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Thursday, February 24, 2011

The Hesitant Hand: Taming Self-Interest in the History of Economic Ideas

“The focus of this book,” according to its author, “is the interplay of self-interest, market, and the state in economic analysis from the mid-nineteenth century up through the latter stages of the twentieth.”

Much of this well-written study, however, is devoted to describing the intellectual origins of the approach to political economy known today as “Public Choice”—the economics of politics. Nevertheless, its subject is the history of the analysis of nonmarket activity generally.

Modern economics offers two separate grounds for interventionism. One traces its origins to John Maynard Keynes, the other to Arthur Cecil Pigou. Both were students of Alfred Marshall; both were fellows of King’s College, Cambridge, in the 1930s; and both proposed theories of “market failure.” Pigou was probably the first to examine so-called “market failure” within a Marshallian, microeconomic framework, pointing out how self-interest can produce systematic inefficiencies. His intellectual descendants often use the framework he created to conduct “welfare analyses” of positive and negative externalities, as well as of the taxes, subsidies, and other measures that are supposed to fix them.

Steven G. Medema deals with the Pigouvian legacy in this fascinating intellectual history. But Pigou lies somewhere in the middle of the story Professor Medema tells.

The book presumes familiarity with economic theory and contemporary ideas in political economy, so I would not recommend this book for the general reader. But anyone who has taken an introductory course in microeconomics should be reasonably comfortable with the discussion. The book opens with a short overview of Adam Smith’s explanation of how self-interest promotes the general welfare via the “invisible hand,” contrasting that view with the more statist approaches of the earlier French Physiocrats and English Mercantilists. In the hands of Smith, self-interest “had finally found legitimacy.” But this is not the Smith of laissez-faire caricature. Medema offers an impressive list of interventions Smith advocated, from regulating public hygiene to taxes on liquor. For Medema, Smith’s great achievement, however, was to make laissez-faire capitalism the “default mode” of government policy.

The next two chapters trace the swing from widespread support for laissez faire among British intellectuals back to a more interventionist proclivity in the latter nineteenth century in the writings of Jeremy Bentham, J. R. McCulloch, J. E. Cairnes, and especially John Stuart Mill and Henry Sidgwick. However, despite important reservations, the default remained laissez-faire capitalism, more or less.

In chapter four we see how, beginning with the Italian La Scienza delle Finanze and the work of the Swedish economist Knut Wicksell, some economists by the mid-twentieth century were beginning to integrate political incentives into the area that we today call “public finance,” something British political economy (Keynes included) had neglected to do. This gave rise to a systematic examination of the causes and consequences of “government failure.”

Chapter five discusses the contributions of Ronald Coase, who opened inroads into the study of nonmarket phenomena. What later became known as the “Coase theorem” emerged from an explicit critique of the Pigouvian market-failure theory (though, as Medema argues, not of Pigou himself), and is the basis of the “economic analysis of law” tradition and modern theories of regulation.

Chapter six addresses the Public Choice school itself, moving in a most welcome and informative way from intellectual to institutional history. It chronicles the beginnings of Public Choice from the University of Virginia in the late 1950s, to the ideological tensions that may have scattered its most important scholars in the 1960s, to its reestablishment at Virginia Polytechnic Institute and the founding of the Center for the Study of Public Choice, as well as the journal Public Choice, in the late 1960s.

Finally, chapter seven could actually stand alone as an essay on how, largely in the masterful hands of Richard Posner, the law-and-economics tradition evolved into the “economic analysis of law.”

This book reads a bit like a “Whig interpretation of the history of political economy,” in that it gives the impression that the developments in political economy after Smith have led to Public Choice as not only the predominant but perhaps the sole market-based theory of government failure.

Thus there is only the briefest, nonsubstantive reference to F. A. Hayek and his influential book The Road to Serfdom and none at all to Ludwig von Mises, who wrote many tracts critiquing the doctrine of interventionism. While their take on government failure does appreciate the role of (perverse) incentives in the political process, its main focus is on how knowledge and calculation problems tend to thwart interventionism by systematically creating negative unintended consequences.

But these are really nits I’m picking here. I wholeheartedly recommend this informative book to anyone with a little background in microeconomics who is interested in a history of Chicago and Virginia political economy told in a clear, scholarly, and engaging way.

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.