate regime for the new currency. In Slovenia, the appreciation<strong>of</strong> the new domestic currency on the foreign exchange market lowered the domesticprices <strong>of</strong> imported goods <strong>and</strong> those <strong>of</strong> import-compet<strong>in</strong>g <strong>and</strong> export goods. Thus,facilitated by the reduced growth <strong>of</strong> the money supply, the tolar ga<strong>in</strong>ed additionalstrength on <strong>in</strong>ternational markets. Of course, the virtuous circle work<strong>in</strong>g throughimport <strong>and</strong> export prices is particularly important for a country as small as Slovenia,whose growth <strong>and</strong> development rely so heavily on <strong>in</strong>ternational markets. This is sobecause by enabl<strong>in</strong>g the adjustment <strong>of</strong> <strong>in</strong>ternal <strong>and</strong> external prices to new tradepatterns, the float<strong>in</strong>g exchange rate promoted a quicker adjustment <strong>of</strong> expectations.In addition, these adjustments helped the country to allocate resources <strong>and</strong> effortstowards comparatively advantageous sectors. 24F<strong>in</strong>ally, temporary measures <strong>in</strong>clud<strong>in</strong>g some price controls also proved useful <strong>in</strong>break<strong>in</strong>g the momentum <strong>of</strong> <strong>in</strong>flation dur<strong>in</strong>g the first couple <strong>of</strong> years after the <strong>in</strong>troduction<strong>of</strong> the new currency. In fact, the analysis <strong>of</strong> the catch up component <strong>of</strong>the <strong>in</strong>flationary momentum leads to the question whether it is better to achievestabi lization gradually or through a shock therapy. Gradualism is favored by argumentsthat h<strong>in</strong>ge on its ability to reduce the friction caused by changes <strong>in</strong> the allocation<strong>of</strong> resources. Additionally, gradualism is supported s<strong>in</strong>ce it takes time toachieve the degree <strong>of</strong> credibility necessary for avoid<strong>in</strong>g severe side effects <strong>and</strong>to change expectations. Arguments aga<strong>in</strong>st gradualism, on the other h<strong>and</strong>, claimthat gradualism leaves sufficient time for speculation <strong>and</strong> <strong>in</strong>flation hedg<strong>in</strong>g, <strong>and</strong>that gradualism may hide a dramatic policy change <strong>and</strong>, therefore, fail <strong>in</strong> turn<strong>in</strong>garound expectations <strong>and</strong> weaken<strong>in</strong>g popular support. The Slovenian stabilizationprocess succeeded <strong>in</strong> creat<strong>in</strong>g the perception <strong>of</strong> a dramatic policy change. It is thisperception that assured voters’ support while, at the same time, tak<strong>in</strong>g a moregradual approach with respect to areas less exposed to popular scrut<strong>in</strong>y <strong>and</strong> concern.Specifically, the stabilization program adopted a slow <strong>and</strong> gradual strategywith respect to the reorganization <strong>of</strong> the bank<strong>in</strong>g <strong>in</strong>dustry.At the time <strong>of</strong> the newly acquired <strong>in</strong>dependence <strong>and</strong> <strong>of</strong> the ongo<strong>in</strong>g war <strong>in</strong> therest <strong>of</strong> Yugoslavia, Slovenian banks found themselves hold<strong>in</strong>g a large portion <strong>of</strong>their asset portfolios <strong>in</strong> the form <strong>of</strong> non-perform<strong>in</strong>g loans, or frozen <strong>in</strong> repossessedYugoslavian assets. 25 These losses, which were <strong>in</strong>creas<strong>in</strong>g rapidly because <strong>of</strong><strong>in</strong>flation, were recorded on the balance sheet <strong>of</strong> the Yugoslavian central bank <strong>and</strong>were recognized at the federal level as public debt. The newly created Bank <strong>of</strong>


160 Maria M<strong>in</strong>niti <strong>and</strong> Lidija PolutnikSlovenia, however, did not report those debts <strong>in</strong>to its balance sheet nor recognizedthem as its liability toward commercial banks. To do so would have meant to be<strong>in</strong>solvent from <strong>in</strong>ception. Instead, commercial banks were obliged to cont<strong>in</strong>uekeep<strong>in</strong>g these losses <strong>in</strong> their balance sheets as claims aga<strong>in</strong>st the Yugoslaviancentral bank. Of course, under these conditions, most Slovenian banks became<strong>in</strong>solvent. Thus, to prevent the collapse <strong>of</strong> the bank<strong>in</strong>g system, the new Sloveniangovernment enacted a bank-specific rehabilitation program aim<strong>in</strong>g at support<strong>in</strong>gbanks <strong>and</strong> prevent<strong>in</strong>g an epidemic <strong>of</strong> bank failures (M<strong>in</strong>niti <strong>and</strong> Polutnik 1999).The Slovenian experience with stopp<strong>in</strong>g <strong>in</strong>flation<strong>Yeager</strong> (1981) identifies some general features <strong>of</strong> <strong>in</strong>flation whose analysis is fundamentalwhen <strong>in</strong>vestigat<strong>in</strong>g ways to reduce its <strong>in</strong>cidence. Among these features, theimportance <strong>of</strong> the <strong>in</strong>flationary momentum, that is the ability exhibited by <strong>in</strong>flationto perpetuate <strong>and</strong> deepen itself, is especially emphasized. Specifically, the <strong>in</strong>flationarymomentum is described as hav<strong>in</strong>g three dist<strong>in</strong>ct elements: (1) the credibilitycomponent; (2) the catch up component; (3) the expectations component. Clearly,all three elements are strictly related. The Slovenian case shows how the threeaspects culm<strong>in</strong>ated <strong>in</strong> a change <strong>of</strong> <strong>in</strong>flationary expectations. We argue such achange, together with a sound monetary policy, to be a necessary condition for thesuccessful <strong>in</strong>terruption <strong>of</strong> the <strong>in</strong>flationary momentum.The formation <strong>of</strong> expectations may be discussed by consider<strong>in</strong>g the length <strong>of</strong> theadjustment process between change <strong>in</strong> prices <strong>and</strong> changes <strong>in</strong> real cash balances.Desired levels <strong>of</strong> real cash balances depend on actual changes <strong>in</strong> prices. In anenvironment characterized by rapidly chang<strong>in</strong>g <strong>in</strong>flation, actual levels <strong>of</strong> real cashbalances are not equal to desired levels. Once decided on the desired level,<strong>in</strong>dividuals can easily adjust their actual balances by spend<strong>in</strong>g them or by sell<strong>in</strong>gother assets for cash. At the time <strong>of</strong> the Yugoslavian regime, Slovenes had done justthat by substitut<strong>in</strong>g d<strong>in</strong>ars with foreign currency. Also, <strong>in</strong> order to choose anappropriate level for their cash balances, <strong>in</strong>dividuals look back <strong>in</strong> time <strong>in</strong> order toassess the current trend <strong>of</strong> prices (Cagan 1956). But there was no trend for theSlovenes. Thus, they could have easily cont<strong>in</strong>ued hold<strong>in</strong>g foreign currency. Thisrisk was re<strong>in</strong>forced by the second element <strong>of</strong> the <strong>in</strong>flationary momentum, that is itscatch up component.The expectation component <strong>of</strong> the <strong>in</strong>flationary momentum makes the credibility<strong>of</strong> an anti-<strong>in</strong>flation policy very important <strong>in</strong> determ<strong>in</strong><strong>in</strong>g the overall costs <strong>of</strong> thestabilization process. Although <strong>in</strong>flation is always a monetary phenomenon, thefact that it may be stopped with a drastic change <strong>in</strong> the political situation suggeststhat its creation <strong>and</strong> sanction<strong>in</strong>g have also political roots. Interest<strong>in</strong>gly, muchhistorical evidence illustrates the importance <strong>of</strong> political <strong>and</strong> social pressure <strong>in</strong>caus<strong>in</strong>g <strong>in</strong>flationary policies. In the case <strong>of</strong> Slovenia, however, political <strong>and</strong> socialcomponents embraced dis<strong>in</strong>flationary policies. With the exceptions <strong>of</strong> pricecontrols imposed by the Yugoslavian government, long-term contracts hadvirtually ceased to exist. Thus, there were no <strong>in</strong>fluential groups lobby<strong>in</strong>g <strong>in</strong> favor <strong>of</strong>ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g the status quo. In addition, “the paramount role <strong>of</strong> price stabilization


No-name money 161was re<strong>in</strong>forced by the fact that creation <strong>of</strong> a new currency was the very process <strong>of</strong>establish<strong>in</strong>g the credibility <strong>of</strong> a new state” (Bole 1996: 234).The temporal dimension <strong>of</strong> the process lead<strong>in</strong>g to the determ<strong>in</strong>ation <strong>of</strong> the value<strong>of</strong> a new fiat currency is also important. It contributes to the explanation <strong>of</strong> thepersistence <strong>of</strong> <strong>in</strong>flation even after its monetary causes have been removed. In thecase <strong>of</strong> Slovenia, the <strong>in</strong>flation rate decl<strong>in</strong>ed rapidly <strong>and</strong> settled, with<strong>in</strong> a few months,at levels that compared favorably with most Western European economies. Thishappened because the anti-<strong>in</strong>flation program was sufficiently credible to overturnexpectations <strong>and</strong> cause at least a sufficient number <strong>of</strong> <strong>in</strong>dividuals to revise theirexpectations accord<strong>in</strong>gly. If prices, <strong>in</strong>clud<strong>in</strong>g the prices <strong>of</strong> labor, rise at a significantrate for a prolonged period <strong>of</strong> time, <strong>in</strong>dividuals learn how to predict those changes<strong>and</strong> adjust their expectations accord<strong>in</strong>gly. A new restrictive policy has the potentialfor succeed<strong>in</strong>g <strong>in</strong> stopp<strong>in</strong>g <strong>in</strong>flation only if <strong>in</strong>dividuals are will<strong>in</strong>g to respond to it.And <strong>in</strong>dividuals react to the policy only if the strength <strong>of</strong> the signal is such to makethem fear that, by not adjust<strong>in</strong>g their behavior, they will lose competitiveness.Evidently, <strong>in</strong> Slovenia, a sufficient number <strong>of</strong> <strong>in</strong>dividuals believed that otherswere to have similar perceptions <strong>and</strong> revised their expectations <strong>and</strong> behavioraccord<strong>in</strong>gly. Thus, given the restrictive policy implemented, the new actual rate <strong>of</strong><strong>in</strong>flation emerged as the un<strong>in</strong>tended consequence <strong>of</strong> adjustments <strong>in</strong> <strong>in</strong>dividualexpectations.F<strong>in</strong>ally, the <strong>in</strong>itial exchange ratio <strong>of</strong> one tolar for one d<strong>in</strong>ar performed the role <strong>of</strong>a “launch<strong>in</strong>g vehicle.” 26 But, <strong>in</strong> fact, the exchange ratio between goods <strong>and</strong> services<strong>and</strong> the tolar was not yet established. Although the policy switch had changed theequilibrium price level, this new equilibrium was still unknown <strong>and</strong>, as discussedpreviously, partly dependent on changes <strong>in</strong> people’s expectations. S<strong>in</strong>ce moneydoes not have a specific market, the determ<strong>in</strong>ation <strong>of</strong> its “price” has to be reachedthrough adjustments <strong>and</strong> trials <strong>in</strong> all markets, <strong>and</strong> such a process may take a longtime. This is a process with multiple possible equilibria, <strong>in</strong>clud<strong>in</strong>g a non-monetaryone <strong>in</strong> which the currency fails to receive acceptance. Indeed, this was certa<strong>in</strong>ly apossibility <strong>in</strong> Slovenia, where people still remembered negative experiences withprevious conversions <strong>and</strong> where a large portion <strong>of</strong> the country’s wealth was alreadykept <strong>in</strong> foreign currency. Interest<strong>in</strong>gly, <strong>in</strong> the case <strong>of</strong> Slovenia, the <strong>in</strong>itial exchangerate with the d<strong>in</strong>ar did represent a “launch<strong>in</strong>g vehicle,” but the new currencyworked exactly because the <strong>in</strong>itial parity was immediately ab<strong>and</strong>oned. In otherwords, the tolar was accepted <strong>and</strong> used on the basis <strong>of</strong> trust, while its real value wasstill unknown.ConclusionShortly after the declaration <strong>of</strong> its <strong>in</strong>dependence, <strong>in</strong> 1991, Slovenia succeeded <strong>in</strong>reduc<strong>in</strong>g <strong>in</strong>flation <strong>and</strong> <strong>in</strong> establish<strong>in</strong>g a new political system. This success wasaccomplished through a gradual approach that <strong>in</strong>cluded tight controls over themoney supply <strong>and</strong> some temporary controls on selected prices. In this paper, weargued that one <strong>of</strong> the crucial factors that allowed the success <strong>of</strong> the stabilizationprocess was the <strong>in</strong>troduction <strong>of</strong> a new, <strong>in</strong>dependent <strong>and</strong> freely float<strong>in</strong>g currency. In


162 Maria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnikaddition to enabl<strong>in</strong>g the Bank <strong>of</strong> Slovenia to implement a new course <strong>of</strong> monetaryaction, the tolar strengthened popular support for the new government <strong>and</strong>cemented a rapid <strong>and</strong> significant change <strong>in</strong> expectations.Dur<strong>in</strong>g periods <strong>of</strong> hyper<strong>in</strong>flation, expectations cause the velocity <strong>of</strong> money toaccelerate as <strong>in</strong>flation <strong>in</strong>creases, <strong>and</strong> to decrease as stabilization policies take place.But the change <strong>in</strong> expectations necessary for this switch to happen requires morethan a change <strong>in</strong> monetary policy. The Slovenian authorities exhibited remarkabletechnical competence <strong>and</strong> based the stabilization process on sound monetarypolicy <strong>and</strong> a freely convertible new currency. S<strong>in</strong>ce a real possibility existed that<strong>in</strong>flationary expectations associated with the d<strong>in</strong>ar would extend to the tolar, acrucial aspect <strong>of</strong> the success <strong>of</strong> the reform was the central bank’s ability tosuccessfully leverage the unstable economic environment <strong>and</strong> to <strong>in</strong>fluence popularexpectations, thereby break<strong>in</strong>g the <strong>in</strong>flationary momentum.The Slovenes’ will<strong>in</strong>gness to accept the unknown tokens <strong>in</strong> exchange for wellknownd<strong>in</strong>ars allowed the success <strong>of</strong> the conversion process. It is unlikely that thepopulation was aware <strong>of</strong> the necessity or desirability <strong>of</strong> controll<strong>in</strong>g the moneysupply. Instead, popular expectations were formed on the belief that Sloveniawould be better <strong>of</strong>f as an <strong>in</strong>dependent state than as a part <strong>of</strong> Yugoslavia. The adoption<strong>of</strong> the new monetary unit strengthened the perception that, <strong>in</strong>deed, policyhad entirely changed. Because <strong>of</strong> this belief, the Slovenes trusted, <strong>and</strong> will<strong>in</strong>glyaccepted, the new nameless tokens even before learn<strong>in</strong>g what their real purchas<strong>in</strong>gpower was go<strong>in</strong>g to be, thereby determ<strong>in</strong><strong>in</strong>g, endogenously, that real purchas<strong>in</strong>gpower be positive <strong>and</strong> a relatively stable one. Overall, without <strong>in</strong>fluential groupslobby<strong>in</strong>g <strong>in</strong> favor <strong>of</strong> ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>g the status quo, Slovenian political <strong>and</strong> socialcomponents embraced dis<strong>in</strong>flationary policies.In the end, <strong>of</strong> course, the more appeal<strong>in</strong>g aspect <strong>of</strong> the Slovenian story rema<strong>in</strong>sits ability to illustrate the unavoidable <strong>in</strong>terdependence between social environment,economic conditions, <strong>and</strong> politics. The Slovenian story shows how the <strong>in</strong>terdependence<strong>of</strong> these factors is especially significant <strong>in</strong> a risky l<strong>and</strong>scape such as thatcreated by hyper<strong>in</strong>flation. And f<strong>in</strong>ally, it shows how their <strong>in</strong>terplay sets the course<strong>of</strong> history <strong>and</strong>, ultimately, can make the difference between war <strong>and</strong> peace.Notes* We thank Michele Fratianni, Roger Koppl, Ross MacLeod, <strong>and</strong> Ivan Ribnikar forhelpful comments on earlier drafts <strong>of</strong> this paper. All errors are ours.1 Pleskovic <strong>and</strong> Sachs (1994) argue that other economies <strong>in</strong> transition benefited greatlyfrom the Slovenian experience.2 This claim is consistent with Menger’s view that the emergence <strong>of</strong> a monetary unit aswell as its value are both evolutionary phenomena (Menger 1976: Ch. VIII).3 Fischer (1982) argues that, under certa<strong>in</strong> conditions, benefits from an <strong>in</strong>dependentcurrency go well beyond those <strong>of</strong> seigniorage. The example <strong>of</strong> Slovenia suggests that thisis true even for a small economy.4 Bank <strong>of</strong> Slovenia, Annual Report, 1992.5 These reforms were proposed <strong>in</strong> 1987 <strong>and</strong> 1988 by the Mikulic government. At thattime, a monetary system committee was set up <strong>and</strong> led by Ivan Ribnikar. Two yearslater, Ribnikar, an economist who had always strongly advocated monetary stability <strong>and</strong>


No-name money 163private ownership, would jo<strong>in</strong> Velimir Bole <strong>and</strong> Jose Menc<strong>in</strong>ger <strong>in</strong> advis<strong>in</strong>g Arhar, thenewly appo<strong>in</strong>ted governor <strong>of</strong> the Bank <strong>of</strong> Slovenia. In 1991 <strong>and</strong> 1992, the four men wereto become the architects <strong>of</strong> the monetary reform <strong>in</strong> Slovenia.6 The share <strong>of</strong> exports as a percentage <strong>of</strong> imports decreased from 105.97 percent <strong>in</strong> 1989to 87 percent <strong>in</strong> 1990 (Statistical Yearbook <strong>of</strong> the Republic <strong>of</strong> Slovenia 1996: 359).7 Yugoslavia had a decentralized central bank<strong>in</strong>g system. Each <strong>of</strong> the eight republics <strong>and</strong>autonomous prov<strong>in</strong>ces had its central bank. The federal govern<strong>in</strong>g body was composed<strong>of</strong> the governors <strong>of</strong> all central banks. With<strong>in</strong> each region, all claims <strong>and</strong> debts to thecentral bank<strong>in</strong>g system were resolved by the local central bank, with currency be<strong>in</strong>g theonly exception.8 Specifically, many voters still remembered the K<strong>in</strong>gdom <strong>of</strong> Serbs, Croats, <strong>and</strong> Slovenes,which preceded Yugoslavia, as well as World War II <strong>in</strong> which different Yugoslavianrepublics had fought on different sides.9 Statistical Yearbook <strong>of</strong> the Republic <strong>of</strong> Slovenia (1996).10 The decl<strong>in</strong>e <strong>of</strong> GDP among all Republics averaged 21 percent (Bank <strong>of</strong> Slovenia 1992,Annual Reports).11 On January 15, 1992, the European Community ratified Slovenia’s <strong>in</strong>dependence,thereby mak<strong>in</strong>g its existence <strong>of</strong>ficial. Six months later, the United Nations followed <strong>and</strong>recognized Slovenia as a sovereign country.12 The complete stabilization program is detailed <strong>in</strong> a report issued at the end <strong>of</strong> 1991 bythe Executive Council <strong>of</strong> the Assembly <strong>of</strong> the Republic <strong>of</strong> Slovenia (Assembly <strong>of</strong> theRepublic <strong>of</strong> Slovenia 1991).13 The name was chosen by the Parliament among several alternatives <strong>in</strong>clud<strong>in</strong>g tolar, lipa,krona, klas, karant, <strong>and</strong>, <strong>of</strong> course, Slovenian d<strong>in</strong>ar.14 A few restrictions were imposed on the conversion process. Amounts <strong>of</strong> up to 20,000d<strong>in</strong>ars (approximately twice the average monthly salary) were converted without anyrestrictions. Amounts between 20,000 <strong>and</strong> 50,000 d<strong>in</strong>ars, <strong>in</strong>stead, were converted <strong>in</strong>totolars <strong>and</strong> credited to the bearer’s current or sav<strong>in</strong>gs accounts. F<strong>in</strong>ally, amounts <strong>of</strong> over50,000 d<strong>in</strong>ars were converted only at branches <strong>of</strong> the Social Account<strong>in</strong>g Service or atspecial counters <strong>of</strong> the Bank <strong>of</strong> Slovenia. In all three cases the <strong>in</strong>stitutions convert<strong>in</strong>g thecash recorded the transaction <strong>and</strong> the identity <strong>of</strong> cash bearers. In l<strong>in</strong>e with the smoothness<strong>of</strong> the conversion, however, the number <strong>of</strong> cash operations exceed<strong>in</strong>g 20,000 wasnegligible.15 Because <strong>of</strong> the flexible exchange rate <strong>and</strong> because <strong>of</strong> the catch up effect <strong>of</strong> theYugoslavian hyper<strong>in</strong>flation, the value <strong>of</strong> the tolar rema<strong>in</strong>ed uncerta<strong>in</strong> for the 10 monthsfollow<strong>in</strong>g its <strong>in</strong>troduction.16 Dur<strong>in</strong>g the collapse <strong>of</strong> the Austro-Hungarian Monarchy at the end <strong>of</strong> World War I,south Slavs formed the State <strong>of</strong> Slovenes, Croats, <strong>and</strong> Serbs <strong>and</strong>, on December 1, 1918,jo<strong>in</strong>ed Serbia <strong>and</strong> Montenegro to form the new K<strong>in</strong>gdom <strong>of</strong> Serbs, Croats, <strong>and</strong> Slovenes.Until 1924, four currencies were <strong>in</strong> circulation <strong>in</strong> the K<strong>in</strong>gdom: crowns <strong>in</strong> the formerAustro-Hungarian regions, <strong>and</strong> d<strong>in</strong>ars, levs, <strong>and</strong> perpers <strong>in</strong> Serbia <strong>and</strong> Montenegro.After several attempts at reforms, central authorities <strong>in</strong>troduced an exchange rate <strong>of</strong> 4crowns per d<strong>in</strong>ar, thereby impos<strong>in</strong>g a significant penalty on crown holders. Slovenes,who at that time populated some <strong>of</strong> the least developed regions <strong>of</strong> the monarchy, traded<strong>in</strong> crowns <strong>and</strong> were among the most heavily penalized groups. Similarly, at the end <strong>of</strong>World War II, the Yugoslav government withdrew from circulation all occupationmonies (Croat kuna, Serbian d<strong>in</strong>ar, Reichsmarks, Italian liras, Hungarian pengos, etc.)<strong>and</strong> <strong>in</strong>troduced a new Yugoslavian d<strong>in</strong>ar. Each old currency was exchanged at adifferent rate for the new one. In addition, at the exchange, a maximum <strong>of</strong> 5,000 d<strong>in</strong>arswere paid <strong>in</strong> cash, while the rest rema<strong>in</strong>ed blocked aga<strong>in</strong>st receipts, which could beexchanged only after three additional months passed (Notel 1986: 508, 547).17 We are thankful to Ross MacLeod for suggest<strong>in</strong>g this useful analogy.18 Specifically, Pleskovic <strong>and</strong> Sachs (1994) proposed <strong>and</strong> advocated a currency board alongwith a fixed or pegged exchange rate regime.


164 Maria M<strong>in</strong>niti <strong>and</strong> Lidija Polutnik19 At the end <strong>of</strong> September 1991, the total foreign exchange reserves <strong>of</strong> the countryamounted to $170.1 million <strong>and</strong> consisted exclusively <strong>of</strong> commercial banks’ operat<strong>in</strong>gaccounts (Bank <strong>of</strong> Slovenia 1995: 42).20 The Slovenian government contracted advisory services from Jeffrey Sachs. Soon, however,substantial differences developed between the views <strong>of</strong> Sachs <strong>and</strong> Joze Menc<strong>in</strong>ger,at the time deputy prime m<strong>in</strong>ister <strong>of</strong> the economy (Menc<strong>in</strong>ger 1993a; Pleskovic <strong>and</strong>Sachs 1993). Eventually, <strong>in</strong> a memor<strong>and</strong>um issued on October 8, 1991, Western expertsJeffrey Sachs <strong>and</strong> Boris Pleskovic changed their view <strong>in</strong> favor <strong>of</strong> unrestricted float<strong>in</strong>g(Menc<strong>in</strong>ger 1993b: 11).21 Frankfurt cross exchange rates determ<strong>in</strong>ed other rates.22 This is consistent with <strong>Yeager</strong>’s concern that “Loosely speak<strong>in</strong>g, the smaller the countryis <strong>in</strong> relation to the rest <strong>of</strong> the world, the more the price <strong>in</strong>centives <strong>of</strong> adjustment occur athome rather than abroad” (<strong>Yeager</strong> 1968: 50).23 By 1994, however, the sharp decl<strong>in</strong>e <strong>of</strong> domestic <strong>in</strong>flation, coupled with some rema<strong>in</strong><strong>in</strong>gwage controls, produced a significant real wage <strong>in</strong>crease that, <strong>in</strong> turn, caused a sharpappreciation <strong>of</strong> the tolar <strong>and</strong> imports to <strong>in</strong>crease. As a result, the balance <strong>of</strong> paymentregistered a significant trade deficit. The Bank <strong>of</strong> Slovenia was forced to <strong>in</strong>tervene to stopthe foreign currency <strong>in</strong>flows by stabiliz<strong>in</strong>g the tolar <strong>and</strong> its foreign exchange reserves<strong>in</strong>creased to $770.1 million (Bank <strong>of</strong> Slovenia 1994: 28). At that time, the central bankadopted a substantive sterilization policy by issu<strong>in</strong>g bonds with warrants <strong>in</strong> order towithdraw liquidity from the market. This <strong>in</strong>dicates that, at least until that po<strong>in</strong>t, thecentral bank ma<strong>in</strong>ta<strong>in</strong>ed its commitment to monetary stability. This episode is analyzed<strong>in</strong> Koppl <strong>and</strong> Mramor (2003).24 Ribnikar (1998) argues that the adjustment <strong>of</strong> trade patterns executed with little to nomonetary distortion was necessary to guarantee that the Slovenian economy was sound<strong>and</strong> competitive enough to successfully survive its possible entry <strong>in</strong> the European Union<strong>and</strong> the adoption <strong>of</strong> yet another super-national currency.25 Most non-perform<strong>in</strong>g loans had been made to Slovenian companies that had lost theirmarkets <strong>in</strong> other Yugoslav republics.26 The concept <strong>of</strong> <strong>in</strong>itial fixed exchange rates as “launch<strong>in</strong>g vehicles” for new fiat currencyis discussed <strong>in</strong> Selg<strong>in</strong> (1994).ReferencesAssembly <strong>of</strong> the Republic <strong>of</strong> Slovenia (1991). 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12 Monetary disequilibriumtheory <strong>and</strong> AustrianmacroeconomicsFurther thoughts on a synthesisSteven HorwitzIt is a pleasure to contribute to a volume honor<strong>in</strong>g the work <strong>of</strong> Lel<strong>and</strong> <strong>Yeager</strong>. It haslong been my belief that Pr<strong>of</strong>essor <strong>Yeager</strong> is, perhaps, the most under-appreciatedmonetary theorist <strong>of</strong> the twentieth century. 1 He has contributed to our underst<strong>and</strong><strong>in</strong>g<strong>of</strong> the role <strong>of</strong> money <strong>in</strong> advanced economies <strong>and</strong> to the macroeconomicprocesses <strong>of</strong> those economies <strong>in</strong> ways that reveal pr<strong>of</strong>ound <strong>in</strong>sights <strong>in</strong>to theoper ation <strong>of</strong> the market process. His pursuit <strong>of</strong> “good economics” withoutsignificant regard to the w<strong>in</strong>ds <strong>of</strong> <strong>in</strong>tellectual fashion, whether those fashions bemethodo logical or ideological, along with his refusal to be pigeon-holed <strong>in</strong>to an allencompass<strong>in</strong>gschool <strong>of</strong> thought by which others could def<strong>in</strong>e, <strong>and</strong> perhaps dismiss,his work, make him an <strong>in</strong>spir<strong>in</strong>g role model for all who see themselves <strong>in</strong> similarterms. In the spirit <strong>of</strong> <strong>Yeager</strong>’s non-sectarianism, I would like to explore the connectionsbetween <strong>Yeager</strong>’s work <strong>in</strong> the monetary disequilibrium theory tradition<strong>and</strong> recent work <strong>in</strong> Austrian macroeconomics. What I hope to show is thatAustrians have much to learn from <strong>Yeager</strong> <strong>and</strong> that <strong>Yeager</strong>’s work is morecompatible with Austrian macroeconomics than he has been <strong>of</strong>ten will<strong>in</strong>g toadmit. 2 In f<strong>in</strong>d<strong>in</strong>g the common ground between these two bodies <strong>of</strong> work, I hope tocreate a common theoretical language through which might emerge a twenty-firstcentury macroeconomics that takes money, the disequilibrium market process, <strong>and</strong>monetary <strong>in</strong>stitutions more seriously.This attempt to f<strong>in</strong>d a common theoretical language that could <strong>in</strong>clude <strong>in</strong>sightsfrom both monetary disequilibrium theory <strong>and</strong> Austrian macroeconomics is <strong>in</strong>contrast to the argument <strong>in</strong> Rab<strong>in</strong>’s (2004: 203) otherwise excellent book that theAustrian theory is an “alternative” to the monetary disequilibrium approach <strong>and</strong>that Occam’s Razor dem<strong>and</strong>s that the Austrian approach be jettisoned because it is“unnecessarily specific” <strong>and</strong> because the monetary disequilibrium approach canexpla<strong>in</strong> the same phenomena more simply. Key to Rab<strong>in</strong>’s argument is his claimthat the sav<strong>in</strong>gs–<strong>in</strong>vestment nexus is largely a sideshow to the ma<strong>in</strong> monetaryissues. I will attempt to argue <strong>in</strong>stead that the two approaches can be comb<strong>in</strong>ed,rather than one subsumed <strong>in</strong> the other, <strong>and</strong> that, if anyth<strong>in</strong>g, we can make good use<strong>of</strong> Garrison’s (2001) three quadrant “macroeconomics <strong>of</strong> capital structure” modelto illustrate important aspects <strong>of</strong> <strong>Yeager</strong>’s approach.


Monetary disequilibrium theory <strong>and</strong> Austrian macroeconomics 167“The essential properties <strong>of</strong> the medium <strong>of</strong> exchange”<strong>and</strong> the market process<strong>Yeager</strong>’s (1968) underst<strong>and</strong><strong>in</strong>g <strong>of</strong> the monetary disequilibrium tradition beg<strong>in</strong>swith the fundamental properties <strong>of</strong> money. The most important <strong>of</strong> these propertiesis that money is the generally accepted medium <strong>of</strong> exchange. In an advancedeconomy, money is half <strong>of</strong> (virtually) every exchange. Although we normally th<strong>in</strong>k<strong>in</strong> terms <strong>of</strong> money holders buy<strong>in</strong>g goods <strong>and</strong> goods holders sell<strong>in</strong>g goods, it isfruitful to remember that the money holders are also sell<strong>in</strong>g money <strong>and</strong> the goodsholders are also buy<strong>in</strong>g money. The exchange <strong>of</strong> money for goods between twotraders is also an exchange <strong>of</strong> money for goods or goods for money <strong>in</strong> the pockets <strong>of</strong>each trader. <strong>Money</strong>’s role as half <strong>of</strong> every exchange po<strong>in</strong>ts out the way <strong>in</strong> which suchexchanges cannot even occur if money does not exist, <strong>and</strong> how potential exchangesthat are <strong>of</strong> mutual benefit might not take place if the supply <strong>of</strong> money is <strong>in</strong>sufficient,whatever that might mean. F<strong>in</strong>ally, it is through the monetary exchange processthat goods acquire prices reckoned <strong>in</strong> money, which enables actors to engage <strong>in</strong>economic calculation <strong>and</strong> contemplate more effectively the costs <strong>and</strong> benefits <strong>of</strong>their actions.Two other features <strong>of</strong> money that <strong>Yeager</strong> emphasizes are that the dem<strong>and</strong> formoney is a dem<strong>and</strong> to hold real money balances <strong>and</strong> that our acquisition <strong>of</strong> moneyhas a “rout<strong>in</strong>eness” to it that dist<strong>in</strong>guishes it from other goods. The so-called “cashbalance” approach to the dem<strong>and</strong> for money dates back at least to Mises, but it isemphasized <strong>and</strong> made effective use <strong>of</strong> <strong>in</strong> <strong>Yeager</strong>’s monetary theory. The dem<strong>and</strong>for money is understood to be a dem<strong>and</strong> to hold a certa<strong>in</strong> quantity <strong>of</strong> purchas<strong>in</strong>gpower <strong>in</strong> one’s wallet, pocket, or bank account. We dem<strong>and</strong> money by allow<strong>in</strong>g itto accumulate <strong>in</strong> our various money balances. When we spend money, we reduceour dem<strong>and</strong> for it. Another way to look at this is that money is one form <strong>in</strong> which wemight choose to store our wealth, thus the act <strong>of</strong> purchas<strong>in</strong>g is, to the buyer, a trade<strong>of</strong> a monetary asset for some other k<strong>in</strong>d <strong>of</strong> asset. The advantage <strong>of</strong> hold<strong>in</strong>g moneyrather than other assets is that money provides the service <strong>of</strong> be<strong>in</strong>g “available” ifone desires to make a purchase. This notion <strong>of</strong> “availability” is equivalent to“liquidity,” <strong>and</strong> the liquidity <strong>of</strong> the medium <strong>of</strong> exchange is (near) absolute. No otherasset can be costlessly used to make exchanges, thus the advantage that money hasover other assets.Noth<strong>in</strong>g <strong>in</strong> these first two properties <strong>of</strong> money would be strange to Austrianmacroeconomists. The first co<strong>in</strong>cides nicely with Menger’s (1892) work on theorig<strong>in</strong> <strong>of</strong> money <strong>and</strong> Mises’s (1980 [1912]) extensions <strong>of</strong> it <strong>in</strong> The Theory <strong>of</strong> <strong>Money</strong> <strong>and</strong>Credit. The second reflects a sound Austrian subjectivism, <strong>in</strong> recogniz<strong>in</strong>g that whatmoney does is precisely what every other good or service does – provide a stream <strong>of</strong>subjectively evaluated use-services. The “return” to money held is ultimately thesubjectively evaluated utility that actors expect from those availability services, justas the “return” to an automobile is the subjectively evaluated utility <strong>of</strong> the various(<strong>in</strong>clud<strong>in</strong>g but not limited to transportation) services it provides. 3These first two properties comb<strong>in</strong>e to provide the dist<strong>in</strong>ction between “actual”<strong>and</strong> “desired” money balances. Much confusion <strong>in</strong> monetary theory comes fromoverlook<strong>in</strong>g this dist<strong>in</strong>ction. Although it is true that at any moment <strong>in</strong> time, all


168 Steven Horwitzmoney is be<strong>in</strong>g held somewhere by someone, that does not mean that the supply<strong>and</strong> dem<strong>and</strong> for money are always <strong>in</strong> equilibrium with respect to each other. 4 Todraw that conclusion is to confuse the “desired” <strong>and</strong> the “actual,” or <strong>in</strong> the terms <strong>of</strong>the Swedish economists <strong>of</strong> the 1930s, it confuses the “ex ante” <strong>and</strong> the “ex post.”Just as with any other good where the amount purchased has to equal the amountsold, so too with money someone must be hold<strong>in</strong>g every dollar. However, that neednot mean people wish to hold those dollars, <strong>in</strong> the same way that goods markets <strong>in</strong>disequilibrium can mean frustrated potential buyers <strong>and</strong> sellers. Differences among<strong>in</strong>dividuals’ actual <strong>and</strong> desired hold<strong>in</strong>gs <strong>of</strong> money are proximal causes <strong>of</strong> themaffect<strong>in</strong>g the level <strong>of</strong> spend<strong>in</strong>g <strong>in</strong> the macroeconomy, as we shall see below. Whenthe supply <strong>of</strong> money is too large or too small, i.e., when we have <strong>in</strong>flation ordeflation, these discrepencies between actual <strong>and</strong> desired money balances appeareconomy-wide. The results are the various costs <strong>and</strong> discoord<strong>in</strong>ation associatedwith both <strong>in</strong>flation <strong>and</strong> deflation. To see those problems more completely, we needto turn to the third property noted above.<strong>Yeager</strong>’s (1968: 645) third property, the “rout<strong>in</strong>eness” <strong>of</strong> our acquisition <strong>of</strong>money, is one that has had less attention paid to it by Austrians historically, despiteit be<strong>in</strong>g at least as important as the other two for underst<strong>and</strong><strong>in</strong>g the monetaryeconomy. What <strong>Yeager</strong> argues is that we will always accept money <strong>in</strong> exchangeeven if this means temporarily hav<strong>in</strong>g more <strong>of</strong> it than we might wish to hold. Weknow we can always trade the excess for goods <strong>and</strong> services. The importantimplication <strong>of</strong> this <strong>in</strong>sight is that we have much more control over gett<strong>in</strong>g rid <strong>of</strong>money than we do obta<strong>in</strong><strong>in</strong>g it. This po<strong>in</strong>t is particularly important when money is<strong>in</strong> short supply. If one’s money balances are lower than one would wish, one hasonly two basic options: acquire more money, or reduce one’s expenditures. Giventhat money cont<strong>in</strong>ues to arrive <strong>in</strong> a rout<strong>in</strong>e way, by reduc<strong>in</strong>g one’s expenditures,one can allow one’s money balances to replenish. Balances can also be replenishedby <strong>in</strong>creas<strong>in</strong>g one’s <strong>in</strong>come or by sell<strong>in</strong>g <strong>of</strong>f assets, but both <strong>of</strong> those require thecooperation <strong>of</strong> will<strong>in</strong>g others. Reductions <strong>in</strong> expenditures are completely <strong>in</strong> thecontrol <strong>of</strong> the actor. With excess supplies <strong>of</strong> money, it certa<strong>in</strong>ly makes more sense toelim<strong>in</strong>ate the imbalance by spend<strong>in</strong>g it <strong>and</strong> acquir<strong>in</strong>g non-money assets than itwould to reduce one’s money hold<strong>in</strong>gs by reduc<strong>in</strong>g one’s <strong>in</strong>come!What becomes clear from <strong>Yeager</strong>’s approach is that discrepancies between theactual <strong>and</strong> desired quantity <strong>of</strong> money will result <strong>in</strong> changes <strong>in</strong> expenditures,affect<strong>in</strong>g the traditional macroeconomic aggregates. When actual hold<strong>in</strong>gs are lessthan desired hold<strong>in</strong>gs, expenditures will fall <strong>and</strong> recession will ensue <strong>in</strong> a process tobe explored below. When actual hold<strong>in</strong>gs exceed desired hold<strong>in</strong>gs, the excesses willbe spent, driv<strong>in</strong>g up prices <strong>and</strong> caus<strong>in</strong>g various forms <strong>of</strong> economic discoord<strong>in</strong>ationthat will also be explored below. The key po<strong>in</strong>t for reconcil<strong>in</strong>g <strong>Yeager</strong>’s approachwith that <strong>of</strong> the Austrians is to recognize that the former case, that <strong>of</strong> the <strong>in</strong>sufficientsupply, corresponds to the traditional monetary disequilibrium theory explanation<strong>of</strong> depressions, while the latter case, that <strong>of</strong> the excess supply, corresponds to theAustrian concern with <strong>in</strong>flation <strong>and</strong> the possibility that it could generate a bus<strong>in</strong>esscycle <strong>and</strong> eventual depression. These two theoretical approaches can fruitfully beseen as two elements <strong>of</strong> the same underly<strong>in</strong>g story.


Monetary disequilibrium theory <strong>and</strong> Austrian macroeconomics 169Central to that story is the market process that is kicked <strong>in</strong>to motion by eithercase <strong>of</strong> monetary disequilibrium. Rab<strong>in</strong> (2004: 71–4) describes this as “TheWicksell Process” (or what both Keynes <strong>and</strong> Friedman called the “fundamentalproposition <strong>in</strong> monetary theory”). We start by not<strong>in</strong>g that because the dem<strong>and</strong> formoney is a dem<strong>and</strong> for real purchas<strong>in</strong>g power, we need to dist<strong>in</strong>guish between thenom<strong>in</strong>al <strong>and</strong> real dem<strong>and</strong> for money. We then comb<strong>in</strong>e this po<strong>in</strong>t with the earlierargument that the actual/desired imbalance will either <strong>in</strong>crease or decrease spend<strong>in</strong>gdepend<strong>in</strong>g on the direction <strong>of</strong> the imbalance. The result <strong>of</strong> those changes <strong>in</strong>spend<strong>in</strong>g will be upward (<strong>in</strong> the case <strong>of</strong> too much money) or downward (<strong>in</strong> the case<strong>of</strong> too little) pressure on prices. As prices beg<strong>in</strong> to move <strong>in</strong> the appropriate direction,the nom<strong>in</strong>al dem<strong>and</strong> for money moves <strong>in</strong> the same direction – as prices beg<strong>in&l