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I was asked to give remarks at the annual Colloquium of the Alexander Hamilton Institute in Clinton, NY regarding the establishment of a sister organization here in Rochester. A draft of that talk follows.

Forgive me for taking the chance to talk a little bit about economics before I say a few words about our new project with the AHI. I typically do not announce to folks that I am an economist in order to avoid the response of either a sympathetic, trite smile or more likely the ghastly gaze of fear, followed by, “I hated economics in college.”

Famed satirist Ambrose Bierce once described a cynic as a scoundrel whose faulty vision sees things as they are, not as they ought to be. He could just as well have been describing good economics. Let me apply some good economics to what economISTS have been doing.

Some economists have famously taken it upon themselves to use their PhD credentials to masquerade their normative views as positive economic policy propositions. I do not limit my remarks to only describe a certain New York Times columnist. In fact, it was such an act by someone once near and dear to me (and to whom I owe much of my success) that roused me from my intellectual naiveté and set my course toward the establishment of AHI-West.

In 5 years of PhD study at Cornell, I was blissfully unaware of the ideas and contributions of Hayek, Friedman, von Mises, Knight, Coase, Buchanan, Alchian, Demsetz, etc. I really did think of economics like a good utilitarian physical science, with each of us dedicating careers in the lab, analyzing data, in order to dispassionately contribute to some vague notion of the “common good.”

Until the Summer of 2006.

As you may recall, that is the summer when Congress debated and passed two minimum wage hikes, raising the minimum wage from $5.15 per hour to today’s $7.25 per hour. Among economists, and I suspect almost everyone in this room, it is well known that mandating pay increases in the name of helping the poor turns out to be a really bad way to help the poor. For starters, not many poor people make the minimum wage. But ignoring this inconvenient fact, raising the costs of hiring workers will end up sending some to the unemployment line, or making working conditions less pleasant, or reduce training opportunities, or raise prices, or reduce profits (which hurts the poor indirectly). There is no free lunch. You’d expect any good serious economist to understand this, especially if they are the author of the best-selling Labor Economics textbook which teaches these very ideas.

Well, you might imagine my surprise and dismay when I opened up the New York Times that summer to see a full-page ad taken out which printed a letter supporting the minimum wage hikes. Why the surprise? Among the leading signatories was the author of this textbook, who also was my dissertation advisor and mentor.

Surely this was a mistake. So I e-mailed him asking if what I had learned in school was wrong – that is it really true that minimum wages are effective poverty fighting tools. And his reply follows:

“I do not believe that the minimum wage is an effective way to fight poverty. My support and endorsement of the letter comes from the symbolic nature of the minimum wage. It was the first piece of protective labor legislation passed at the national level in the United States. Over time its value has eroded relative to average hourly earnings, … In a world in which … we are constantly giving tax breaks to the rich, we need to make a symbolic statement about our concern for the people who are less well off than us.”

There you have it – even ardent supporters of the minimum wage do it for symbolic reasons, even if it is useless economics. What is the harm in that? The harm is that government mandated prices are bad policy. Always have been, always will be. Mandated wage laws lead to an increasingly paternalistic economy that stifles creativity and business creation. Getting people comfortable with mandated wages will lead to them getting comfortable with other laws too.  Gas prices too high?  Lower them by fiat!  Salaries of managers too high?  Cap them!  Profits too high?  Tax ‘em!  Health care is too expensive: decree it to be cheaper! It all leads to a long and treacherous road to serfdom.

Sanctimonious strutting by statists like this does nothing to address the important question of what causes prosperity. Forcing entrepreneurs to increase their costs is both bad economics and morally wrong. Only by advocating policies that increase the ability of the poor to produce more goods and services can their lot be improved. A morality play in which those who care crusade against those that supposedly do not makes for great theater, but awful economic policy.

We’ve talked very little since that day 5 years ago. And I also have spent every day since that time learning economics from the ground up, by reading the original thinkers not only in economics, but history, philosophy, anthropology, sociology and more.  Were it not for organizations like the AHI and its kindred spirits, I probably would never have walked down this intellectual path. Milton Friedman was right about the importance of having “good ideas lying around for when people need them.”

Why the name, AHI-WEST

In a famous 1893 paper, historian Frederick Jackson Turner exclaimed the closing of the American West and advanced the idea that what we have come to know as the American spirit and rugged individualism was only possible due to the confluence of civilization and the now-non-existent wilderness frontier. I also submit that it was the ease of pioneers to exit from unfavorable government by moving 10 miles further West and the limited communication and transportation technologies at the time that limited the reach of the state into private life.

Turner argued that Westward expansion allowed settlers to cast off bad European institutions and adopt and experiment with new uniquely American ones – in addition to democracy and initiative, he also assumes violence, crudeness and informality were products of this settlement. He was wrong about the latter – it is somewhat remarkable that the Western miners, vigilantes and cattlemen (drawn from young males most susceptible to violence) chose contract again and again in dealing with disputes, and chose enterprise over government coercion in establishing important institutions. The West stood for freedom, order, entrepreneurship and contract.

Turner’s timing of the closing of the American West seems to correspond with what I consider a closing of the American (good liberal) mind. He is writing at a time when increasingly the thinking of American intellectuals and leaders reflected developments in Bismarkian Europe – wherein lies the rise of American Progressivism and the corporate state with which we live today.

So the name of our organization reflects far more than setting an azimuth of 270-degrees from Clinton, NY. The physical western frontier in America may be closed, but the intellectual frontier remains as open as ever. And as anyone who studies longitude knows there is no natural beginning and end and therefore no reason to believe that “Western” ideas as such face the prospect of a “natural” closing so long as pioneers still boldly trek forward with them.

The Complacency of Modern Economics

Our students have spent the entire year reading the works of Hayek. A major theme in his work is a condemnation of the complacency of 19th century liberals (in the good sense of the word) which allowed utilitarian ideas, unanchored from natural law and dismissive of evolved institutions, to dominate – thereby setting the stage for what Neal Stephenson describes in his 1999 novel, Cryptonomicon:

“The twentieth century was one in which limits on state power were removed in order to let the intellectuals run with the ball, and they screwed everything up and turned the century into an abattoir. . . . We Americans are the only ones who didn’t get creamed at some point during all of this. We are free and prosperous because we have inherited political and value systems fabricated by a particular set of eighteenth-century intellectuals who happened to get it right. But we have lost touch with those intellectuals.”

I blame many economists for a similar complacency in the 20th century. In promoting policy tweaks to perceived problems with markets, they have been assuming that people would understand and respect Adam Smith’s, David Hume’s, Adam Ferguson’s, David Ricardo’s ideas irrespective of whether they were widely read or taught today. Modern economists falsely assume that the failure of hot-blooded socialism permanently taught us to be humble regarding central planning in the presence of complex social processes.

The problem I am describing actually derives from a good faith effort by 20th century economists to identify the difficulties with currently accepted classical economic theories, by identifying “market failures” and sets of conditions for which these might be mitigated by enlightened policymakers. This is admirable and noble, especially if your audience respects the intellectual foundations that economics was built upon. But many intellectuals, and many in the lay public, are hostile to these ideas, and have been unwittingly handed a fulcrum that would make Archimedes blush to justify virtually any intervention into our peaceful, private voluntary associations.

Allow me to illustrate:

In modern economics, the very starting point of our first course, the very premise it begins with, is wrong. Our greatest minds and books start by asking, “What are the causes of poverty?” Note that Adam Smith never committed this error. The natural state of man is poverty. If you do nothing, you remain poor. Nothingness requires no explanation. It makes as much sense to ask what causes poverty as to ask “what caused Rizzo to miss that penalty shot during the New York Rangers hockey game last night?”

Even our most market friendly books then say, “poverty happens when we don’t have markets.” And then lay out unrealistic, undesirable and never existing conditions for what a “perfectly competitive market” would look like for it to work. This permits an easy attack on the assumptions without forcing opponents to attack the chains of logic which are the foundations of economics, not the assumptions of simplifying models.

For thousands of years nearly every human being lived in excruciating poverty, and despite the existence of some people today who said we were freer back then, or happier or better, it was risky, dangerous, lonely and scary. Life expectancy at time of Jesus was less than 25 years old and stayed that way until the 19th century, and for millennia average income was about $800 per year – imagine having $800 today and then imagine not even being able to spend it on anything that exists only today. The most powerful and wealthy people in the world saw half their children die before adulthood, they themselves died from simple infections, could not enjoy a cool drink on a hot day, nor do any of the thousands of things that even the poorest Americans take for granted each and every day today.

Market Capitalism as a Problem Solver, Not a Problem Creator

Then something happened, gradually from the 11th century to the 18th century, and an explosion since. It is this somethingness which requires explanation. Prosperity requires purposeful action that serves the ends of others and oneself. This action includes a massive expansion in entrepreneurial risk taking, a massive expansion of trade, a massive expansion of the division of labor, and an overall massive coordination of the actions, hopes and plans of billions of people from all the reaches of the globe.

The fundamental economic question is this: what prevented such massive coordination from taking place for so many thousands of years? What institutions emerged to lubricate and promote the intermingling of humanity in this beautiful fabric we call commercial society? What barriers did these institutions have to break down in order for human beings to flourish?

In other words, what economists now call “market failures” or statists call, “justifications for giving away some of our freedoms to the state,” are simply the natural barriers that prevent human cooperation from happening in the first place, and that had persisted in oppressive magnitudes until something emerged to overcome them.

Among the web of vital institutions that emerged is this thing called market capitalism – an evolved social order based upon the peaceful exchange of private property rights to goods and services. You see, socialism fails NOT because we are not all priests and altruists, quite the contrary. No, socialism (or its lighter manifestations today) does not work because it is far inferior at overcoming these barriers than other evolved institutions. It simply is not true that “man is not yet good enough for socialism,” quite the opposite. Socialism is not good enough for man.

The entire idea of “market failure” is an unfunny non-sequitur. Man in his NATURAL state is inundated with “social failures” or what might be better termed “cooperation thwarters.” Market capitalism emerges as the result of human actions to thwart these thwarters without a single person or group ever deliberately planning it.

What are these thwarters? There are three major ones: externalities, “market” power and information asymmetries. At the risk of extreme oversimplification, these are merely fancy ways of saying that cooperation between men is prevented because of, or coerced because of, a lack or property rights, a lack of competition or a lack of trust.

In the case of externalities, would you call a LACK of property rights characteristic of market capitalism? Do MY actions impose costs or confer benefits on you ONLY when I engage in commercial activities? Or to put it another way, if the government banned capitalism and produced cars and chemicals and energy itself, would those plants magically stop emitting CO2 and other so called pollutants? I’d remind you that the enlightened Soviets turned the Aral Sea from the 4th largest lake in the world (about the size of West Virginia) into several spotty bodies of water that in aggregate make up 10% of its original size, now smaller than the state of Delaware.

In the case of monopoly and monopsony power, would you call a LACK of competition characteristic of market capitalism? The first entrepreneurs were by definition monopolists. The first employers the only game in town. What erodes their power? The ability to pursue profits, acquire property, and attract new customers is THE ONLY thing that can protect consumers and producers from exploitation. Indeed, what is it that enabled men to overcome the crippling grip of tradition that led men to be beholden to the church and the aristocracy for thousands of years? The state itself is the embodiment of market power. Ironically, the story of the Progressive era turns out to have been one of the government PREVENTING market competition from eroding the power of inefficient and well-connected large businesses and the story of the “Robber Barons” is overwhelmingly one of lower-prices, higher product availability and better quality products. Or to think of it another way, is the difficulty in establishing a new organization, or the possibility of “exploiting” customers or participants NOT happening within churches, athletic teams, civic groups and other organizations that have nothing to do with commercial activity?

In the case of information problems? Would you call a LACK of trust or an inability to make credible commitments characteristic of market capitalism? Once again, man in his natural state deals with nothing BUT information problems. What ensured food safety in the year 1000 BC? Was there a consumer reports in Ancient Rome?

In our pre-modern hovels, externalities are everywhere, imbalances of power are everywhere, information asymmetries are everywhere – and these are the iron fetters of human cooperation. It is competitive capitalism that emerged as the superior institution to first chisel away, and now melt away most of these shackles. Yet the institution continues to stand condemned in a trial because a few trace ounces or metal remain on our man. And it was the economists who reminded the rest of the world that these filings remained.

Two ironies are still sitting there like giant elephants in the room. It is that in each case, the CANONICAL examples used by statists to make their cases, the very best examples, turn out not to be even relevant. For example, the “textbook” illustration of how information problems destroy markets is the “used car market for lemons.” Today, there is no lemons problem, and it has nothing to do with government interventions to fix the problem. A second and perhaps more damning irony, is that if one wishes to argue that these forces cause markets to fail, the VERY SAME forces operate within governments, causing IT to fail, and with no competitive or entrepreneurial safety valve to potentially overcome it.

Shame on us.

And shame on us for not taking the moral high ground too. Competitive capitalism has eradicated poverty, reduced inequality, lengthened lives, made us trust and cooperate with strangers, and indeed has INCULCATED the very virtues that socialist man is supposed to be required to have for that system to work. And it has done so peacefully.

We economists have allowed others to win arguments from intimidation, “Only cold hearted reactionaries BELIEVE IN PURE LAISSEZ FAIRE? ONLY THE FEEBLE MINDED BELIEVE THAT THE POOR ARE BETTER OFF under capitalism?  … and so on”

When we press our accusers to justify the claims of our nuttiness, they offer a few platitudes, such as, “everybody knows that we have capitalism now, and inequality is higher, so capitalism is destructive” … or “everybody knows that a climate of deregulation led to 30 years of failed economics” … but when challenged to explain or identify what this means… CRICKETS … an illustration of intellectual impotence.

The Establishment of AHI-West

Writing in the Baltimore Evening Sun on New Year’s Eve, 1928, H.L. Mencken said:

“the great majority of American colleges are so incompetent and vicious that, in any really civilized country, they would be closed by the police.

(public schools) They are staffed by quacks and hag-ridden by fanatics. Everywhere they tend to become, not centers of enlightenment, but simply reservoirs of idiocy.  The profession mainly attracts not young men of quick minds and force of character, but flabby, feeble fellows who yearn for easy jobs.

Pedagogues are perfectly willing to teach the nonsense prescribed for them by frauds, and to invent nonsense of their own. Anything that will make their jobs secure seems good enough to inflict upon their pupils.

What you will find is a state of mind that will shock you, it is so feeble that it is scarcely a state of mind at all

After more than a century of free education at least two out of three Americans, remain completely ignorant of the veriest fundamentals of human knowledge, and are aroused to fury against them on hearing them stated.

Now, Mencken was talking largely about the damage Education PhDs have inflicted upon public high school students, but he could very well have been talking about modern colleges. Sadly, we are not in the business of improving the undergraduate experience, and even if we were it would be dedicated to making our kids better mathematical modelers.

After two years of dedicated students calling me, texting me, google-chatting me, commenting on my website, e-mailing me and visiting my office hours clamoring for a more in-depth intellectual experience, a more intimate intellectual experience, a more serious intellectual experience, and a chance to further associate themselves with other serious people, it became apparent that there was more than a critical mass of young men and women to get AHI-West off the ground.

Our current student fellows are an exceptionally committed, accomplished, and respectful group of men and women. Working with them has easily been the highlight of my professional career. Of course, we are all united in our passion for liberty and the mission of the AHI and our new organization. But what is most encouraging is that our students genuinely want to know what they know and don’t know about their views. They want to put their ideas to the test, to be confident about publicly stating the reasons why they have come to hold the views they do, to be able to share those views freely, openly and honestly, and to understand and deal with respectful criticisms and challenges to those views. We are unwavering in our commitment to intellectual consistency and honesty and welcome any and all individuals who are similarly committed. Our students are making sure they have the intellectual adventure that the glossy catalogs convinced them they would otherwise be having for a mere quarter million dollars.

Among the programming activities we have planned for next year include a series of reading groups, spearheaded by our weekly seminar on Entrepreneurship and supplemented with several short intensive studies on topics as varied as the Great Depression or the Witticisms of George Stigler. We will be hosting a series of lunchtime/dinnertime discussions with both college republicans and democrats on the economics of inequality. We will be conducting economic research on various topics, including for a series of “Economic Ideas that Dare Not Speak Their Name!” We will be hosting several film screenings and sponsoring several guest lectures/discussions debates. We are developing an “Economist in Good Standing” certification program. We are building our connections with kindred spirits at local colleges, including supporting events at their locations and working on other ways of collaborating. And we will be engaging in several outreach initiatives, one of which I’ll highlight momentarily.

We have 21 founding members, and have serious interest from over 50 additional students (and not a single one of them came to us from advertising the group). Every single one of them is academically accomplished, a good human being to boot, and many have already been recognized by others for their accomplishments. Two of our students have been selected to be part of the Koch Internship program during the summer. Several will be or have already participated in summer seminars at Clemson, FEE, Columbia, and the Mises Institute. Another one of our students has been selected to attend an exclusive Liberty Fund Seminar on the Foundations of Liberty and Society.

In particular I’d like to point out the accomplishments of three of our students.

One of our founding members is Stephen Macaskill (who is unable to be here tonight due to a prior commitment). In addition to participating in a range of AHI-West programming activities, Stephen has received national recognition from his business, Amagi Clothing. He established Amagi Clothing as an independent clothing line to promote and embrace the ideas of personal freedom and individual liberty. Earlier the year his efforts were recognized by Judge Napolitano on his Freedom Watch program, and just this past week Stephen was selected as one of three finalists for the Messenger Award given by the Sam Adams Alliance In the spirit of Paul Revere, who warned the colonists and, more importantly, knew which doors to knock on, The Messenger is a master of the media, awakening the American people to the principles and cause of liberty.

Jason Birnbaum is a current senior and will be staying on next year as the AHI-West’s Associate Director to help us get this thing off the ground. While he has a bright future in medicine ahead of him, his love for liberty and free markets compelled him to dedicate a year of his life making sure that future students will have a greater opportunity to explore these ideas than he had. Jason was engaging me in terrific discussions for two years before I ever had him in a class, and unbeknownst to him, his enthusiasm coupled with what I saw as a perfect model at the AHI convinced me that I should give up some of the other things I was doing to turn my attention to the AHI-West.

Andrew Joliet is an inspiration to all of us. He paid his own way through the University of Rochester because he did not want to burden his family and because he refused to accept a single dollar of assistance from the government for his education. He did it by establishing an extremely successful metals business, and working mornings, nights, and weekends all while his peers were having a good time. In the midst of this, Andrew has managed to enmesh himself in several local community networks, and be among the most engaged and thoughtful students a professor could ever have. But that’s not all. A year ago, Andrew decided it was time to put his economic knowledge into practice, and to share it with his passion for working with children and young adults. He established the Economic Literacy for Students Program (ELFS) which AHI-West plans on supporting even after Andrew has graduated and moved into the next stage of his life. Perhaps ironically, by working with children and young adults, Andrew and the ELFS program are of the mindset that if 6th graders are capable of understanding the verities of sex education or biological evolution, they are certainly capable of appreciating how human beings come to peacefully engage in commercial activities. He has excited students from 6th to 12th grade in several Rochester area schools as well as some in his hometown, about trade, supply and demand, money and markets.

With fantastic young people like Stephen, Jason and Andrew, and with organizations such as the AHI becoming more important each year, I am sanguine that the horse of innovation, enterprise and achievement will continue to outrun the horse of privilege, mysticism, and collectivism.

A mere 5 years after the AHI was a glimmer for Bob, Doug, Jim, Hunter and Dick it has produced its first offspring, and we are as pleased as punch that it could be us. Thank you much for your time and attention.

12 Responses to “The Problem with Economics”

  1. Harry says:

    Wow. Five gold stars.

  2. Harry says:

    The first part of your speech (not to diminish your talk about AHIW) is strikingly original to me, the way you put the question.

    In my meditative moments I have thought often about the law of the primitive waterhole, and about how come until just recently, in a few centuries, our world has become prosperous.

    You are onto a big idea, Rizzo. You have not wasted your time thinking and writing and teaching and thinking, and it is my humble wish that I can understand better the full implications of what you have expressed.

  3. chuck martel says:

    Great speech. Why Alexander Hamilton? May I recommend for a film excursion, “The Treasure of the Sierra Madre”? Walter Huston’s spiel in the flophouse in Tampico is a great presentation of the labor theory of value.

  4. Michael says:

    You’ve made my night as I’ve been reading a lot about externalities as of late and have framed the issue in a way that I’ve been thinking about lately; namely when we mention externality as a negative (usual case), do we have any true concept of all the benefits that the market provided in the first place? As you stated, without the market our situation is at best a Robinson Crusoe. I’ve been hoping to get a copy of Buchanan’s “Externality,” but it was published in 1962 and I can olny go back to 1965 (same as another paper on the topic). But I don’t think that that article would have clarified the issue any better than what you’ve written here.

  5. Z.L. says:

    Hi Prof. Rizzo,

    This excellent speech reminds me that, in response to my email about a certain student club on campus, you remarked that “people have no appreciation for how advanced our standards of living have come and from whence those improvements came.” Those words were so awakening to me that they completely changed my understanding of how our world has evolved to where it is today.

    Thank you so much for the continued enlightenment in and out of class.

  6. jb says:

    wow. I’ve been away. Great speech Mike. I am going to send the link on to others.

  7. […] basic analytical tools to students, the entire course is a course on “market failure” (see here for why that term is not helpful. In other words, we focus on what can go wrong when we rely on purely private incentives to handle […]

  8. […] basic analytical tools to students, the entire course is a course on “market failure” (see here for why that term is not helpful. In other words, we focus on what can go wrong when we rely on purely private incentives to handle […]

  9. […] basic analytical tools to students, the entire course is a course on “market failure” (see here for why that term is not helpful. In other words, we focus on what can go wrong when we rely on purely private incentives to handle […]

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