EconTalk: Law and Legislation

I recently listened to an EconTalk podcast featuring Don Boudreaux discussing with host Russell Roberts another book by F.A. von Hayek titled Law, Legislation, and Liberty. The focus is on a subtle, yet extraordinarily insightful distiction between what Hayek terms "the law" and what is merely legislation. But the discussion does not stop there and touches upon several other concepts treated by Hayek regarding the common law, spontaneous orders, and the use of knowledge in society.

At the beginning of the podcast Dr. Boudreaux and Dr. Roberts try to stress the importance of language and the particular words we use to describe the orders that emerge through human actions yet are not the product of any one mind's deliberate construction. We tend to anthropomorphize things like "the market" and "society" when they have no sentience; they have no ability to act on their own volition. We typically say that "the market" determines the price of such and such, or that "society" should strive to establish a more fair and equitable distribution of resources, but these are just abuses of language. Society is the derivation of an incomprehensible multitude of seperate, yet interconnected human actions. The market is a term we ascribe to the results of the interplay of these human actions, and the prices that are determined on the market are not products of "the market" as such, but instead are established by these actions. The market determines nothing; it is the people that establish the relative prices of resources in the economy.

Like prices, according to Hayek "the Law" also emerges from the interplay of human actions apart from any deliberate design by any one mind. Law can only be codified by authorities, not established by them. Hammurabi's code is cited as an example. Also, Dr. Roberts and Dr. Boudreaux use another interesting example to illustrate the point. Think of a cafeteria someplace where a table has someone's backpack on a chair or books on the table. Most people would assume that this table is claimed and would move on to find another place to sit. Although no one in particular is sitting there at the moment, we commonly regard the seat to be taken. No one has codified this fact; there is no rule stating that "if a table has either: a) a backpack on a seat, or b) books on the table, then it is currently in use by the person owning any of those materials." But if someone came and sat at the place with either a backpack or books on the table, many would percieve this to be a wrong committed against the person who's stuff was there first. It took no authority or legislation to establish that taking someone's seat is wrong. It was established by no one person, but instead emerged spontaneously from the actions of many people over time. This is one of the most important insights I ever encountered in that it conveys a few simple facts: 1) that no legislation is necessary to establish laws to which people adhere to in their day-to-day lives; 2) Laws, to the extent that legislation can establish them, are merely codifications of existing behavior; 3) Any disequilibrium (excuse the economic terminology but I know no other way to express this) between "the Law" and what is legislated by the legislators can only serve to cause confusion amongst the people, and results in the wasting of resources and productive effort as people now need to discover what the legislation states and how it differs from the existing actions of people as they truly act.

Roberts and Boudreaux also touch on another interesting concept as they were explaining the spontaneous emergence of prices on the market. They cite the housing market to provide examples but leave a very keen insight untapped. I now believe that there are no specific "markets" per se, at least to the extent that one can say "the housing market" or "the automobile market". There is a market for something to the extent that the good or service is similar. The more homogenized a good or service, then the more one can call the trading of it a market, ie. according to this definition there is an oil market, though this is tenuous to the extent that the crude varies (Canadian crude differs from Saudi crude and that from Texas crude). So in the real world most any goods and services are monopolies, at least in a very loose sense (again, I cannot think of a more apt way to express this). There is no better example to illustrate my point then that which is typically called the "housing market". Only one house exists at such and such address. Each house differs in its relative quality, size, age, and numerous other characteristics that make a house unique. What creates the competition, the downward or upward price pressures that are commonly attributed to supply and demand, are the extents to which there exist satisfactory substitutes for a particular good or service. The competitiveness of a market consists in the relative distances between 1st, 2nd, and so on best choices. So long as alternatives exist, then a market is "competitive", at least in the only sense that this term can be used to describe anything pertaining to reality. There exists no specific market, only one great economy wide market.

Friedrich von Hayek: A Model Scholar

I want to excerpt a fairly brief paragraph from F.A. von Hayek's book Individualism and Economic Order not because I believe it to be particularly insightful passage but that I think it is indicative of Hayek's method of analysis and attentiveness to detail. Hayek took pains to use the most precise language when articulating his message, and I think that many aspiring scholars can learn a lot from Hayek's precision, as well as from his conceptions of economics and social order.

Without further ado, here it is:
"But if our conclusions on the merits of the beliefs which are undoubtedly one of the main driving forces of our time are essentially negative, this is certainly no cause for satisfaction. In a world bent on planning, nothing could be more tragic than that the conclusion should prove inevitable that persistence on this course must lead to economic decay. Even if there is already some intellectual reaction under way, there can be little doubt that for many years the movement will continue in the direction of planning. Nothing, therefore, could do more to relieve the unmitigated gloom with which the economist today must look at the future of the world than if it could be shown that there is a possible and practicable way to overcome its difficulties. Even for those who are not in sympathy with all the ultimate aims of socialism there is strong reason to with that, now that the world is moving in that direction, it should prove practicable that a catastrophe be averted. But it must be admitted that today it seems, to say the least, highly unlikely that such a solution can be found. It is of some significance that so far the smallest contributions to such a solution have come from those who have advocated planning. If a solution should ever be reached, this would be due more to the critics, who have at least made clear the nature of the problem--even if they have despaired of finding a solution."

This is Hayek commenting toward the end of an essay written in 1935 on socialist calculation. Although scientifically the arguments of the planners and collectivists were not anywhere near as detailed and comprehensive as those of the market theorists, public opinion and the overall societal zeitgeist, at least throughout Europe and among the so-called intelligentsia, was thoroughly imbued with notions derived from a crude conception of marxism (class conflict, capitalist exploitation, etc). A preponderance of the populace favored some form of collectivism and, indeed, some of the most fascinating writings on the history of thought attempt to break down and interpret the development of the ideas pertaining to the various forms of socialism. Unfortunately, for all the eloquent rhetoric and grandiose speeches, the theoretical foundations of socialism were essentially empty and exceedingly vague. It was commonly lamented that after WWI when the old forms of governance in Central Europe disintegrated and the parties espousing socialism assumed power, they had no conception as how they were to govern. Believing that socialism was an inevitable and inexorable stage of a future human organization they failed to develop an idea as to how it would function once in practice!

Few people recognized this cataclysmic gulf that seperated our understandings of the functioning of a society based upon private property and, ostensibly, free markets versus the functioning of a mysterious and hitherto untried system based on collective ownership. The more famous, at least to those living today, Ludwig von Mises and F.A. Hayek.

Hayek had the only system that was functional and understandable according to economic theory on his side. He wrote extensively on the unintended consequences associated with an economic system that would increasingly blur the distinction between remuneration for individuals based upon the value-in-exchange of their contribution to the economy against the rewards stemming from political favors, and he felt that this distinction would eventually be eliminated altogether. It stood in 1935 as it does today, socialism remains an economic system incapable of being used to maintain and grow our standards of living. Numerous examples from the past 100 years attest to this fact. Despite the overwhelming intellectual case for capitalism and the free market, rather than unabashedly declaring that the free market was the only functional method--Mises wrote that socialism would be chaos--Hayek carefully argued that, although today socialism is inpracticable, this does not necessarily imply that it will forever be impracticable. He wrote that in the future there could be discoveries that would show that socialism would be at least as efficient as the capitalist system. If it's not practicable today this does not preclude anyone from searching for a satifactory solution for the future, and any attempt to arrive at a solution can only be encouraged by those aspiring to uncover it. Even if there is no solution to a problem today, there may be one for it in the future. But it would be foolhardy to implement an untried and unknown social system that has no theoretical justification.

Quote of the day (#2)

"[W]hile is it easy to protect a particular person or group against the loss which might be caused by an unforeseen change, by preventing people from taking notice of the change after it has occurred, this merely shifts onto other shoulders but does not prevent it. If, e.g., capital invested in very expensive plant is protected against obsolescence by new inventions by prohibiting the introduction of such new inventions, this increases the security of the owners of the existing plant but deprives the public of the benefit of the new inventions. Or, in other words, it does not really reduce uncertainty for society as a whole if we make the behavior of the people more predictable by preventing them from adapting themselves to an unforeseen change in their knowledge of the world. The only genuine reduction of uncertainty consists in increasing its knowledge, but never in preventing people from making use of new knowledge."

This quote can be found in the 21st footnote of Friedrich von Hayek's essay titled "Individualism: True and False". The essay is taken from a lecture given by Hayek in 1945, and a copy of it can be found in his book, published in 1948, Individualism and Economic Order.

"Individualism: True and False" is a fabulous essay, one that is filled with many interesting thoughts pertaining to the debate over Socialism and Capitalism, as well as a brief, yet thoroughly fascinating, explaination of the subtle differences between the ideas on individualism orginating from the French physiocrats and British classical liberals. But the most important idea that Hayek discusses is that on the distiction between institutions and human societal organizations based upon Reason, with a capital R, and those that have orginated without any specific design by the human mind. Hayak argues that much of what contributes to the cohesiveness of modern society is essentially unknowable to any one person--the extent of these processes cannot be grasped by any one mind, making it impossible for society to be successfully managed by rules and regulations conceived by the human mind (Reason) and then implemented in a top-down fashion. Hayek concludes that the only basis for a truly free and prosperous system of social organization consists in the adherence to a set of principles that serve to solidify and codify commonly agreed to norms that facilitate peaceable social cooperation. Hayek's views are humbling; it takes a lot of courage to admit that there may be limits to the extent that the human mind can fully grasp the extensiveness and magnificence of modern civilization.

The goal is to develop principles that treat people equally before the law and in the protection of their personal property rights, not in any programs or policies that have the objective to make all people equal absolutely. It seems that modern civilization and our method of social cooperation depends upon it, as Hayek warned "while it may not be difficult to destroy the spontaneous formations which are the indispensible bases of a free civilization, it may be beyond our power deliberately to reconstruct such a civilization once these foundations are destroyed." Yikes!

The Business Cycle: A Brief Introduction

My interest in economic theory stems from a desire to learn about what is commonly called the "business cycle". Since the beginnings of the "Subprime Crisis" in the housing market and the credit market problems that have become associated with the meltdown in many structured investment products I've tried to familiarize myself with what were the causes of these problems. Was it a fundamental, though necessary, defect inherent to capitalism? Was it government mismanagement as many free-market propenents are wont to blame? Does the crisis represent a need for more regulation and intervention by government?

Unfortunately I haven't determined precisely what were the causes of the recent economic crises. I became sidetracked reading about economic theory. I began by reading Schumpeter and became acquainted with his book Business Cycles: A Theoretical, Historical, and Statistical Analysis (though the abridged version). Schumpeter's book is a suberb history of capitalism. Starting at the beginnings of industrialization up to the early 20th century when the book was published, Schumpeter applies his theory of cyclical waves that are inherent to the capitalist system and are caused by how fast (or slow) new innovations are adopted by the system and how the effects of these innovations cause adaptations in surrounding industries.

The Schumpeterian theory does not coincide with what I found elsewhere, like in the work of von Mises, and the man who expounded upon the Misesian conception of the Business Cycle, F.A. von Hayek. In Prices and Production, Hayek argues that the cyclical fluctuations that have been experienced throughout the history of modern capitalism up to that point were not caused by anything inherent to the capitalist system, but instead were products of what Mises termed in his 1912 monetary treatise, "Fiduciary Media", ie. credit. Hayek's chief new contribution in the book was his insight into the stages of productions. After Bohm-Bawerk, Hayek and Mises combated a misconception found in the work of American economists F.H. Knight and John Bates Clark, where they argued that "capital" was a homegeneous fund, a flow of goods that is for all intents and purposes perpetual. The Austrians view "capital" as being heterogenous, with differing capital goods according to their relative specificities. Some elements of capital are relatively easy to transfer from industry to industry, but others, such as specific machinery equipment, are basically fixed in their employment in a specific industrial pursuit. Hayek also built upon Bohm-Bawerk's roundabout process of production by explaining that a longer period of production represents more capitalistic (capital intensive) methods of building and creating things.

According to the fiduciary media argument, the business cycle is caused by monetary inflation, this monetary inflation distorts economic calculation depending on where it is injected within the economic system. Typically, new money is introduced through the banking system, with the newly created funds appearing on the loan markets (because that is the main business of banks--to loan money) the rate of interest is artificially lowered below the "natural rate of interest". The Natural Rate is an insight credited to the Swedish economist Knut Wicksell, in which he explained that the natural rate is derived from the relative time preferences of individuals in society, reflected in how willing or unwilling they are to save money. More savings implies a lower natural rate of interest and, therefore, a lower time preference, and vice versa. If the rate of interest is artificially lowered below the natural rate, then the more capital intensive industries will mistakenly believe that it is now profitable (and it temporarily is) to construct more specific capital goods. A lower interest rate implies a lower time preference, which tells entrepreneurs that it is now potentially profitable to lengthen the period of production. For a while this will cause booms in the prices of many raw materials and other resources needed in the construction of this new plant equipment. Unfortunately, once the newly created money has worked its way upon the whole system through the payments of wages and spending habits of those recieving them, as well as through the purchases of the companies that recieved the new money, the interest rate will tend to rise toward the rate that was previously present before the inflation (though its rare for it to be precisely the same rate, for reasons too detailed to get into here). Since the time preference of those in society did not shift radically enough to justify the construction of much of the newly created capital goods, they are no longer as profitable as previously thought (if profitable at all), and this then calls for a liquidation of many of the enterprises that were created during the boom, with the more non-specific capital goods being shifted toward enterprises that are closer to consumption. The economic crisis that creates the notion of the "business cycle" is essentially this process of liquidation of pursuits that were altogether unsustainable, and these pursuits would not have been pursued had there been no monetary inflation in the economic system that served to distort the economic calculations of entreprenuers. Some capital is forever squandered and workers employed in the unsustainable enterprises must find new jobs. This is the view of Hayek and Mises.

This just touches the surface of the varying opinions about what causes the business cycle (I neglected to mention the Keynesian view). To be sure, there is much more worth investigating. In a later post I'll write about Mark Skousen's book The Structure of Production and what it says about the Business Cycle and the many theories that attempt to explain it.