Thursday, June 9, 2011

Close Encounters With Thorstein Veblen

Perhaps I am only flattering myself, but in the latter course of writing my last series on Veblen's economic theories I felt as if I were being tag-teamed by Robert Murphy and Gary North. Murphy wrote two different pieces for on pricing in oddball market circumstances and the flaws of classical cost-based pricing theory. (Update -- he just posted another one). Gary North wrote a piece on the role of the very wealthy in the economy and the inadequacy of the desire for consumption to account for their productive efforts and the efforts of others. All of their points strike at critical economic assertions made by Veblen.

Robert Murphy's points are the most damaging to Veblen's theories, so I'll start with them first.
And the first thing that I will say is that as far as Murphy's assertions about pricing are concerned, he is correct -- classical theory is inadequate to explain many aspects of pricing behavior, and is in fact fundamentally incomplete. Carl Menger, considered one of the first economists of the Austrian school, was the first to articulate the ideas of subjective valuation and marginal utility to explain pricing, and for most purposes his theory is fully accepted as the standard of economic orthodoxy.

My critique of the use of modern pricing theory as a refutation of Veblen's position would be several fold. First, note that Murphy used two very unusual examples to illustrate situations for which classical theory fails -- the pricing of the Mona Lisa at an art auction and a farmer selling a gold-nugget meteorite that lands in his field. Neither of these situations would be expected to have significant large-scale economic ramifications, and certainly aren't generally applicable examples that would be expected to much impact, let alone order, people's lives.

But to be fair to the argument, there are economically more important situations where this logic would apply -- for example, urban real estate, where the total available land is fixed (like the supply of Mona Lisa's), and mining, where some mines have lower costs of ore extraction than others and can therefore consistently deliver higher profits. But note the defining characteristic of both cases -- a market restriction is in force, in these cases a natural restriction. The restriction creates 'surplus' profits above what is available to other producers which can be leveraged as described by Veblen for parasitic business aggression. Murphy is using exceptions that prove Veblen's rule. His slushee drink essay falls in the same category, though to such a lesser degree as to be trivial. I don't think the world is going to be taken over by slushee drink vendors.

Secondly, Veblen did not make stringent use of classical pricing theory as Marx did. His theory does not depend on it. Veblen cites Bohm-Bawerk repeatedly, so he no doubt knew full well the subjective pricing model. He did not seem concerned.

A classical pricing model only really enters the conversation because I used it as an easy way of explaining the basic idea Veblen was trying to get across. And I was mostly using it to illustrate concepts of profit -- not to explain pricing. Most people can grasp classical pricing (even though it is the wrong model to use in many cases) and it is much easier to explain and understand than subjective valuation and marginal utility. Whichever model is in operation and however prices are determined, as far as Veblen is concerned the outcome is the same. All other things being equal and however costs are to be accounted, in a comparison of two otherwise identical businesses, the business which effectively imposes a market restriction evades competitive pricing and will realize higher profitability than the one which does not. The profit differential -- and the ability to influence prices -- can be attributed to nothing other than the restriction.

All things never being equal, the result of such behavior is parasitism, economic stagnation, centralization, and an eventual unwarranted wealth accumulation by some at the expense of others and of the overall productivity of the system. Note that this is exactly the same outcome produced by restrictive economic orders like socialism, though different in degree.

As to the question of the market rendering judgment in terms of the price mechanism, I am not objecting to a price on the grounds of my subjectively perceiving it to be too high or to low. I am not qualified to render such a decision -- nobody is. That is what the market is for, and was one of the main points of the mathematical analogy in the last essay. (Which, incidentally, in hindsight was a somewhat dangerous analogy to make, as economics and finance are so often taken to be 'like math' in ways which they are not.) I object on the grounds of markets and the price mechanism being so easily subverted by pecuniary meddling and market restrictions. Any evidence of such meddling must necessarily call the legitimacy of market judgment into question, as well as the wisdom of submitting one's life and calling to its guidance or judgment. Actually, that is also one of Gary North's frequently repeated points.  If he's making exactly that point, then...isn't he also making mine?  Oh, wait... I'm still dealing with Murphy's arguments.

The important thing here is to see that a negative activity -- market restriction -- can create undue profits in a parasitic fashion -- by limiting choice and hurting other participants -- under the capitalist economic order. This situation thus encourages attempts to restrict markets, and to make use of 'natural restrictions,' in order to gain pecuniary advantage over others and thereby spread and expand existing pecuniary advantage. So long as these strategies are not effectively thwarted by other forces, they will tend to proliferate and impact economies and society in a destructive fashion.

Murphy is correct to note that 'cost pushing' cannot determine pricing because the classical model is invalid, or at least is not generally valid. However, the classical economists would not have come up with the idea if there had been nothing to it. As he said, they weren't dummies. If consumers are not willing to pay for things like solid gold roofing shingles, whatever the cost to produce them they will not be bought, so the costs don't matter. But for goods which are bought and sold in significant volume, and for which markets are competitive, prices almost invariably approach costs as profits get squeezed by competition to near zero. It works both ways, actually, as he points out. The cost of upstream goods will also increase to reduce profits as competing producers bid for raw materials. Ultimately, after all the dust has settled, it is the demand for their final use as finished goods that sets the price of raw materials. But whether by raising raw materials prices or pushing down finished goods prices, profits tend towards zero in competitive markets.

If this is the approximate case for most markets most of the time, it is arguably a more important concept to grasp even than the more accurate model of marginal effects, and more significant in terms of determining the shape of the economic order. It is under competitive markets that rational economization of resources can take place by the pricing mechanism, and real productivity can be increased. That is a basic tenet of capitalism.

It is when pricing is arbitrary and uncompetitive that things begin to go awry. Yet the standard free-market economist will argue that, in the long term, all markets are effectively competitive. Ultimately, high prices lead to competing innovations. Cartels eventually fall apart due to the greed of individual members. The problem here is that long term forces are being invoked to counteract short term phenomena. It may be true that at some point, a cheap replacement for oil will be developed. In the meantime, which could be and certainly has been a very long time already, OPEC will make a mountainous fortune by deliberately restricting the supply of oil. Vast resources will have been wasted solving a problem created by a market restriction. Immense productivity will have been suppressed to enrich Saudi sheiks.

The point being, it can take very little scheming and effort to create a restriction that takes generations for the free-market to undermine. Even if it takes much less time than that, which is admittedly most cases, so long as the marginal benefit of inserting restrictions exceeds the marginal cost as compared to actual productive activity, the economy will find itself in a state of perpetual restriction. Undermining individual cases is irrelevant so long as there is a constant stream of opportunity. Increasing economic complexity creates ever more opportunity, and ever increasing durability of a restrictive insertion. Thus, despite the validity of the claims that any such attempt at market interference will be undermined, Veblen's claim that the economy operates under the burden of a steady extractive interference to sustain a priveleged parasitic class will still hold. It is only that the mechanisms of extraction are continually being shifted about and discovering new forms. It is a steady state model, not a static model.

These facts cannot be refuted by reference to the legality of such actions, or even to voluntarism or right of property. By its very nature, law is coercion, and therefore restriction. Even basic rights to property are  restrictions of sorts. To be viable, all social orders must require participants to submit to some notions of proper conduct and behavioral limitations. The nature of the order is defined by the notions and limitations to which its participants submit. Capitalism has chosen a regime of freedom of contract and right of property, and general submission to these legal notions produces this particular outcome.

Note that I am not saying that I believe that these are wrongful legal restrictions or that anyone should abandon the capitalist legal order, only that it will eventually produce the situation Veblen describes. I do, however, think these are problems worthy of discussion and not to be dismissed with reassurances of capitalism's inherent virtue. To do so is grave error, in my opinion, and a disservice to the cause of liberty. Pretending that a problem does not actually exist looks callous to those impacted by it and tends to persuade them to reject the system in question and seek redress by other means, usually destructive means. More than that, it really is callous, and cruel.

In terms of addressing these problems, it would seem that any effective change would most certainly not be in the direction of centralization or government controls, as the resistance to such forces is precisely what makes capitalism work as well as it does, and it is restrictive processes which creates the problems in the first place. Any useful change would need to be in the opposite direction -- more freedom -- in such a way that it would address the presence of these restrictions. One would think that the 'properly applied freedom' would aleviate them. Such changes might not be legal in nature, however, I am at a loss as to what they would be.

Likewise, Gary North's claims seem to me mostly true, but again, irrelevant to the aspects of Veblen's theories that I am interested in -- though perhaps they are only intended as interesting points of discussion and nothing more. Veblen became famous for the most part because of certain claims he made which I have almost completely neglected, mainly because I am not much interested in them. He thought that the principle motive of the predatory pecuniary class was the pursuit of status. In fact, he thought the principle source of economic demand apart from the bare necessities of life was the pursuit of status among one's fellows, principally displayed through 'conspicuous' consumption and leisure, i.e. 'showing off.'

North points out that this cannot possibly be true, as one simply does not generally observe the fantastically wealthy consuming much more than even a tiny fraction of all that they possibly could --
In every social order, there is a hierarchy of wealth. At the very top of the income production system, there are people who do not have to work in order to be fed, clothed, housed, and generally kept happy by retainers who cater to his every whim. The question I ask is this: Will most of these rich people be indolent? That is, will they use their one irreplaceable resource -- time -- exclusively to consume or to "set aside for a rainy day" so as to consume later? I have never read of such a society.

In richer societies, where consumption is a matter of taste rather than survival, more people can afford to accumulate capital in order to . . . what? Not consume. For consumption costs time, and time is not replaceable. The cost of time is high for the productive masters of capital. They do not waste it in full-time orgies of consumption. They could afford to, but they don't.

Thus, in general, one should look elsewhere for their motivations. He suggests they are generally interested in ever more production, significance, and impact from their lives, as evidenced by their tendency to accumulate ever more production goods as opposed to consumption goods.

That is all fine as far as it goes, but this simple treatment does not even begin to touch the elaborate ideas Veblen had about the situation, most of which I found insanely boring and some of it incredibly stupid to boot. But as I said, for whatever reason this seems to be the aspect the thing which most others latch on to, and is probably the aspect most economists are familiar with. I do not want to go into it except to say that North's observation(s) can be perfectly true and Veblen still be correct about the matter.

The fact is that criticism of the choice of goods which consumers desire falls outside the realm of valid economics. Veblen even admits as much. Economies exist to satisfy consumer demand, whether that demand is expressed as desire for elaborate codpieces or for bibles. Although it is a mildly interesting question, I am far more interested in how people are behaving in the economy to acquire funds than how they are disposing of them. I am also far more likely to take umbrage with something I see in the former sphere than the latter.

The tendency of the wealthy to acquire production goods can in no way exonerate them from accusations of foul play in the way they go about accumulating those goods, nor does it address the existence or non-existence of a pecuniary class in the first place. Their consumer motives have no bearing on their existence or their activities, whether parasitic or not.

To the question of parasitism -- I have remarked about this before, but it surprises me the degree to which economists, who otherwise seem to have a fantastic theoretical grasp of the subject as a whole, seem to completely flub the dynamics of behavior within a corporation. One of the most important insights of the Austrian school is the danger of aggregating assumptions. But when it comes to the behavior of 'corporations,' they seem nevertheless to treat the thing as as a single aggregate of people seeking profit in the marketplace, when it should be obvious that no single person really has much individual stake in the real, long-term profitability of the company -- though admittedly a few do on paper, at least in the short term.

It seems to me much more accurate and realistic to treat the corporation as an organization composed of self-seeking individuals. And as self-seeking individuals, there is a tendency for those employed by the company to subordinate the interests of the company to each one's own -- which leads directly to a tendency towards inefficiency and parasitism. The larger the company, and the more specialized and dilute one's influence, the less responsibility one would have for the overall effort and the more the tendency would assert itself. There is so much acknowledged humor about these kinds of behaviors -- from Dilbert to Office Space, etc. -- I would think it common knowledge.

Economists assert that freedom of action and the individual possession of specialized information help a spontaneously ordered economy -- a free market -- to outperform a regimented one. It would seem, then, that a corporation that allowed employees closer to a particular situation to have discretion over decision making would outcompete a strictly regimented corporation. Yet in practice, one almost never observes such a structure. Gary North even acknowledges that real-world big-businessmen almost always tend towards the meddling control-freakish side, and if one of them would try the model of actual delegation of authority he would probably mop up the floor with the competition.

Yet almost none seems willing to use this obvious management strategy. They seem more interested in power-mongering -- status, if you will -- than the performance of the company. Which does not much surprise me, because these people are selected by way of their skill at aggressive corporate ladder-climbing. What would surprise me would be if they got to the top through relentless self-seeking, then suddenly changed personalities once they got there. But then I don't think corporations are efficient business structures, so I don't expect businessmen to act optimally.

As far as managing companies is concerned, in my experience upper management tends to be too far removed from operations to make good specific decisions about it. But that does not stop them from issuing edicts that attempt to 'improve' operations by micromanaging them but which actually snarl everything up. It is typically up to the lower level employees to protect the company's physical operations from the brunt of management's poor decision-making through, shall we say, selective implementation. Most of the really successful changes I have experienced have come from economists and engineers, usually with grudging reservation from the businessmen, who I think want to shield themselves from blame if the idea fails.

So far as I can tell, the principle contribution of businessmen is just what Veblen attributes to them -- pecuniary maneuvering. Admittedly my experience is limited, but most of what I hear higher level businessmen talking about is ways to hogtie their customers into paying inflated prices for their products, or some other such scheme to force their customers' hands, eliminate competition, or otherwise take advantage of some situation to restrict markets to their benefit. I don't see how this adds to the overall wealth of society.

Yes, they often show great skill at this, especially in navigating capital markets, and these behaviors certainly are advantageous to the firms that they work for. But I already accept that capital markets have been warped by the activities of the FED, the banking system, and various government agencies, so as far as actual economic reality is concerned they are a sham. Are a businessman's successes here advantageous because they result in a materially better world, for which the company rightfully profits? Or is it just so much account shuffling?

In the end it boils down to a "who are you going to believe? My elaborate theory or your lying eyes?"

Sorry, Gary.

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