The Chicago School in Historical Perspective Joseph W.H. Lough, Ph.D. Professor, Economic History,...

The Chicago School in Historical Perspective

Joseph W.H. Lough, Ph.D.Professor, Economic History, University of California, Berkeley

phone: +387 603375497 email: joseph.lough@gmail.comblogsite: http://www.newconsensus.org/New_Consensus/Welcome.html

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• The Problem

• Classical and neoclassical Economics

• Neoclassical Economics and the Chicago School

• Robert Lucas, Lectures on Economic Growth

The Problem

• In the early 19th century, GWF Hegel theorized a comprehensive, rational, thoroughly integrated, moral system that had become actual, real, over time.

The Problem

• When did economics become a science of everything?

The Problem

• Some common terms:

‣ οἶκος

‣ οἰκονομία

‣ δεσπότης

‣ πολιτεία

The Problem• For most of human history (~ 2.5M years)

and most places, individuals in communities have been guided by a wide variety of incommensurable, irreducible practical logics

• Social totality in such communities was impossible because the practical logics that governed individual’s behaviors could not be worked together into a rational consistent whole

The Problem• In western Europe, in the 14th century, for

the first time, human beings began to measure the value of productive human activity in equal units of abstract time

• This way of measuring human action and its products edged out other practical logics — religious, guild, familial, communal

• Over time these other practical logics were either folded into the new logic or they disappeared

The Problem

• By the 18th c. in western Europe social action was sufficiently integrated, rationalized, and comprehensive to lend itself to rigorous scientific modeling

The Problem

• Social totality was not invented by the economic science

• Economic science became possible when social action was sufficiently integrated, rational, and comprehensive as to lend it to rigorous economic modeling

Classical and Neoclassical Economics

• How would you distinguish classical from neoclassical economics?

Classical and Neoclassical Economics

• Some neoclassical definitions of our science:

• Since the value any buyer lends to any item falls either inside or beyond its marginal value; and since all such values in aggregate determine the value of that item, the subjective determination of value is identical to its objective value

Eugene Böhm-Bewerk 1888

Classical and Neoclassical Economics

• Science begins and ends with mathematics

Leon Walras 1874

Classical and Neoclassical Economics

• Mathematical modeling is the only form of modeling adequate to any science, including the moral sciences

WS Jevons 1871

Classical and Neoclassical Economics

• All of reality is subject to cause and effect, including economic reality

Carl Menger 1871

Classical and Neoclassical Economics

• Neoclassical economic theory more adequately grasps contemporary social reality because social reality is now structured by the economic rationality that rigorous mathematical economic theory measures

Neoclassical Economics and the Chicago School

• What is the Chicago School?

• Who are its rock stars?

• By whom was Chicago founded?

• Who held the first chair in Economics at Chicago?

Neoclassical Economics and the Chicago School

• Among Thorstein Veblen’s first articles as Chair of Economics were several reviews and articles devoted to the German Economist Gustav von Schmöller

• What is Gustav von Schmöller known for?

• What was Schmöller’s legacy?

Neoclassical Economics and the Chicago School

• The German Historical School held that social reality could not be reduced to rigorous mathematical modeling

• Wilhelm Roscher, Karl Knies, and Bruno Hildebrand held that, in addition to economic causation, social action was also shaped by culture, tradition, and physical and psychological forces that could not be reduced to rigorous mathematical modeling

Neoclassical Economics and the Chicago School

• Gustav von Schmöller set off a firestorm when he criticized Carl Menger for reducing economics to mathematics in the Methodenstreit.

• When von Schmöller retired as editor of the Archiv für Sozialwissenschaft und Sozialpolitik, he handed it off to Max Weber

Neoclassical Economics and the Chicago School

• The University of Chicago School of Economics was defined against the German Historical School

‣ rely only on rigorous mathematical modeling

‣ price is the central variable in economic modeling

‣ prices accurately reflect markets only where markets are free from distortions; where they reflect consumer and producer choice

‣ governments must not interfere with markets

Neoclassical Economics and the Chicago School

• Two scholars, three articles

‣ Jacob Viner, “Who Paid for the War?” Journal of Political Economy 28:1 (Jan. 1920) 46-76

‣ Frank Knight, “Ethics and Economic Reform: Liberalism” Economica NS 6:21 (Feb. 1939) 1-29

‣ Frank Knight, “Ethics and Economic Reform: Christianity” Economica NS 6:24 (Nov. 1939) 398-422

Neoclassical Economics and the Chicago School

• J Viner, “Who Paid for the War?”

‣ how did the US pay for its involvement in WWI?

‣ who purchased war bonds and how did these bonds perform?

‣ what happened to employment during the war?

‣ what happened to consumption during the war?

‣ who benefited from the war?

‣ should the purchasers of bonds be asked to pay for the war?

Neoclassical Economics and the Chicago School

• FH Knight, “Ethics and Economic Reform. Liberalism”

‣ liberalism is based on the absence of coercion in relations among individuals

‣ “economic” liberalism is not limited to economics but applies to all spheres of life

‣ economic rationality facilitates compromise and lessens conflict

‣ liberalism aims at efficiency; absent specific moral positions

‣ opponents of liberalism are by definition illiberal

‣ inequality is a natural consequence of liberalism

Neoclassical Economics and the Chicago School

• FH Knight, “Ethics and Economic Reform. Christianity”

‣ in 1931 Pope Pius XI issued his famous papal encyclical Quadragesimo Anno condemning capitalism as a system

‣ in 1939 the Oxford Conference on World Protestantism issued a similar condemnation

‣ Historical Christianity knew nothing of the market system

‣ Historical Christianity knows only submission to authority

‣ Submission helps create capitalism (T Veblen)

‣ Non-experts and public have no place in economic decision-making, which should be left up to experts and markets

Neoclassical Economics and the Chicago School

• Two more scholars, three articles

‣ G Becker, Competition and Democracy 1958

‣ Why is market competition more democratic than the ballot box?

‣ G Becker, Irrational Behavior and Economic Theory 1962

‣ Why are markets always by definition rational?

‣ M Friedman, Capitalism and Freedom1962

‣ Why is the free market a better guarantee of freedom than the US Constitution and Bill of Rights?

Neoclassical Economics and the Chicago School

• Race Relations?

• Racism is economically inefficient

• Poverty?

• Wages and benefits rise to equilibrium

• Licensing of physicians and engineers?

• Poor treatment and collapsing buildings is inefficient

• Gender discrimination?

• The market will decide

Neoclassical Economics and the Chicago School

• Problem:

‣ if society lends itself to rigorous mathematical modeling

‣ then wherein does freedom lie?

‣ if no “laws” governed the movement of subatomic particles (in aggregate)

‣ would physics be possible?

‣ does it make sense to speak of the “freedom” of quarks, muons, or any phenomenon subject to rigorous mathematical modeling?

Robert Lucas, Jr. and GWF Hegel

• The Chicago School was born out of the Methodenstreit between the Austrian School and the German Historical School

• Among Thorstein Veblen’s first articles at Chicago were vicious critiques launched against Gustav von Schmöller’s “Hegelian” (i.e., historical) approach to economic theory Thorstein Veblen, Quarterly Journal of

Economics16:1 (Nov. 1901) 69-93

Robert Lucas, Jr. and GWF Hegel

• Throughout the 1920s, 30s, 40s and 50s, Chicago economists inveighed against “unscientific” “historical” economic theory

• The aim of economic theory was solely to develop rigorous mathematical models that faithfully grasped the behavior of markets

Robert Lucas, Jr. and GWF Hegel

• How will we describe an economic theory . . .

‣ that assumes the comprehensive, rational integration of all social action?

‣ that assumes that this integration happens at a supra-personal, supra-individual level of abstraction?

‣ whose models operate “in the long run”?

‣ that presupposes eventual systemic equilibrium?

‣ that assumes an objective correspondence between theory and objective reality?

Robert Lucas, Jr. and GWF Hegel

• When it claimed that all social life lent itself to rigorous mathematical modeling, neoclassical economics in general, and the Chicago School in particular, could not avoid being pulled into the orbit of GWF Hegel

• But why did it take the Chicago School so long to recognize its debt to the historical school?

Robert Lucas, Jr. and GWF Hegel

• The central contradiction within neoclassical economic theory:

‣ liberal economic theory presupposes the indeterminacy of agents’ choices

‣ neoclassical economic theory presupposes that all choices (in aggregate) lend themselves to rigorous mathematical (scientific) modeling

‣ this means that, in aggregate, market choices are not indeterminate, but determinate

Robert Lucas, Jr. and GWF Hegel

• GWF Hegel and the Historical School avoided “metaphysical” premises about “human nature”

• The historical school limited itself to addressing economic behavior in aggregate over time

• As the Chicago School developed ever more rigorous models to grasp economic behavior — with ever more interdependent, mutually constitutive variables — it could not avoid developing a model of social totality that was Hegelian

Robert Lucas, Jr. and GWF Hegel

• Why does capital not flow down hill from rich to poor countries?

• The answer? Obviously because of market distortions; but what kind of market distortions in particular?

• Can we account for these distortions in rigorous mathematical models?

Robert Lucas, Jr. and GWF Hegel

• Let us begin with the standard Cobb-Douglas production function:

• y=income per worker; x=capital per worker; with a marginal product:

Robert Lucas, Jr. and GWF Hegel

• Problem:

‣ communities are not endowed with the same human capital

‣ different levels of human capital derive different benefits from A (the technology function)

will expand y from

so that

to

where h^γ measures variable rates of

benefits derived from technology

Robert Lucas, Jr. and GWF Hegel

• Problem:

‣ communities also encounter different imperfections in capital markets (interest rates, political stability, other risks, patent law enforcement, oligarchic factors, etc.)

‣ such differential imperfections in capital markets requires that we include a “monopolist” function that measures the opportunity cost of capital

Robert Lucas, Jr. and GWF Hegel

• For the sake of simplicity, Lucas chooses the classic case of a colonial power and its colony, where the producer enjoys monopoly power over wages:

• So that the major challenge is to ensure that monopoly profits sufficiently exceed market profits to justify costs:

Robert Lucas, Jr. and GWF Hegel

• We could and should add functions to account for urban-effects, information spill-overs (or blockages), climate pattern shifts, racism and ethnic effects (or cosmopolitanism), effects of local tradition and culture, religious effects, hegemonic effects (or “balkanization”)

• All of these effects can and should receive a specific weight (less than 1, but greater than 0) until our model accurately grasps actual social behavior globally within and between communities

Robert Lucas, Jr. and GWF Hegel

• If a community is failing to attract capital, we need to identify the variable that accounts for this market distortion

• What does this model assume?

Robert Lucas, Jr. and GWF Hegel

• It assumes that any factor that prevents, slows, or distorts the movement of capital and goods can be and must be eliminated if we want a comprehensive, integrated, rational, uniform global economy with as few distortions as possible.

• This means the elimination of all historical, cultural, social, and political particularities — because, by definition, these are distortions.

Robert Lucas, Jr. and GWF Hegel

• Communities following upon the initial rise in income in the UK in 18th century

• So what percentage of the world’s communities have shed their particularity and embraced the universal over time?

Robert Lucas, Jr. and GWF Hegel

• We now have the mathematical tools and models we need to accurately map and predict human behavior globally into the foreseeable future

• If we have these tools, we can use them to create the future

• We know where history is going and we know where it will end

Robert Lucas, Jr. and GWF Hegel

• We now grasp all of history together; its beginning and its end

• Its end (as we have seen) entails the elimination of all historical, social, cultural, regional, religious, institutional, legal and ethnic particularity; the elimination of particularity

• Its end (as we have seen) entails the creation of a comprehensive, rational, integrated, uniform global system that lends itself to rigorous mathematical modeling

Robert Lucas, Jr. and GWF Hegel

• A century and a half ago, neoclassical economic theorists objected to the “Hegelian” German Historical School of economic theory, arguing that the kind of society it theorized left no room for individuality, particularity: freedom

• A century and a half later, the Chicago School of Economics now contemplates just such a homogeneous, uniform, undifferentiated society

Robert Lucas, Jr. and GWF Hegel

• Begging the question . . .

• Where is freedom now?

• Is this the economics we want for the twenty-first century?

• And if not, what is the alternative?

• Do we have a choice?

The Chicago School in Historical Perspective