The Role of the Economist in a Free Society: Friedman to Coase

In my previous article, I explored the intellectual engagement with controversy on the part of great thinkers in economics from Ludwig von Mises to Frank Knight. In this piece, I explore the contributions of several Nobel laureates in economics, focusing on their Nobel addresses, in consideration of the question of the role of the economist in a free society.

Friedman and Stigler

In 1946, two promising young economists, Milton Friedman and George Stigler, published a pamphlet for the Foundation for Economic Education critically examining housing policy entitled “Roofs or Ceilings.” They concluded their essay with the following:

A final note to the reader—we should like to emphasize as strongly as we can that our objectives are the same as yours: the most equitable possible distribution of the available supply of housing and the speediest possible resumption of new construction. The rise in rents that would follow the removal of rent control is not a virtue in itself. We have no desire to pay higher rents, to see others forced to pay them, or to see landlords reap windfall profits. Yet we urge the removal of rent ceilings because, in our view, any other solution of the housing problem involves still worse evils.

In framing their analysis in this way, Friedman and Stigler were following the same approach that Mises laid out.1 Treat ends as given, and critically analyze the effectiveness of chosen means to achieve those ends. But the reaction to Friedman and Stigler’s essay was telling. Intellectuals on the left either ignored or disregarded it, and intellectuals on the right condemned it as granting too much moral high ground to the egalitarian ethos. Both reactions illustrated the economist’s plight as discussed by Frank Knight in his AEA address—why is nonsense so attractive to intellectuals, rather than sense, in matters of public policy? This is especially damning when, as Mises noted in Human Action, that “economic history is a long record of government policies that failed because they were designed with a bold disregard for the laws of economics.” In other words, the stakes are high, and in the case of the housing policy being discussed by Friedman and Stigler, the consequences are dire and relatively visible.

The reactions to this episode in the two scholars’ careers are instructive. Friedman would devote more of his efforts to engaging the public, becoming one of the leading public intellectuals of the 20th century as well as a superstar in the world of elite scientific economists. Stigler—the student of Knight—would interpret the lesson differently and seek to follow the scientific strictures that follow from the criticism of economics as unscientific. He also would become a superstar in the world of the scientific elite. But he was never the public intellectual that Milton Friedman became. As he writes in a letter to Friedman in December of 1948, “if a pure scientist—one believing only demonstrated things—is asked his opinion on policy, he must decline to answer—and listen to his intellectual inferiors give advice on policy. Hence the role of the pure scientist is terribly painful to assume in economics.” This becomes Stigler’s dictum; economists can either become preachers, or they can become economists, and he believes they will have a near impossible task of being both. Thus, the correct choice to make is clear for the scholar/scientist. The economist as scientist must remain silent even when nonsense is being peddled.

Stigler may have taken this position one step too far, and in doing so lost the very means/ends analysis that is the stock in trade of economists as social critics. Insisting that one can productively infer intentions from outcomes changes the analyst’s stance as the law of unintended consequences is pushed aside, and inefficiency in the choice of means with respect to ends is denied. Whatever is, it is postulated, must be efficient because if it wasn’t, than things would already be different. So this means arguing over policy choices is arguing over values even when we pretend it isn’t. And in doing so, this means we are preaching, not analyzing.

Which then is to be preferred—a dialogue among preachers, or a deep discussion among students of civilization over the liberal principles of justice and the good society? To hark back to Knight, the intellectual agenda in the second half of the 20th century could be summarized as the effort to elaborate a new liberalism for the post-war era. Civilization had just stared down its impending demise in the 1930-1950 period with the Great Depression and World War II, and three things seemed necessary to breathe life into a new and renewed liberalism worthy of that name. First, it was vital to cultivate an appreciation for economic principles and the operation of a free market economy, as well as their limitations as guides to understanding.. The economic way of thinking had tobe practiced and taught effectively, and that begins with teaching price theory, and exposing popular fallacies. Secondly, a democratic people needed to come to recognize not just the benefits, but also the limitations of political solutions to social problems. Intelligence in democratic action can result only through open and critical dialogue—democracy is essentially government by discussion—and thus the potential for fraudulent speech and political salesmanship must be recognized as a threat to the free society, and to the acceptance of the exploratory nature of all social action. What Knight, and later James Buchanan would stress as the “relatively absolute absolute” is an essential component to any discourse about freedom and reform within a democratic society. Truth seeking in science is foundational to the enterprise, but the assertion of truth claims in politics are the path toward tyranny, and must be guarded against constantly. Finally, according to Knight, a free society requires free and responsible individuals willing to shoulder the burden of living and thinking, so a renewed liberalism must be accompanied by an independent conception of the ethics of freedom. Knight’s conundrum, as he put it, was that it was unclear that our human nature would be adaptable and resilient enough to live up to the challenge that liberation from the oppression of authoritarian rule demands.

Buchanan and Coase

That is some challenge. But it is a challenge that was picked up by others in this same tradition, such as Buchanan and Ronald Coase, and it set them apart from others who sought to pursue public policy in a more direct manner. Neither Buchanan nor Coase sought to engineer the policy environment to promote market friendly policies. They were market economists because, as Buchanan would put it famously in his “What Should Economists Do?” essay,2 they studied markets. Nothing more and nothing less. The Buchanan-Coase project was one that studied exchange relations, and the institutions within which exchange takes place.

Buchanan, beginning in 1949, represented a radical departure from the emerging consensus in the economic analysis of the public sector. Though his analysis would sharpen over the coming decades, all the basic elements of his later approach are evident already in that earlier essay on “The Pure Theory of Government Expenditure.” In particular, here Buchanan is already working with his criticism of the “fisc”, which is a mythical unified governmental planner that chooses the optimal level of taxation and expenditure to reflect the known preferences of the democratic polity and is guided by the expertise of the economists. There is simply no stable social welfare function that the planner can maximize—there is no procedure for aggregating preference, there is no omniscient and benevolent planner, and there is no teleology of the economy as a whole. The economist, Buchanan would come to stress, has no privileged position in the political discourse of a democratic society.

Modern welfare economics, Buchanan insisted, reflected a utilitarian, engineering, and elitist mentality that must be rejected if we are to make progress in the field of political economy. It evolved as it did using the omniscience assumption as a resolution to difficult questions in political economy, but that “seems wholly unacceptable.” The neoclassical social welfare economics exercise can assert that it provides the economic foundation for the good society, but it can only do so by introducing various assumptions that lead to normative theorizing parading as positive analytics. With the tools of modern welfare economics in place, the observing economist is supposedly empowered to identify those welfare-enhancing positions independent of the individual behavior of the agents within the model because the all-knowing benevolent social planner can perfectly predict what individuals would in fact choose if faced with the circumstances postulated. Optimality and efficiency are, in this exercise, defined within the confines of this specific modeling exercise.

Rather than accepting the presumption of omniscience, Buchanan sought to substitute the presumption of ignorance. The idea of presumptive efficiency does some of the work for Buchanan in this task ofchallenging the conventional wisdom. The economist who utilizes the notion of presumptive efficiency retains various features of the Paretian analysis. The observing economist makes judgments about “efficiency” and attempts to translate individual preferences to alternative social arrangements. These must be understood to be provisional statements, not precise ones. And, they are offered only as hypotheses to be tested in the arena of collective action, and not as definitive policy choices. The economist cannot recommend policy A over policy B per se because without recourse to an objective social welfare function, and without the accompanying assumptions of omniscience and benevolence there is no scientific basis for such a judgement. All policy discussions necessarily move us from the realm of the positive to that of the normative, and we only fool ourselves when we don’t recognize this explicitly in our work in the field of welfare economics. “But,” Buchanan insists, “there does exist a positive role for the economist in the formation of policy. His task is that of diagnosing social situations and presenting to the choosing individuals a set of possible changes.” Buchanan continues, “He does not recommend policy A over policy B. He presents policy A as a hypothesis subject to testing. The hypothesis is that policy A will, in fact, prove to be Pareto-optimal. The conceptual test is consensus among the members of the choosing group, not objective improvements in some measurable social aggregate.”

Two points of emphasis in designing the “test” follow from this Buchanan perspective. First, the proposed change must be accompanied by a true compensation scheme. Second, the proposed changes must be restricted to changes in the structural rules under which individuals make choices and interact with one another. Compensation is vital to this exercise because there will always be vested interests in the status quo and as a result there will be motivated reasoning in the collective decision-making process. Buchanan does not attribute any normative weight to the status quo, as we will see; it is merely the starting state from which any discussion of change must begin. In ensuring intelligence in democratic action, the discourse among reasonable parties must transform motivated reasoning into indifference, and thus allow purely rational discourse concerning the consensus to be built. The political economist’s job, in Buchanan’s rendering, “is completed when he has shown the parties concerned that there exist mutual gains ‘from trade.’ He has no function in suggesting specific contract terms within the bargaining range itself.”

Ronald Coase also challenged the conventional wisdom of welfare economics as it was formulated in the 20th century. As he argues in an essay on “Saving Economics from the Economists,”3

Government is increasingly seen as the ultimate solution to tough economic problems, from innovation to employment. Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates… it is hardly up to the task.

Coase’s own approach to the role of the economists in society follows from his interpretation of the theory of economic policy in the British classical economists. He is in that London School of Economics tradition of Edwin Cannan and Lionel Robbins, which is decidedly different from the Cambridge approach either of Alfred Marshall and Arthur Cecil Pigou, or of John Maynard Keynes and modern welfare economics. In his AER paper on “The Economics of Broadcasting and Government Policy,” Coase argued that:

I would emphasize that belief in the invisible hand does not imply that the government has no part to play in the economic system. Quite the contrary. If it is in general true that men, following their own self-interest, act in a way that is of benefit to society, it is, to quote Edwin Cannan, “because human institutions are arranged so as to compel self-interest to work in directions in which it will be beneficent.” Our task as economists is to help in the devising and improving of those institutions.

This is equivalent to Buchanan’s thinking about the important of the structural rules of the game, or as we will eventually see, Friedrich Hayek’s good gardener cultivating a vibrant garden, rather than an engineer orchestrating an economic miracle.